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Why You Shouldn’t Use a Finder to Find Venture Capital

Picture of a compass (for determining direction based on magnetic North)

I recently spoke with three startup entrepreneurs who had just retained a finder to locate venture capital in exchange for an equity stake in the form of warrants (the right to purchase shares at a specified price by a specified date). They got very nervous when, after reading their agreement with the finder, I told them the business and legal reasons why retaining the finder was a bad idea:

  • The finder would start by sending nondisclosure agreements to targets – but VCs generally will not sign NDAs and are likely to think the entrepreneurs don’t know what they are doing.
  • The finder then would send an Executive Summary to each VC. But virtually no ExSum that is sent to a VC cold is read, let alone responded to.
  • Next, the finder would make follow-up calls to the VCs. But such follow-ups will be of little, if any utility. The way to get to a VC is via an introduction from someone that the VC knows and trusts. Furthermore, VCs who are interested will not want the finder’s answers to questions – they will want to talk to the entrepreneurs.
  • More fundamentally, VCs will be suspicious of, and will have little interest in engaging with, entrepreneurs who use finders. The typical VC believes that if you cannot figure out a way to be introduced by someone that the VC knows, you don’t have what it takes to build a successful business.
  • The finder’s form of warrant agreement gave him anti-dilution protection – a feature that would turn off many VCs and would make them think, again, that the entrepreneurs don’t know what they are doing.
  • The finder required that the entrepreneurs indemnify him against any claims associated with his activities, even if the claims arise from the finder’s negligence.

Finally, use of an unregistered finder can be a violation of federal or state securities laws!

A look at the finder’s website helped explain his inappropriate, counterproductive approach: He normally provided investment banking services to established companies seeking up to $100 million – a far cry from the needs of this startup.

So, while the lack of fit made this finder worse than most, the fundamental principle still remains: A finder is unlikely to help you find venture capital, and may cause you more harm than benefit.

Photo credit: Brith-Marie Warn via stock.xchng

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Financing, Startup
  1. 4/26/2012 | 7:21 pm Permalink

    These are excellent points.

    If I may add:

    People should really be aware of “advance fees” these finders usually ask for; in the form of Due Diligence, travel expense etc. This should raise a burning red flag right away. Even when they give you a written agreement that looks fairly reasonable – such as: “should the finder fail to locate funding for the project within a period of x months the fees will be returned” – Stay Away. Its very likely you will never see that money again, even after taking legal actions. It is especially true in Canada, where after a lot of paperwork you’ll still have very little luck collecting the monies owed to you post judgement.

    Always demand for references from the finder (clients, successful transactions). If they claim they can’t disclose any references due to the nature of their agreements with clients. Avoid.

    Even small things such as how they present themselves:
    – If their websites have extensive use of capital letters. It is a scam.
    – If they promise you a really good deal, its very likely that deal is too good to be true.
    – Look for spelling errors in any documents they ask you to sign. A lawyer-drafted document will most likely not have a spelling error. This mean they are using templates that might have been “acquired” from a network of other fraudsters.
    – If they have provided you with references list per your request – double check these references. It is very simple to create a website for a non-existing company and make it look legitimate with emails, telephone numbers etc. etc. Google is your very best friend: Look for news about these companies. Look for clients these companies work with. Contact them
    – Its not very expensive to conduct criminal record check, although some times you will find a clean record so this may not be the best indicator.

    While, Mr. Shultz’s excellent post mostly referred to the incompetency of finders and their strange requests as there are plenty of those, there is also an ocean of fraudsters out there that will not only hold you from looking into real leads but may also take your money and disappear.

    Stay sharp, be cautious and diligent in order to outsmart them.

    Good luck to you all folks :)