The Pitfalls of Paying for Investor Introductions

They may call themselves brokers, consultants, or facilitators. They say they know angels or VCs who are eager to invest in your company. In today’s challenging fundraising climate, it can be tempting to listen to their pitches. But before you do, be aware that paying someone to contact investors on your behalf can be hazardous to your company’s long-term health.

As someone who does commercial transactions for startups and small businesses, I’m sometimes asked to prepare a contract for one of these intermediaries. Some founders think of this arrangement as similar to engaging a marketer or business coach. Unfortunately, hiring someone to contact investors on your behalf has larger implications.

What could possibly go wrong?

From a legal perspective, if someone is selling shares of your company to the public, they usually need to be licensed as a broker. This applies whether they’re selling stock in a corporation or membership interests in an LLC. If someone acts like a broker but is not licensed, any deals they make for you could be invalidated, giving your investor the option to back out – and obligating you to refund their money. In some cases, you could even face regulatory consequences.

Many of these would-be dealmakers lack the in-depth industry knowledge needed to effectively match your business with potential investors. They may have a long contact list, but without a deep understanding of your industry, their efforts may fall short. In addition, they often lack a track record of making successful introductions, let alone structuring deals that benefit the companies they represent.

Paid “finders” may not negotiate on your behalf or even do diligence on whoever is providing the money. Without a carefully drafted financing agreement, you may encounter problems when you try to raise more money or sell your company. An intermediary may accept a less-than-optimal offer due to a lack of financial, industry, or legal knowledge. This can cost you significant amounts of money due to dilution, giving away too much control, or other subpar terms.

Despite these uncertain outcomes, working with intermediaries often comes at a significant cost. Hefty fees and/or commissions can apply to their services, immediately reducing the funds available to your company. For example, here are some proposals I’ve seen from self-described “connectors”:

  • A flat fee before starting work. Some “finders” claim, “That’s what it will take to open up my contacts list.” However, a demand for an up-front payment requirement does not suggest confidence in their ability to get results.
  • An ongoing consulting fee. Again, the incentives are not aligned; a consultant gets paid for effort rather than solutions.
  • A commission on a financing deal that closes. This gives the intermediary a stake, but also encourages them to finalize an agreement quickly, rather than pushing for terms that benefit your company.
  • A combination fee. This typically includes a recurring flat fee to work on contacting potential investors, plus a “success fee” for an introduction that yields funding. This may be the best of both worlds for the “finder,” but can be an expensive proposition for your company.
  • Why the best introductions are the ones you make yourself

    While bona fide brokers can provide valuable services, it’s important to recognize that they are most useful for more mature businesses, especially those looking to sell to a new owner. Startups and small businesses seeking investment typically have a shorter history with less revenue, and need to demonstrate potential to investors. The best way to do this is by being your own advocate.

    Instead of relying on paid intermediaries, take the initiative to build your own relationships with investors. It’s still the case that networking at industry events, reaching out to potential investors directly, and leveraging your existing contacts can all help secure funding without the need for paid facilitators.

    Consider, also, whether fundraising is really the best course of action for your business. Investing in sales and marketing strategies that allow you to grow without external funding can make your business more attractive to investors at all stages.

    In the words of expert startup lawyer Jose Ancer, “Nothing says ‘I can’t hustle’ like a paid introduction.” So don’t let a vision of quick and easy cash lead you to rely on paid “finders.” Save your money, do your own outreach, and make genuine connections with the investors who can take your company to the next level.