By Andy Tiwari
Television shows like “Shark Tank” and fundraising portals like Kickstarter have inspired many with a great idea to believe the modern adage, “if you build it, they will come.” But startups should take notice: the scammers will come calling too.
While “Shark Tank” may have you believe that investors are waiting in line to fund your brilliant idea, only a small percentage of startups actually get capital from private brokers, angel investors, think thanks or government grants. Most startups encounter great difficulty raising capital: after all, ideas don’t offer much tangible security against the loss of loaned or invested funds. Enter the unscrupulous “fundraiser” who we’ll refer to as the “false shark.”
Paying a fee to an underwriter or investment “finder” to raise capital is actually common in the market. But the timing of when that fee is due makes a difference: true investors wait for results, and true “finders” are similarly confident they will be paid for their efforts once they deliver on raising capital. In contrast, the often flashy, “well-connected,” full of superlatives false shark will offer to help you for an upfront fee. Of late, the false shark seems to have reemerged thanks to stalled rulemaking from the U.S. Securities and Exchange Commission on crowdfunding.
Spotting the false shark is pretty straightforward. In the beginning stages of the hunt, you’re likely to be wined and dined and introduced to important-sounding people. The false shark will regale you with stories of successes, often using fancy terminology and referencing layers of complex financial arrangements that you likely don’t understand.
Then, the false shark promises – for a “small” upfront payment often in the tens of thousands of dollars – to raise a large sum of money for you or line up financing using that well established investor network he/she has. Of course, instead of raising millions, the so-called fundraiser eventually walks off with your fee. Naturally, there will be excuses galore about why no funds were raised. No one thinks they will fall victim to traps like these, but “too good to be true offers” cloud our judgment, particularly when we’re passionately working on an idea.
Finders and “true sharks” in the business of private fundraising have licenses or credentials to show and are often accredited by organizations that specialize in investing in businesses. Experienced business connectors are confident in their ability to get paid and normally charge a percentage of what’s raised and then, will only do so after funds have in fact been generated. Legitimate deals often aren’t that complex – the simpler, the more likely it’s legit.
Now, it is possible that a well-established fundraiser could ask for certain cost payments upfront. But before you give money to any fundraiser, do your homework: is the dealer affiliated with a company registered with the SEC and is that person licensed by a state securities board to market securities? In Texas, a person must generally register if he or she receives a fee for offering or selling a stake in a business to a third party, who expects to turn a profit from the efforts of someone other than the investor. You can get more information about private fundraising in Texas from the State Securities Board at www.ssb.state.tx.us
What about references? Those who make a living from investing have a track record and portfolio. Most private placement deals cannot proceed without a prospectus or private placement memorandum or offering “circular” that details the investment. These documents are usually prepared with the help of an attorney. Your would-be-finder should be able to provide examples of promotional materials for legitimate deals he or she assisted with in addition to having contact information for the businesses they helped. You might be required to sign a non-disclosure to view them. Also, don’t underestimate the power of Google.
Before turning to a finder, a small business owner seeking funding should check legitimate financial lenders and microlenders first and then turn to capital markets with the help of attorney knowledgeable about state securities laws.
If you need legal advice, schedule a meeting with Tiwari + Bell PLLC through our website or by calling (210) 417-4167