Many businesses, including startup companies and real estate funds, are tempted to employ individuals and companies to aid in the fundraising process. These individuals or companies are typically called “finders” and their role is to aid in the capital raising process. Finders are often compensated using the following structure:
A finder introduces the issuer to someone that invests $100,000 into the company, and the finder gets a commission of 2% of the $100,000 raised ($2,000).
The type of compensation structure laid out above to an unregistered finder is not compliant with SEC regulations and would subject the finder and the company employing the finder to penalties, enforcement proceedings, and rescission of the money raised by this action.
A broker is defined as “Any person engaged in the business of effecting transactions in securities for the accounts of others.”
The following factors are typical of broker activity on behalf of a finder where the finder should be registered as a broker-dealer:
- Participates in discussions and negotiations between the issuer and the potential investors;
- Assists in structuring the transactions;
- Receives transaction-based compensation (a commission) or some form of compensation that is correlated to the size of the investment brought in
- Assists in the sale of securities by sending private placement memoranda, subscription documents, and due diligence materials to potential investors.
The SEC weighs the factors based on the facts, but transaction based compensation is one factor that almost certainly will trigger a broker-dealer finding from them. The SEC has stated that “the federal securities laws require that an individual who solicits investments in return for transaction based compensation be registered as a broker.”
How A Finder can comply with the SEC regulations and no-action letters
If Finders introduce investors to issuers without further involvement or discussion and without giving advice on the investment’s structure or stability, and receives compensation for making introductions, regardless of if the introduction was successful (i.e. not a commission), they do not need to be registered as a broker-dealer.
Though this limitation is not ideal, companies and issuers can still come up with creative ways of compensating a finder, so long as the compensation is not tied to the amount of money the finder raises. Flat fees can be paid at various times spaced apart, to see how well the finder does; the finder can be compensated with both fees and stock options that vest over a period of time, etc. Whatever mechanism you come up with, just keep in mind that if the finder’s fees are based on the amount of money they bring in, that needs to be avoided.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.