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Raising capital through placement agents

Editor's note: After more than a year-long "break" in Iraq, Matt Storms is ready to continue his series of columns about raising capital. His previous columns covered due diligence and corporate clean up, the mechanics of raising capital, and Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) grants. We thank Matt for his service, and we thank him for the following advice to Wisconsin entrepreneurs.

Once you complete your due diligence and corporate clean up and you have decided that your company is ready to raise capital, the obvious next question for most is where to find it. Many technology-based companies consider SBIR, STTR, Advanced Technology Program, or other government grant programs. For a variety of reasons, grants are not always a viable, sufficient, or perhaps timely option for many companies. In fact, businesses frequently raise money from friends and family. Usually, however, that is not sufficient to fund the needs of a growing technology company. As a result, most technology companies look to outside investors to invest equity capital.

Few entrepreneurs seeking equity investments have personal contacts with people that can offer adequate and available money. For those who don't, one option is to engage an intermediary or "placement agent" to assist them in the process of finding potential investors. A placement agent usually refers to a person or firm that is a registered broker-dealer, but sometimes also includes "finders."

Broker-dealers are regulated professionals or firms that have passed a series of exams and have gone through a lengthy registration process that includes interviews. Finders, on the other hand, are not generally regulated. According to federal law, a broker-dealer is "any person engaged in the business of effecting transactions in securities for the account of others."

For purposes of this article, the key language is "in the business of effecting transactions." A finder is someone not in "the business of effecting transactions." Rather, finders infrequently bring investors and companies together, but that's all they can do. By law, a finder is not permitted to pitch for the company, develop deal terms, or negotiate for or represent the investor or the company.
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There are likely many finders out there who actually perform the services of a broker-dealer, but have failed to register as one because of either ignorance or the time and cost that it takes to become registered. However, it is a violation of federal and most state securities laws to fail to register if a person or firm is engaging in conduct that constitutes broker-dealer activities. A violation of one of those laws can bring fines, investment rescission, penalties, headaches, and in egregious situations, imprisonment.

Wisconsin Law

Wisconsin, for example, places significant restrictions on performing any "finder-related" activities, and takes away common Blue Sky exemptions (which I will discuss in a future article) if a company compensates a finder as part of a sale of securities to a Wisconsin resident. Moreover, there are regulatory issues of giving transaction-based compensation to finders, which often times is exactly what the company and finder want to do.

Because of these and other regulatory issues and various limitations in using finders, it is usually better to work with a broker-dealer rather than a finder. However, there are many more finders that are willing to work with early-stage companies than there are broker-dealers willing to do so.

You may ask, "how does one find a placement agent?" Typically, they find you. However, if that hasn't happened, entrepreneurs can talk with their lawyers, accountants, or other entrepreneurs about their experiences with various placement agents in their area.

When selecting a placement agent, there are many things to consider. Probably the most important consideration is trust. By using a placement agent, you are putting a lot of faith in an individual or firm. Below are some other considerations:

• Experience generally as a placement agent.

• Experience and success with companies in similar industries raising comparable amounts of money.

• Reputation.

• Knowledge and experience with securities laws.

• For broker-dealers, good written policies and procedures.

• For finders, the impact of using a finder on state Blue Sky exemptions, and potential legal issues with using the particular finder.

• Pre-existing substantive relationships with prospective accredited investors.

Contracts with placement agents vary significantly. At the extremes, I have seen handshake deals, which I strongly advise against, and I have seen 25-page agreements. Below is a list of areas that are commonly negotiated in arrangements with placement agents:

• Exclusivity.

• Duration.

• Compensation amount and type (e.g., retainer/monthly fee versus a transaction-based fee).

• Events that give rise to compensation.

• Additional services.

• Indemnity.

• Representations, warranties, and covenants.

• Use of affiliates to assist in process.

• Ability to terminate and effect of termination.

Once a company decides to engage a placement agent, finding the right one(s) under the right terms are essential. The placement agent may not only affect the success of your offering, but the placement agent may also affect (positively or negatively) the reputation of you and your company, expose you to securities law liability and sanctions, and bind you to a long-term, comprehensive, and expensive set of services.

So, if you decide to work with one or more placement agents, be sure to select carefully.

Other articles by Matt Storms

Due diligence and corporate clean-up

Matt Storms: The mechanics of raising capital for your business

SBIR/STTR Programs: Free Money or an Invitation to Governmental Bureaucracy

Matt Storms is the president and founder of AlphaTech Counsel, S.C. , which works primarily with high growth companies with operations in the Midwest. In addition to his many articles on WTN News, Matt posts regularly on the AlphaTech blog, which can be found at http://alphatechcounsel.com/blog/. He can be reached at mstorms@alphatechcounsel.com.

Comments

Mike responded 8 years ago: #1

I second the editor's note Matt and welcome home! Good and timely article too.

Steve W. responded 8 years ago: #2

I believe that placement agents rarely should be used. Many institutional investors will not go through placement agents to do investments. I believe that none of the local VCs will (VI, Mason Wells, Baird). VCs don't want to see any portion of their investment (usually 5-15%) go to a placement agent. They want the capital to be used to build the company.

John Romano responded 8 years ago: #3

A major difficulty facing small business, is obtaining equity capital, and the current regulatory environment, including registration rules for broker-dealers, unfairly restricts capital formation for small businesses. Let’s not live under the illusion that the aforementioned avenues for financing high tech businesses is adequate. These avenues fall short and are somewhat outdated.

The broker-dealer universe for equity financing has been dramatically shrinking both in terms of the number of firms out there and scope of services that they render. With bank acquisition, consolidations of regional brokerage firms, and the loss of firms in the current economic downturn, the scarcity of investment banking services, particularly for mid- to small-size issuers, has been dramatic.

Matt Storms responded 8 years ago: #4

With regard to Steve's comment, thankfully most of the VCs in Wisconsin (and Minnesota) are very approachable. It's unnecessary to use a placement agent for them. And you're right, many VCs are not happy with 5-10 percent (15 percent is outside the norm of what I’ve seen) going out the door to a placement agent. But, for many companies that have exhausted their own funds and their contacts with angels and VCs, placement agents are a necessary reality.

With regard to John’s comments, you’re absolutely right in terms of having an out-dated system and set of regulations. I believe the NASD has recognized the problems concerning BD/finders, but to date has not adopted rules to address them. Hopefully, the issue will be addressed before long to enable finders to provide legitimate value-added services that they are currently prohibited from providing. I believe it would not only facilitate capital formation, but also likely place downward pressure on costs with a larger supply of available placement agents.

Kao, Ti . U-W Graduate responded 8 years ago: #5

Un.Wis's WCSAR want build my ROBOT for Space tests. Need $75,000 from me. May I use my US Patents to placement agent as collecterals and get $,75,000 to WCSAR? You can asking Director- Dr. Zhou by phone:(608)262-5526. ti_kao@yahoo.com

Mike Caska responded 7 years ago: #6

I am a placement agent, fully licensed. You should see what I see. I not only package, market and structure a presentation, I find the right investor. There is no such thing as a passive institutional investor in my opinion. Just patient or impatient. Being a good placement agent is not like being a real estate broker, you have to be financial, you have to know law, you have to research industries, you have to know science, you have to know government grants and on and on.

I love what I do, but it has taken 20 years to be any good at it.

scott olguin responded 7 years ago: #7

Mike, I can appreciate your comments. I would like to visit more regarding your experiences and knowledge.

Scott

Paul Rees responded 7 years ago: #8

Matt-How can one utilize insurance agents as finders in conjunction with a private placement? The agents are not registered but have all the customer contacts. Are they allowed to distribute PPMs and then collect info back from their clients as potential investors such as an investor questionairre? And is it possible to compensate them on some basis such as percentage of the capital raised?
Thanks.
Paul D. Rees, JD, LLM

Matt Storms responded 6 years ago: #9

Paul,

In this regard, insurance agents are no different than lawyers, accountants, consultants, and anyone else for that matter. They are all subject to the same rules and regulations and would be considered mere "finders" unless properly licensed as broker-dealers.

Lakis Agathocleous responded 6 years ago: #10

Hi,
I have read the article and I still have a question in regards to who is a legitimate placement agent and who is not?
Could you kindly indicate the exams that placement agents must take and pass succesfully in order to be able to act as placement agents.
And a second question is, should a company use a placement agent whenever is selling restricted shares?
I ask the above because that is a form of raising capital.
Thanks in advance
Look forward to your response.

Matt Storms responded 6 years ago: #11

Lakis,

Here's a link to probably more information than what you want to know on the topic: http://www.sec.gov/divisions/marketreg/bdguide.htm.

You by no means have to use a placement agent when selling securities in the U.S. Placement agents can be useful service providers to the extent you need assistance finding investors. However, they are usually expensive and aren't always succesful. There are websites available that check the history of registered broker-dealers to the extent you want find more information on a particular broker-dealer.

Matt

roberto johnson responded 6 years ago: #12

Hi.

i am considering raising capital to produce a motion picture (feature film) and i am considering using private placement. I am offering 50% of profits as you know profits can never be guaranteed in these high risk venture. i would like your position on this. whether it would be a good idea to go through private placement or not if so why.

Lakis responded 6 years ago: #13

Dear Matt,

Can a company that is not a registered broker dealer promote herself as a placement agent and sell restricted shares to the public?
Can a company do that if it is based outside the US?
Are venture capitalists required to be registered with the US SEC?

Lakis

Ramzi responded 6 years ago: #14

as a placement agent, what are the main criteria that i have to care of in taking the opportunity or leave it? at the end the company am raising its capital will affect my reputation as well,

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