Traps for the Unwary: Finders and Small Biz Investment

April 17, 2013

pic-money-investUnfortunately, operating a business in America today involves navigating a legal minefield. Unexpected legal liability or expensive litigation can ensnare businesses that do know the law. And the law can be absurdly complex and counter-intuitive. In NSBA’s new “Traps for the Unwary” series, we aim to offer insight on a wide variety of subjects including labor, employment, occupational safety, tax, employee benefits, securities, business entity, intellectual property, immigration, federal contracting, contract and tort law. This series should not be construed as legal advice.

If you raise money from investors, you need to understand the current state of the law (or lack thereof) regarding “finders” (or “private placement brokers”) and the potential consequences of using them.

A finder is a person that helps you raise money from investors, usually in exchange for a fee specified as a percentage of the money raised.  A finder can be: a business colleague down the street that you informally offer a percentage of money raised in exchange for introductions to investors that actually invest; someone in the business of helping you find investors; or someone who helps companies to find investors as a side-line to another ancillary business. Finders remain commonplace but they are very much under a regulatory cloud.

In 2000, the Securities and Exchange Commission (SEC) yanked all of the guidance saying finders were often okay and various SEC officials gave a series speeches saying they would pursue finders as unregistered broker-dealers.  It is, of course, very expensive to register as a broker-dealer.  The SEC specifically attacked those finders that only take a fee if they succeed in helping the business raise money because those are “transaction-based fees.” These finders are, of course, the finders that most businesses preferred to deal with.

The SEC view of who is and is not a broker-dealer is ridiculously broad.  If you took their verbiage literally, just about everyone involved in your company (including your lawyer, accountant, any consultants and probably your bookkeeper) would be required to register as a broker-dealer.  The case law does not support a reading of the securities laws’ broker-dealer registration requirement that is as expansive as the SEC would prefer.  On the other hand, you really don’t want to become entangled in securities litigation with the SEC or disgruntled investors over finders. The one thing that is very clear is that the state of the law is very unclear. The SEC is the reason.

Nevertheless, the fact that the SEC has targeted finders in principle, if not all that much in practice, makes people nervous.  Most importantly, it makes sophisticated investors nervous — the kind of investors that may provide your company with the mezzanine financing necessary to grow and potentially go public.  In fact, companies that have used success fee based finders may find it difficult to go public in the current environment because the underwriters will not want to be involved with a company that used “unregistered broker-dealers” to raise capital.

There has been a serious effort to get the SEC to act to clarify these rules and establish a reasonable regulatory environment that does not shut finders down.  These efforts have been largely ignored by the SEC.  Some states (e.g. Texas) have adopted statutes regulating finders without requiring them to register as broker-dealers.  That, of course, does not necessarily solve the federal problem.

The bottom line is this.  Using finders may help you find capital that you desperately need or very much want.  But using finders may make it very difficult for you to raise money from more sophisticated investors because of the legal risk that using them entails.  And if you have aspirations of going public, using finders may make that very difficult.

Finders can play an important role in helping small businesses raise the capital that they need. NSBA is working to create a safe-harbor so finders that only do a relatively small number of relatively small deals and business brokers are exempt from the broker-dealer registration requirements.  But it will be some time until that occurs.  Meanwhile, you need to be aware of the risks of using finders.

To read the SEC take on who must register as a broker-dealer, click here.  You will notice that this document is full of words like “may need to,” “less clear” and “depending.”

Please click here to read Traps for the Unwary #1: Arrest Records & Employment.

Please click here to read Traps for the Unwary #2: Social Media Policies.

Please click here to read Traps for the Unwary #3: Selling Stock in your Company.

Please click here  to read Traps for the Unwary #4: Preserving Limited Liability.

Please click here to read Traps for the Unwary #5: Credit, Consumer Reports & Hiring.

Please click here to read Traps for the Unwary #6: Employee Non-Compete Agreements.


For questions, please contact NSBA General Counsel David R. Burton at


NSBA cannot give legal advice with respect to specific situations.