The SEC’s Proposed New Rules about ‘Finders’ Opens Up Possibilities for Small Businesses

Raising seed or growth capital for many early stage businesses is no small feat. It’s an extremely competitive process, where investors often have the choice of dozens, hundreds, or even thousands of different options.  So, getting connected and standing out is imperative, but extremely difficult nonetheless.   I have often recounted to my clients that the companies that we have seen be successful in fundraising often have the right sort of network and connections.  

Historically, many of the entrepreneurs that don’t have that immediate access to great investor networks have sought outside assistance to help gain that access, often through a “finder.”  However, in my experience, those relationships have seldom been proposed or structured legally.  In fact, my most utilized blog article for clients raising money has been this one. Frankly, this issue has been one of the most black and white issues that I see in my practice to date.  As of the date of this blog, the existing rule is, essentially, that finders are only allowed to make introductions between investors and issuers and can only be compensated in a number of limited ways. Any compensation arrangements tied to the amount an investor actually invests in the issuer or whether or not the investor invests in the issuer were deemed to be “transaction based compensation” that would require a broker-dealer license.  Finders and issuers are subject to civil and criminal penalties based on whether the Finder relationship are structured correctly.

But, the SEC is rethinking things.  

 

New Proposed Rule

 

On October 7, 2020 and  in response to years of input and encouragement from small businesses, the SEC issued a proposal on new rules that would apply to a finder and permit more leniency in how a finder may be compensated (using “transaction based compensation”) in connection with a capital raise for a company.   The most important takeaway from the proposed rule is the creation of two tiers of finders (Tier I and Tier II). 

 

 

Tier I Finders would be limited to providing the issuer with contact information of a potential investor in relation to only one capital-raising transaction or offering by a single issuer within a 12-month period.  Tier I Finders would also be required to meet the general conditions discussed in greater detail below.

Tier II Finders are those who would engage in solicitation-related activities on behalf of an issuer that are limited to the following:

  • Identifying, screening, and contacting potential investors.
  • Distributing informational or offering materials from the issuer to potential investors.
  • Discussing with potential investors any information contained within the materials the issuer submits; provided, however, that the Tier II Finder does not provide advice as to the valuation or advisability of the investment.
  • Arranging and participating in meetings between the issuer and potential investors. 

A Tier II Finder would be allowed to engage in more than one capital raising transaction or offering within a 12-month period.  However, in addition to the foregoing and the general conditions below, a Tier II finder would be required to provide certain additional disclosures and information to prospective investors.  

The general conditions that would apply to both Tier I and Tier II Finders are 

  • The Finder is a natural person;
  • The issuer is not required to file reports under Section 13or Section 15(d) of the Exchange Act;
  • The issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act of 1933, as amended, such as Rule 506(b) of Regulation D;
  • The Finder does not engage in “general solicitation”;
  • The potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the Finder has a reasonable belief that the potential investor is an “accredited investor”;
  • The Finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
  • The Finder is not an associated person of a broker-dealer; and
  • The Finder is not subject to statutory disqualification, as that term is defined in Section 3(a)(39) of the Exchange Act, at the time of their participation.

 

Not Law Yet

At this point, the rule is only proposed and the SEC is collecting analysis and comments from the public on this proposal to determine whether it should be adopted and, assuming so, what “tweaks” are needed to the rules.  But, assuming something similar to this is ultimately adopted by the SEC, it could be a real game changer for both intermediaries and entrepreneurs seeking capital.  

While raising capital for your startup might seem like the most complex task on your plate, Doida Law Group is here to ensure that you follow the rules and properly structure your fundraising efforts. We have years of experience assisting businesses of all sizes; get in touch with our team today to see how we can provide value to your company.

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