In this age of outsourcing, why not outsource the task of finding capital to grow your new business? Traditionally, it's been the job of the entrepreneur and the CEO to raise money to grow a business, so what will potential investors think if you hire someone to do this for you? Here are four tips that can help you decide whether to raise money on your own or get the help of a paid consultant.
1. Some investors will be turned off, but more will be turned on. There's a widely held myth among small-business owners that if they hire a financing broker, potential investors will think less of their business or their abilities as an entrepreneur. While some investors avoid businesses that come from brokers as a matter of policy, most don't. Savvy investors recognize that brokers play a useful role. The skills it takes to build a solid business and manage people may not be the same skills required to network among private investors and build a funding pipeline.
But keep in mind that you'll need thick skin if you decide to hire a financing broker who represents you when dealing with potential investors. There's no doubt that you'll hear some investors tell you it reflects badly on your business.
2. Be aware of licensing requirements. Securities laws require institutions and individuals who introduce entrepreneurs to potential investors to be licensed as brokers. The laws are somewhat vague, however, and there's not much case law that exists regarding how to define what constitutes incidental matchmaking and what constitutes brokerage.
As an entrepreneur, you need to tread carefully when deciding whom to hire as a broker. The vast majority of individuals who present themselves as financing consultants and/or "advisors" are not licensed brokers. They may have letters after their name like CPA or CFP, but that may not entitle them to get paid for introductions to investors--particularly if this is part of their core business. (If your accountant refers you to an investor and charges you a bit extra, there's a reasonable argument that he or she doesn't need to be licensed.) The safe route is to hire only licensed brokers, although that will undoubtedly cost you more money. But it's better to be safe than sorry, especially when it comes to your finances.
3. Negotiate favorable terms. Most established brokers will require you to pay a retainer, which can range from a few hundred to a few thousand dollars per month. As a startup or young company in search of investment, the retainer may be very difficult for you to afford. If your broker requires a retainer, I'd recommend requiring them to meet minimum performance goals, such as a minimum number of in-person introductions to investors. A good rule of thumb is $500 per introduction; therefore, a retainer of $3,000 per month would lead to six introductions. Don't agree to a retainer without performance guidelines and without cancellation provisions.
The standard form of compensation is to pay a percentage of the money raised, ranging from 3 to 10 percent. Establishing the correct percentage fee is based on several factors, including the amount of the financing needed (brokers generally get a lower percentage for larger rounds of financing), the state of the capital market (brokers take a lower percentage when capital is flowing), and the extent to which the business is ready to be financing (you'll pay a lower percentage when the fundraising package is compelling). Note that the industry standard is to pay the percentage fee net of any retainer payments. In other words, if you've already paid $10,000 in monthly retainer payments, you would subtract $10,000 from the total fee due to your broker when the money is raised.
4. Understand the conflict-of-interest ramifications before you sign any agreements. Your broker has an economic incentive to get you funded. You have an economic incentive to grow your business properly. At times, these incentives don't match. For example, your broker may refer to you to investors who are not ideal for your business or your broker may tempt you to take the first deal you're offered. A good broker will work with you to find the right investor, but it's very difficult to sort the good from the bad in the murky world of investment brokerage for small-scale companies. So how can you protect yourself? Be sure to check references and understand the conflicts of interest clearly before you sign on with any financial consultant, money finder or investment broker.
Asheesh Advani is CEO of Covestor, an online marketplace for investors. He founded CircleLending, which was acquired by Virgin.