Brokering Investments and Referral Fees

For a growing start-up, a major event in its early development as a company will be the acquisition of capital, whether in the form of a loan, a gift, or an investment. Founders who seed the company from their personal funds can consider their company as the recipient of a gift. When the money comes from outside, it will either be a loan, which can be quite difficult to acquire unless the arrangement is being made privately, or as an investment, in which case equity is being given in exchange for cash.

Rules differ between countries, but there are a few basics which seem to be fairly common which govern the acquisition of investment capital.

First, there is often a limit on the number of investors you can approach before you will be required to file a formal prospectus with the appropriate regulatory body. As such, it is important that you limit your discussions regarding investments to the smallest number of prospects as possible, and only those you realistically believe will actually personally invest in your business.

Second, before your investment can be completed, you will need to have a formal entity for your business – that is, some form of corporation which can issue shares – along with associated banking and financial accounting in place for accountability.

Because of these restrictions, finding a potential investor, at the early stages of development of a company, can be difficult. If a corporate structure does not yet exist, there is nothing to invest in. If you cannot broadcast your interest in acquiring capital, potential investors won’t know about you.

This is where your network can come into play. You may have a family member or friend who does know investors, and can make an introduction. The value of such introductions can be quite high, but that should not be taken to mean that the price is also expensive. Be wary when making use of such a referral in regard to payment – in some places, payment can only be made to a registered broker, while in other places, no such restriction exists, at least from a regulatory perspective.

However, investors will not be pleased to see their investment dollars going to a third party who has done little to no work in growing the company. An introduction, while invaluable in terms of opening doors that might otherwise not exist, is only a drop in the bucket in terms of the effort that will be needed to close the deal.

The investor will question the founders and their team intensively to determine the potential value of the deal – the broker will have little to do here. Lawyers will be hired to document the terms and finalize the arrangements. Accountants will be needed to perform due diligence on the finances of the company to determine, as closely as possible, the actual value of the company.

That’s not to say that the broker should not be rewarded. However, the reward should either be handled privately, in the case of a private introduction with no risk, or perhaps outside the terms of the deal. For example, if the broker runs a company which performs a service that your company is in need of, consider giving the broker rights to exclusive bids on projects, which will survive an audit of your company’s actions.

If the broker is asking for equity, beware. Even if it is allowed by the regulatory bodies for such a transaction to take place, there is going to be a conflict of interest, and the broker is likely being overpaid for their work. There are plenty of ways to reward the broker without giving up a piece of the company.