Think It's Found Money? Better Do It Right When Raising Investment Capital

When a business needs to raise money it may consider hiring a 'finder,' which is normally a consultant who helps the company find investors in the business. The company should proceed with caution in retaining a finder due to the regulated nature of its business, and there are several 'market' terms in a written Finder's Fee Agreement that the company should insist upon.

Generally, a 'finder' or 'placement agent' receives a 'finder's fee' depending upon the amount of capital it introduces to the company. The Securities and Exchange Commission ('SEC') has long regulated this practice and, depending upon a facts and circumstances test (known as the 'Issuer Exemption'), requires finders to be registered as broker-dealers under '15(a)(1) of the Securities Exchange Act of 1934. The factors the SEC considers for a finder to fall under the Issuer Exemption include:

• Whether the finder is an employee or independent contractor of the company;
• Will the finder's compensation be linked to the amount of securities sold or is it a fixed compensation;
• Does the finder devote a substantial portion of his or her time to rendering services for the company that are not related to the sale of securities;
• Does the finder intend to remain with the company after completion of the offering; and
• In the past, has the finder participated, or will the finder in the future participate, in other offerings by this or other companies?

The rationale for exempting finders from registration is that the finder is not a broker because he or she is not 'effecting' transactions for others. That is, the finder's activities are limited to identifying potential investors and introducing them to the company. The negotiation of the investment terms, the theory goes, is strictly between the company and the investor.

More likely than not, however, the 'finder' answers at least some of the foregoing questions in a manner requiring registration as a broker-dealer. What does this mean to the issuing company that hires an unregistered finder? It could mean that its exemption from registration of the offering is blown, and the company is in violation of federal and state securities laws. It could also mean that the company is not allowed to accept the investments by the investors identified by the unregistered broker. In any case, it could mean that state and federal securities regulatory agencies are investigating the business and affairs of the company, which could be quite uncomfortable for even the cleanest of businesses.

Accordingly, I recommend that a carefully drafted Finder's Fee Agreement be negotiated with the finder prior to the commencement of any services on behalf of the company. The typical Finder's Fee Agreement includes provisions related to the services to be rendered on behalf of the company and the compensation due to the finder. I recommend the following additional provisions that will protect the issuing company:

Services to Be Performed

Clearly establish that the finder's obligations are to introduce the company to prospective investors by setting up face-to-face meetings. The finder has no authority to participate in any negotiations or discussions regarding the terms of the investment or to bind the company in any way. Ultimately, it is important for the company to retain, in its absolute discretion, the right to accept or reject any investor, and to decline to accept an investment from any prospective investor, identified by the finder.

Compensation

Ideally, the finder's fee would not be linked to the amount of capital raised by virtue of the finder's introductions. Since the Issuer Exemption test is of all of the relevant facts and circumstances, a 3% to 5% success fee, plus the finder's reasonable expenses, will probably not, in itself, require broker registration. It should be stated in the agreement that the finder's fee will not be deemed to be a brokerage fee or commission and will be compensation only for the act of introducing the company to prospective investors.

It is important to recognize that, in most cases, the finder's compensation will be tied to the amount of funding he or she secures for the company. The finder's interests are, therefore, different from the company's. The finder could put real pressure on the company to accept terms of an investment that are not favorable to the company with the hopes that the finder receives its compensation at any price despite the ill-effects on the company.

Investors

If there are funding sources that the company has already identified, they should be explicitly excluded from the potential investors so that the finder cannot lay claim to having introduced the company to them. Also, only 'accredited investors' should be considered as prospective investors.

Restrictive Covenants

'Confidentiality' and 'Non-Solicitation' provisions are key to protect the business secrets of the company, including its trade secrets and its employees and subcontractors. After all, the finder may be given valuable access to the company's business and personnel, which the company wants to protect from its competitors.

Representations, Warranties, and Covenants

The finder should represent and warrant to the company that: a) it has no conflicts of interests in the performance of the services under the agreement, b) it has and will maintain all of the required permits or licenses to perform the services (remember the broker-dealer registration discussion above), c) it has not been the subject of any investigation or proceeding brought by any state or federal agency having jurisdiction over the purchase or sale of securities, and d) in the case of an 'entity finder' (as opposed to an individual finder), a certain identified person within the entity will be responsible for the proper performance of the services. The finder should be prepared to indemnify the Company for breaches of these representations and other obligations.

Term and Termination

The agreement should be terminable within a reasonable time, and immediately in the event of a material breach by either party. The finder will want a 'tail' on investments that the company receives based on introductions it made prior to termination of the agreement. Typically, six to 12 months is customary.

Boilerplate

Although provisions such as anti-assignment, survival, integration, and choice of law/venue may seem unimportant, these are critical to protecting the business. That is, you want to make sure: a) the finder you hire will perform the services, not a substitute (anti-assignment), b) the representations, warranties, obligations, and restrictive covenants survive termination of the agreement so that if you later discover a breach, you still have recourse (survival), c) that there are no other 'side agreements' (integration), and d) that you can sue the finder (or be sued) on your home turf, not theirs (venue; choice of law).

Conclusion

Finders can provide valuable services on behalf of a company seeking funding since they may have access to investors that would not otherwise be known to the company. The terms of their involvement on behalf of the company are critical. Since a lot of investment capital is at stake, the company should take the time to make sure the investments are done properly and not place the company in undue jeopardy.

Adam J. August is an attorney in the McLean, VA office of Holland & Knight LLP (www.hklaw.com). He practices law in the areas of securities and financing transactions, mergers and acquisitions, and other business transactions. He can be reached at [email protected] or 703-720-8059.

When a business needs to raise money it may consider hiring a 'finder,' which is normally a consultant who helps the company find investors in the business. The company should proceed with caution in retaining a finder due to the regulated nature of its business, and there are several 'market' terms in a written Finder's Fee Agreement that the company should insist upon.

Generally, a 'finder' or 'placement agent' receives a 'finder's fee' depending upon the amount of capital it introduces to the company. The Securities and Exchange Commission ('SEC') has long regulated this practice and, depending upon a facts and circumstances test (known as the 'Issuer Exemption'), requires finders to be registered as broker-dealers under '15(a)(1) of the Securities Exchange Act of 1934. The factors the SEC considers for a finder to fall under the Issuer Exemption include:

• Whether the finder is an employee or independent contractor of the company;
• Will the finder's compensation be linked to the amount of securities sold or is it a fixed compensation;
• Does the finder devote a substantial portion of his or her time to rendering services for the company that are not related to the sale of securities;
• Does the finder intend to remain with the company after completion of the offering; and
• In the past, has the finder participated, or will the finder in the future participate, in other offerings by this or other companies?

The rationale for exempting finders from registration is that the finder is not a broker because he or she is not 'effecting' transactions for others. That is, the finder's activities are limited to identifying potential investors and introducing them to the company. The negotiation of the investment terms, the theory goes, is strictly between the company and the investor.

More likely than not, however, the 'finder' answers at least some of the foregoing questions in a manner requiring registration as a broker-dealer. What does this mean to the issuing company that hires an unregistered finder? It could mean that its exemption from registration of the offering is blown, and the company is in violation of federal and state securities laws. It could also mean that the company is not allowed to accept the investments by the investors identified by the unregistered broker. In any case, it could mean that state and federal securities regulatory agencies are investigating the business and affairs of the company, which could be quite uncomfortable for even the cleanest of businesses.

Accordingly, I recommend that a carefully drafted Finder's Fee Agreement be negotiated with the finder prior to the commencement of any services on behalf of the company. The typical Finder's Fee Agreement includes provisions related to the services to be rendered on behalf of the company and the compensation due to the finder. I recommend the following additional provisions that will protect the issuing company:

Services to Be Performed

Clearly establish that the finder's obligations are to introduce the company to prospective investors by setting up face-to-face meetings. The finder has no authority to participate in any negotiations or discussions regarding the terms of the investment or to bind the company in any way. Ultimately, it is important for the company to retain, in its absolute discretion, the right to accept or reject any investor, and to decline to accept an investment from any prospective investor, identified by the finder.

Compensation

Ideally, the finder's fee would not be linked to the amount of capital raised by virtue of the finder's introductions. Since the Issuer Exemption test is of all of the relevant facts and circumstances, a 3% to 5% success fee, plus the finder's reasonable expenses, will probably not, in itself, require broker registration. It should be stated in the agreement that the finder's fee will not be deemed to be a brokerage fee or commission and will be compensation only for the act of introducing the company to prospective investors.

It is important to recognize that, in most cases, the finder's compensation will be tied to the amount of funding he or she secures for the company. The finder's interests are, therefore, different from the company's. The finder could put real pressure on the company to accept terms of an investment that are not favorable to the company with the hopes that the finder receives its compensation at any price despite the ill-effects on the company.

Investors

If there are funding sources that the company has already identified, they should be explicitly excluded from the potential investors so that the finder cannot lay claim to having introduced the company to them. Also, only 'accredited investors' should be considered as prospective investors.

Restrictive Covenants

'Confidentiality' and 'Non-Solicitation' provisions are key to protect the business secrets of the company, including its trade secrets and its employees and subcontractors. After all, the finder may be given valuable access to the company's business and personnel, which the company wants to protect from its competitors.

Representations, Warranties, and Covenants

The finder should represent and warrant to the company that: a) it has no conflicts of interests in the performance of the services under the agreement, b) it has and will maintain all of the required permits or licenses to perform the services (remember the broker-dealer registration discussion above), c) it has not been the subject of any investigation or proceeding brought by any state or federal agency having jurisdiction over the purchase or sale of securities, and d) in the case of an 'entity finder' (as opposed to an individual finder), a certain identified person within the entity will be responsible for the proper performance of the services. The finder should be prepared to indemnify the Company for breaches of these representations and other obligations.

Term and Termination

The agreement should be terminable within a reasonable time, and immediately in the event of a material breach by either party. The finder will want a 'tail' on investments that the company receives based on introductions it made prior to termination of the agreement. Typically, six to 12 months is customary.

Boilerplate

Although provisions such as anti-assignment, survival, integration, and choice of law/venue may seem unimportant, these are critical to protecting the business. That is, you want to make sure: a) the finder you hire will perform the services, not a substitute (anti-assignment), b) the representations, warranties, obligations, and restrictive covenants survive termination of the agreement so that if you later discover a breach, you still have recourse (survival), c) that there are no other 'side agreements' (integration), and d) that you can sue the finder (or be sued) on your home turf, not theirs (venue; choice of law).

Conclusion

Finders can provide valuable services on behalf of a company seeking funding since they may have access to investors that would not otherwise be known to the company. The terms of their involvement on behalf of the company are critical. Since a lot of investment capital is at stake, the company should take the time to make sure the investments are done properly and not place the company in undue jeopardy.

Adam J. August is an attorney in the McLean, VA office of Holland & Knight LLP (www.hklaw.com). He practices law in the areas of securities and financing transactions, mergers and acquisitions, and other business transactions. He can be reached at [email protected] or 703-720-8059.