“Ask the Attorney” – Beware of Finders

by Scott Edward Walker on February 24th, 2010


This post is part of my weekly “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”

I have two goals here: (i) to encourage entrepreneurs to ask law-related questions regardless of how basic they may be; and (ii) to provide helpful responses in plain English (as opposed to legalese).  Please give me your feedback in the comments section.  Many thanks, Scott


We launched our company about a year ago, and we’re having trouble raising money.  I met a consultant at a conference who said he has a lot of connections and could help us raise about $500K if we paid him 6%.  This seems like a pretty good deal.  Are there any legal issues we need to worry about?


Yes, there are number of legal issues you need to worry about — and the one that jumps out front and center is whether the consultant is licensed as a “broker-dealer”; if he isn’t, I strongly suggest that you run the other way, as discussed below.

The securities laws are complex and are a potential minefield for the unwary.  Under both federal and California securities laws, a so-called “finder” – i.e., someone who holds himself out as being able to introduce companies to interested investors – must be registered with the Securities and Exchange Commission (SEC) and the California Department of Corporations if he is acting as a “broker-dealer”.

The term “broker-dealer” is very broadly defined under both federal and California law and includes any finder who receives some form of commission or success-based compensation (such as in your situation).  Other broker-dealer activities include making presentations to investors, participating in the negotiations between the company and the investors, structuring the transaction between the company and the investors, and/or regularly engaging in the business of finding investors for companies (as opposed to a one-off).

The bottom line is that if a finder does anything beyond merely introducing the company to potential investors, he will likely be characterized as a broker-dealer requiring registration.

You may be thinking, so what – not my issue.  Wrong!  If he is not registered (which is probably the case since he’s calling himself a consultant, as opposed to an investment banker) and you pay him his 6% commission, the company faces the following consequences:

First, the company’s issuance of securities will be in violation of applicable securities laws, which could result in possible SEC and/or state regulatory action, including injunctive relief, fines and penalties, and possible criminal prosecution.  Indeed, as I have previously discussed, in light of the Madoff affair and other external pressures, the SEC and state securities are significantly stepping-up enforcement of the securities laws.

Second, investors will be able to sue the company to rescind the transaction – i.e., to unwind the sale and get their money back, plus interest.  Under California law, they also arguably would have a right to sue for damages up to $10,000.

Finally, the company’s use of an unregistered finder may adversely affect any future capital raising activities, including an initial public offering, and may subject to the company to liability for “aiding and abetting” the securities law violations of the finder. 


I hope the foregoing is helpful.  I, of course, understand that this is a tough environment for entrepreneurs to raise capital – and adding one more hurdle (i.e., avoiding unregistered finders) makes the fundraising process even more difficult.  That being said, it is foolhardy for entrepreneurs not to comply with applicable securities laws.  Indeed, my firm is representing several clients who did not and now regret it.   If you would like to learn more about the five common mistakes entrepreneurs make in raising capital, you can check out my post here.

Tags: , , , , , ,

Comments are closed.