Be careful when using “finders” to raise capital for your startup company

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:

  1. Participates in discussions and negotiations between the issuer and the potential investors;
  2. Assists in structuring the transactions;
  3. Receives transaction-based compensation (a commission) or some form of compensation that is correlated to the size of the investment brought in
  4. 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.

Should I use 506(b) or 506(c) to raise seed capital for my startup company?

Startup companies that need to raise seed capital ($100,000-$2,000,000 approximately) should consider either a Title II Regulation D 506(b) or 506(c) private offering, which each have far less regulatory and filing requirements than other fundraising regulations like Regulation CF and Regulation A+.

The choice between doing a 506(b) or 506(c) private offering is up to the company, and should be determined before soliciting investors about the securities offering. Below is a brief summary of the two types of offerings, as well as the benefits and setbacks of each.


Regulation D of the 1933 Securities Exchange Act lays out the regulations for a 506(b) private offering. A company doing a 506(b) offering is exempt from registering the securities with the SEC. The only filing that must be made with the SEC is a Form D (and subsequent amendments), and possibly similar filings under blue-sky laws depending on where your investors reside. The company can sell its securities to an unlimited number of accredited investors (annual income of at least $200,000 or net worth exceeding $1 million) and up to 35 non-accredited, sophisticated, investors (though companies probably should stick to accredited investors as “sophisticated” is up for interpretation). The company needs to have a “reasonable belief” that its investors are accredited, which is typically accomplished by having the investor fill  out a questionnaire displaying how they believe that they are accredited.

The downside of 506(b) is that the company is unable to “generally solicit” its securities offering, meaning that it cannot advertise that is attempting to raise money, orally, in print, online, or in any other form, to the general public. For any investors that end up investing into the company, the company (really meaning its founders, employees or agents) must be able to prove that it had a “pre-existing, substantive business relationship” with the investor.


The SEC added 506(c) to Regulation D in 2013 which says that companies can only sell securities to accredited investors, unlike 506(b). However, the more important difference between 506(b) and 506(c) is that under 506(c) a company can generally solicit its sale of securities, either in print, radio, email, or other means. The caveat with general solicitation is that any accredited investor that does invest needs to have an independent accountant or attorney verify that the investor is accredited by reviewing the investor’s tax returns, financial statements, and any other documents that go to show the investors financial status.

Choosing which regulation is right for you

506(c) opens up the investor pool for a startup company to anyone that it can reach via its marketing campaign, while 506(b) is limited to who the founders have in their contact list.

When considering which regulation to use for your offering, consider this:

A company should have a private placement memorandum for investors to review and sign, as well as a shareholder agreement, and other relevant documents that a shareholder would need to review (like company bylaws).

Adding more paperwork slows down the fundraising process, possibly gives the investor more time to back out, or the investor may not feel comfortable disclosing their financial information to a third-party.

A business decision should be made concerning the actual process of onboarding an investor, and what an investors preference might be. If a company has a few “family and friend” investors that are going to invest, but it wants to generally solicit to find the remaining investors, the company should first find out what the family and friend investors are comfortable disclosing, as this can dictate how the company can proceed in attracting more investors.

A company can always switch from a 506(b) to a 506(c) offering, but it can’t do the reverse if it has already advertised that it is raising money. Therefore, this decision should be made early on. Founders with a good network might be safer sticking with a 506(b) offering, while founders that don’t have a private network of accredited acquaintances may choose to do a 506(c) offering, but the business considerations of the process should be considered just as much as the legal process.

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.