Most startups are still raising some early-stage capital from friends, family and business associates. They are downloading a variety of useful templates for private placement memorandum, subscription agreements and other key offering documents. They may be learning everything they need to know about EDGAR’s Form D and about state notice filings.
By the bye, all of them face two challenges.
The first is how to identify and implement the optimal one or two exemptions for their offering, typically Reg CF, Reg A+, Reg D, Reg S or Rule 144A.
The second is positing and justifying a valuation of the shares.
To address these questions, some issuers are finding welcoming incubators or accelerators. Others are finding some success with online funding platforms. Others have lucked into one or more deep-pocketed angel investors. But the great majority find themselves working with broker-dealers or funding consultants. Embryonic issuers usually engage a funding consultant with JOBS Act experience. Issuers with an operating history, signature technology or other signal market advantage have traditionally been able to retain the good offices of a FINRA-licensed broker-dealer.
What’s the difference?
The responsibilities of broker-dealers are the same as those of funding consultants, but most broker-dealers can deliver on a much larger scale. Funding consultants and broker-dealers both act as agents when they serve as a face for the issuer with investors. Both can negotiate terms but cannot agree to terms without authorization. Neither owe fiduciary duties to the client-issuer and their acts and omissions are not necessarily driven by its best interests. Neither characteristically work in long-term alignment with the issuer.
Broker-dealers always ask for and receive a success fee. Funding consultants sometimes ask for and sometimes receive a finder’s fee. Success fees and finders’ fees are the same thing. The difference is that an issuer may have to lawyer-up to avoid problems if it pays finders’ fees.
Why use a broker-dealer?
Available resources, for starters. An individual advisor is most often a one-person show. A broker-dealer is typically an organization that can bring to the table a team of people, a wider breadth of institutional knowledge and a greater depth of financial market expertise. A broker-dealer’s strong reputation can add needed credibility and confirm the issuer’s upbeat narrative. It should signal that at least some due diligence has happened. Broker-dealers maintain regular contact with their investors and get their phone calls returned. A broker-dealer may possess invaluable institutional knowledge about a particular issuer’s industry. Some broker-dealers offer administration help for time-consuming back-0fice chores.
A broker-dealer’s engagement letter may include a post-engagement success fee for investor capital brought in by others. Some engagements include a right of first refusal to represent the issuer on any future offerings. Equity compensation can also be a part of the equation, in the form of warrants or options to buy the issuer’s shares on the same terms, or at a slight premium, for a period of years.
Why use a funding consultant?
A qualified funding consultant should be able to advise on the optimal exempt offering business models, help establish and defend a range of valuations, draft or edit professional-looking offering documents and assist with closings. Costs are visible in real time and they can be capped by a stipulated number of hours or some other measure. Smaller issuers frequently rely on fundraising advisors to help with non-fundraising tasks.
Why avoid funding consultants?
The major biggest drawback is the retainer or upfront cost. Consultants are more expensive than employees. There is no guarantee of results and there is no refund. There can be unproductive onboarding time.
Given their druthers, both accredited and non-accredited investors prefer disintermediation in JOBS Act transactions, consistent with the intentions of the authors of the Act. They want issuers to forego broker-dealers as much as practicable mostly because of the percentage of proceeds that comes off the top. Separately, principals can usually sell their service or product with more sincerity than third-parties known by prospective investors to be working for a commission.