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.
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.