What do I need to know about paying someone to help me find investors?
Takeaway: If you are going to pay someone to help you find investors, they need to be a broker-dealer that has registered with the SEC. If they are not a registered broker-dealer, the company could be fined and the SEC could unwind any deals the person helped broker.
For many startups, raising capital is a critical component of their growth strategy. While some founders have extensive networks and can tap into potential investors, others may consider paying someone to help them find investors. However, this approach comes with potential risks and regulatory requirements that must be considered. In this post, we will explore the broker-dealer regulations and the implications of violating these rules when paying someone to help find investors for your startup.
Broker-Dealer Regulations
In the United States, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) oversee the activities of broker-dealers – individuals or firms engaged in the business of buying and selling securities on behalf of clients or for their own accounts. To engage in such activities, broker-dealers must be registered with the SEC and be members of FINRA.
Under the federal securities laws, anyone who receives compensation for assisting with the sale of securities must be registered as a broker-dealer. This includes individuals or firms that help startups find investors in exchange for a fee, typically a commission or percentage of the capital raised.
The Risks of Violating Broker-Dealer Regulations
If a startup engages an unregistered individual or firm to help find investors, both parties may face potential legal and financial consequences. Some of the risks associated with violating broker-dealer regulations include:
Rescission Rights: If an unregistered broker-dealer is involved in a securities transaction, the investors may have the right to rescind the transaction, meaning they can demand the return of their investment, plus interest.
Fines and Penalties: Both the unregistered broker-dealer and the startup may face fines and penalties imposed by the SEC and FINRA for violating securities laws.
Loss of Credibility: Being associated with an unregistered broker-dealer can damage a startup's reputation, making it more challenging to attract future investors and customers.
Legal Liability: The startup and its founders may be held personally liable for any legal issues arising from engaging an unregistered broker-dealer.
Navigating Broker-Dealer Regulations for Startups
To mitigate the risks associated with paying someone to help find investors, startups should consider the following:
Verify Registration: Before engaging anyone to help find investors, startups should verify that the individual or firm is registered as a broker-dealer with the SEC and is a member of FINRA. This can be done through the BrokerCheck tool on FINRA's website.
Use Alternative Methods: Instead of engaging a broker-dealer, startups can consider alternative methods for finding investors, such as networking events, startup incubators, and accelerators, or crowdfunding platforms.
Consult Legal Counsel: Startups should consult with experienced legal counsel to ensure compliance with securities laws and regulations, including broker-dealer requirements.
Understand the Scope of Services: When engaging a registered broker-dealer, startups should clearly understand the scope of services provided and the associated fees to avoid any potential conflicts or misunderstandings.
Conclusion
While paying someone to help find investors for your startup may seem like an attractive option, it is essential to understand and comply with broker-dealer regulations to avoid potential legal and financial risks. By verifying the registration status of potential broker-dealers, considering alternative methods for finding investors, and consulting with legal counsel, startups can navigate the fundraising process more effectively and protect their interests in the long run.