So, you realized that “equity and capital” fundraising consultants tend to charge WAY less than almost any broker-dealer you could find (the industry average is around 1-4%) but they won’t take a percentage, and they request substantial upfront payment without any guarantee.
If you’re thinking, “Why can’t I just give them a piece of the pie? It’s better money for them, and I can pay if we close; no strings attached. Everyone wins!” Then you’re not alone.
For the finance nerds that find their way here:
Fundraising consultants in equity, debt, real estate, and other securitized spaces can’t do it, ethically, at least for transactions in the United States or transactions involving US-based investors, FINRA member firms, or US-based fiduciaries.
For those not immersed in the depths of finance jargon:
Simply put any form of contingency-based payment, commission, finder’s fee, success fee, cut, “slice”, referral bonus, or other names for a “piece of the pie” is off the limits for fundraising consultants—save for those with valid FINRA membership and the corresponding FINRA Series License(s).
If you are caught taking that piece of the pie by FINRA or the SEC, they will (likely) make an example of you. Securities don’t just mean tokenized assets, equity, or derivatives. Debt-based funding rounds are still considered securities in many cases—debt is MORE LIKELY to be considered a security if the term of the loan or note exceeds five years, further increasing at the ten-year note mark.
Who Determines What Makes It a “Piece of the Pie?”
Ultimately, the Securities and Exchange Commission (SEC) and FINancial Regulatory Authority (FINRA) work together to make these determinations. For a simple litmus test, your consultant may be at risk of taking a piece of the pie if:
- They don’t have a stable, realistic cost basis for your efforts other than a percentage of the transaction.
- They only get paid if the funding reaches a certain milestone or closes successfully.
- This is commonly referred to as “Contingency Basis”
- They only get paid based on the amount of “Attributable Funding” that you raised.
- They only get paid on “commissions”.
- They only get paid a small portion of your price before any checks are cut.
- You offer to pay them “out of the first check” OR
- They offer a refund or guaranteethat you will receive a refund if the event isn’t successful.
- For any reason, except something like gross negligence on their part.
Expert fundraising consultants know that generally speaking, any terms like the following may put their neck on the line with regulators in the US:
- “You only get paid if…”
- “I want a guarantee that you will get us funded or you will offer us a refund…”
- “I can pay you a small percentage upfront, but I want to know that you have skin in the game.”
- “You get paid after the first check is cut.”
As a result, most (legally operating) equity, securities, and capital fundraising consultants normally charge flat hourly fees or a per-project basis, generally based on the amount of time, effort, and specialized knowledge needed to do the job.
Larger raises often mean more moving parts and added complexity. Some SEC registration exemptions actually won’t allow businesses to raise more than a specific dollar amount per year.
- Regulation A (Reg A)
- Tier 1 ($20m limit per 12-month period) or
- Tier 2 ($75m limit per 12-month period)
- Regulation CrowdFunding (Reg CF) ($5 million per 12-month period)
A lot of questions ultimately boil down to the question:
Are Fundraising Consultants “Unregistered Broker-Dealers”?
The answer is:
South Park via GIPHY
- We don’t provide due diligence for the investors.
- We don’t manage transactions.
- We don’t meet with investors on your behalf.
- We aren’t fiduciaries or escrow providers (though ethical consultants follow fiduciary best practices, generally speaking).
Why Can Broker-Dealers Charge Success Fees While Fundraising Consultants Cannot?
Broker-dealers have special licenses, strict protocols, and specific bookkeeping requirements to ensure that no information falls through the cracks. They also have personal information, bonding insurance, and other things at risk when they are managing transactions.
That means there are specific standards and rules they have to follow in order to be broker-dealers.
In fact, any party that touches the money from securities transactions (including registration-exempt transactions, such as a Reg D issuance) from the time an investor sends it and the moment the receiving party claims it will need special licenses.
Following the “Silver Leaf Decision,” brokers cannot pay out referral fees if they are contingent on a deal closing. These fees will be considered “transaction-based compensation” and subject to regulation under Section 15 of the Securities Act of 1934, with very few exceptions.
National Adjudicatory Council (NAC) on June 29, 2019
“The Silver Leaf Decision” Complaint No. 2014042606902
“The Hearing Panel also found that Silver Leaf paid transaction-based compensation to nonmember brokers, and failed to establish and maintain a supervisory system reasonably designed to prevent those payments.”
This basically means that brokers aren’t allowed to share their success fee with anyone who is involved in the transaction. The SEC has since proposed a series of potential exemptions, based on the concept of “Finders” but has not published any concrete guidance yet.
Here’s more information about proposed exclusions for “Tier 1” and “Tier 2” Finders.
To be clear, Fundraising Consultants aren’t “Finders.” They may participate in investor relationship management via chats or emails but do so with a clear disclosure that they are working on behalf of the company they are engaged with.
Finders are expected to be people that are outside of the company in most cases.
It’s not uncommon for larger companies (Series B and so on) to hire an interim CEO or CFO to lead fundraisers. These folks are “insiders” and are expected to lead investor meetings and often take a small piece of the pie.
They are also limited to raising with ONLY ONE company per calendar year. This is a special exemption used by companies that are looking to raise and can afford to pay a full year’s executive salary PLUS an equity-based compensation bonus.
Fundraising consultants that engage in practices such as charging success fees or requesting other “transaction-based” compensation packages are taking actions that risk placing themselves in the “Non-member broker” category.
At best, this can trigger cease-and-desist orders from FINRA. In the worst case, the consultant and their client may be at risk of a civil action or criminal action (in the case of fraud or other criminal activity.) Clients that have raised funds, in exchange for success fees that are paid to nonmember brokers may also be forced to rescind their offering.
Banks (specifically bancorps) often hold “money transmitter” and “Money Service Business (MSB)” licenses on a state-by-state basis—usually alongside other requirements.
If you’ve heard about crypto projects getting regulated in the US, it’s mostly been about them getting approved for money transmitters and/or MSB licenses.
Broker-dealers have several more stringent restrictions on what they are able to do, as compared to fundraising consultants.
For example, a private placement transaction may be exempt from SEC filing requirements (you still have to file Form D under Regulation D exemptions.) A broker-dealer will still be subject to certain parts of Section 15 of the Securities Act of 1933.
It’s worth noting that only a select few circumstances will allow a fundraising consultant to legally participate in connecting investors to businesses. Part of these circumstances include:
- In most cases, broker-dealers are bonded to an investment banking job. They normally require a minimum term commitment in order to accept the risk and vouch for Series 7 hopefuls.
- You cannot even take the tests for becoming a licensed broker-dealer (Series 7, etc.) without a FINRA-regulated firm backing you.
- Interested parties are able to sit for their Securities Industry Essentials (SIE) exam without having the backing of a FINRA member firm. The SIE is a prerequisite for all Series exams.
Series-Licensed Broker-Dealers (BDs)
Licensed Broker-Dealers are involved in structuring deals, as well as the range of services provided by fundraising consultants. A few added responsibilities include specialized marketing channels and relationships with investment banks.
BDs may also pre-purchase and sell a client’s securities (unless they are restricted securities.)
Most of the time, BDs come from an investment banking background, meaning that, commonly, they have a Rolodex of potentially relevant contacts. Most BDs are also limited to selling general securities.
The term “General Securities” typically covers corporate finance instruments such as:
- Corporate bonds (debt)
- Mezzanine Financing (debt with equity-based collateral)
Other relevant licenses include the Series 7 and Series 24 licenses. If you’re in doubt about whether or not they have legit licenses, use FINRA’s BrokerCheck site.
FINRA Central Registration Depository Number (CRD Number):
If they aren’t listed or don’t have at least one of the following licenses, be aware that they may not know they are working outside the bounds of the law.
- Series 7
- Series 8 (these are no longer issued)
- Series 9 & 10 (This combination has replaced Series 8), or
- Series 24
Equity and Capital Fundraising Consultants: Scope of Work
Fundraising consultants have a specific limitation on their scope of work. They can assist in creating collateral, reviewing materials, and conducting investor outreach & relationship management activities.
Fundraising Consultants can NOT commit to any deals or offers on behalf of their clients UNDER ANY CIRCUMSTANCES.
Further, fundraising consultants should not be present in due diligence activities or investment advisory activities, such as recommending their clients’ offerings to non-accredited investors, outside the scope of any related exemption, such as Reg D 506(b/c).
Many fundraising consultants prefer to maintain exclusivity by involving onlyaccredited investors in their clients’ raises.
- Securities Act of 1933
- Section 12
- Section 15 (Broker-Dealers, Control Persons, Registered Persons)
- Rule Section 2000
- Rule 2040 (Payments to Unregistered Persons)
- Subsection 2100 (Transactions With Customers)
- Rule 2111 (Suitability)
- Subsection 2200 (Communications and Disclosures)
- Rule 2210 (Communications with the Public)
In short, between the steep pitfalls that come with accepting any form of performance-based bonus, fundraising consultants generally prefer to stick with hourly-based or per-project compensation structures.
So Why Would Anyone Hire a Fundraising Consultant?
We often come with more deeply specialized skills, tend to communicate more effectively with the C-level, and seldom send associates (that we don’t have) to do the work for us.
Beyond the skills or preferences you may otherwise have, fundraising consultants are, generally, MUCH cheaper to collaborate with.
If you raise a Series A at a normal $2-4m deal against a $10-$20m valuation, expect to pay a broker-dealer:
- 4-8% of funds raised (1-4% is normal on deals that exceed $5-$10m raised); AND
- 1-3% of offered equity, whether outright or as “warrants” at a steep discount.
Fundraising consultants are very similar to BDs in their scope of work, but generally for a much more modest payoff and in a much shorter timeframe. Fundraising consultants usually step away once the contracts are closed for your raise, so you only pay them for the term of the engagement.
This article was originally published by Matthew Proffitt on Hackernoon.