Ask the attorney: ‘Finder’ keepers could be losers, weepers

(Editor’s note: “Ask the Attorney” is a weekly VentureBeat feature allowing start-up owners to get answers to their legal questions. Submit yours in the comments below and look for answers in the coming weeks. Author Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs.)

Question:  We launched our company about a year ago, and we’re having trouble raising money.  I met a consultant at a conference who said he has a lot of connections and could help us raise about $500K if we paid him 6 percent.  This seems like a pretty good deal.  Are there any legal issues we need to worry about?

Answer: There are, in fact, a number of legal issues you need to worry about. – the biggest one being whether this consultant is licensed as a “broker-dealer”. If he isn’t, I strongly suggest you run the other way.

Securities laws are complex and are a potential minefield for the unwary.  Under both federal and California securities laws, a so-called “finder” (someone who holds himself out as being able to introduce companies to interested investors) must be registered with the Securities and Exchange Commission (SEC) and the California Department of Corporations if he is acting as a “broker-dealer”.

The term “broker-dealer” is a broadly defined one under both federal and California law. It includes any finder who receives some form of commission or success-based compensation (such as in your situation).  Other broker-dealer activities include making presentations to investors, participating in the negotiations between the company and the investors, structuring the transaction between the company and the investors, and/or regularly engaging in the business of finding investors for companies (as opposed to a one-off).

The bottom line is that if a finder does anything beyond merely introducing the company to potential investors, he will likely be characterized as a broker-dealer – and he’ll require registration.

You may be thinking: So what? That’s not my issue.

Wrong!  If he is not registered (which is probably the case since he’s calling himself a consultant, as opposed to an investment banker) and you pay him his 6 percent commission, your company could face the following consequences:

First, the company’s issuance of securities will be in violation of applicable securities laws, which could result in possible SEC and/or state regulatory action, including injunctive relief, fines and penalties – and possible criminal prosecution.  As I have previously discussed, in light of the Madoff affair and other external pressures, the SEC and state securities are significantly stepping-up enforcement of the securities laws.

Second, investors will be able to sue the company to unwind the sale and get their money back, plus interest.  Under California law, they also arguably would have a right to sue for damages up to $10,000.

Finally, the company’s use of an unregistered finder may adversely affect any future capital raising activities – including an initial public offering – and may subject to the company to liability for “aiding and abetting” the securities law violations of the finder.

Tread carefully and make sure you have all the facts before moving forward.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.

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