Fundraising Help

Founders are excited to build their high-potential startup. Raising money to realize that dream is rarely viewed as a favorite way to spend their precious time, so a first-time founder often casts about wondering who might help them navigate the complicated, nuanced, and confusing world of fundraising.

The mechanisms startups use to raise money are primarily stock, convertible notes, and SAFEs, in which investors provide funds to the startup in exchange for the issuance or potential issuance of securities. New fundraising founders may not realize that, in the United States, the Securities and Exchange Commission (SEC)  regulates the sale of corporate securities under the Securities Act of 1933 and the Securities Act of 1934. Created by Congress in response to the stock market crash of 1929, the SEC’s mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Basically, the sale of all securities is regulated and, if you are offering securities (that’s what startup fundraising usually is!), then you need to know the rules (your corporate lawyer can help with that!) and comply with them. Since few startups are public companies for whom the reporting and transparency requirements are enormous, most private company startups rely on specific regulatory exceptions to raise money.

As vulnerable founders discover fundraising is hard, they will often search for someone who can make it happen for them. Along that journey, they will often encounter one or more of the following types of fundraising “help” and not realize the downside risks they are accepting if they engage one or more of them:

• Fundraising “finders”
• Investment/merchant bankers
• Accelerators/entrepreneurial training programs

Some Don’ts for Fundraising

1. Never Pay Finders Fees. Sometimes, people will approach fundraising startups with an offer to help them raise money for a cut of the funds raised. This sounds like a good deal to the struggling fundraiser! Why not have an expert who claims to have all the right contacts to help source funds? First and foremost, anyone offering securities must be a registered broker-dealer with the SEC. That means this startup consultant probably does not qualify – and hiring them to do so is illegal, with significant potential consequences for you and them. Furthermore, other sophisticated startup investors know that sometimes startup founders get sucked into this trap and will be asking you to affirm that you have NOT agreed to pay anyone a finder’s fee for any investment when you are finalizing your round’s investment documents. That means you are in trouble within sight of the finish line if you cannot affirm you have not agreed to pay any finder’s fees. Think of it this way. Sophisticated investors like VCs and angel groups know the rules and want nothing to do with a startup that is not following them. Don’t agree to pay finders fees to anyone. And if someone pretends to know what they are doing and asks you to commit to a finders fee, that should be a red flag about that person’s knowledge and/or integrity.
   
   
2. Do Not Hire an Investment Banker. Investment bankers are registered broker-dealers with the SEC and are allowed to offer securities. However, for early-stage startups, the small rounds you are raising are not worth the single-digit commissions the investment bankers can earn by representing you to potential investors, even if they are legally allowed to do so. Furthermore, many early-stage investors will immediately reject any startup that approaches them via an investment or merchant banker, which means if you somehow sign an exclusive agreement with a banker (that’s right…exclusive), you are excluding most early-stage investors in the ecosystem. The banker won’t tell you that it is a black eye on you to hire them. Instead they will sell you on how they will solve all your fundraising problems. But, unless you are raising massive rounds at a later stage or have gone public, steer clear, as the hidden costs of such a strategy are not worth it. Check out point #1 under the “Do’s” below for insight into why.
   
   
3. Do Not Raise from Non-Accredited Investors. While there are some complex ways to raise money from non-accredited investors (sometimes known as friends and family), the disclosure and legal documentation rules are significant, so be sure you have the money to invest in proper legal counsel to pursue this capital in a way that minimizes future litigation risk and does not create a morass of problems that will get in the way of future fundraising with sophisticated investors. Under Regulation D, the SEC provides some exceptions for raising money via unregistered and illiquid securities like startup investments from “accredited investors” (know the definition – and take the proper legal steps to ensure those you are raising from meet the standard) who are assumed to be financially sophisticated and able to bear a high risk of total loss. There are a few additional exceptions allowed for employees and others; however, be sure to get your attorney’s advice to ensure you are on the straight and narrow.
   
   
4. Don’t Expect Accelerators or Other Entrepreneurial Training Programs to be a Magic Ticket to Raising Money. These programs can provide good foundational training for newbie entrepreneurs and exposure to potential investors. However, while they can help teach you how to package a compelling startup story, they cannot ensure you have the keys to success inherent in your opportunity. Think of accelerators as a way of getting the basics sorted, finding a cohort of like-minded folks, and potentially a springboard into a network of curious investors. Do not assume that getting accepted by an accelerator means you are set for fundraising. Even if the accelerator can point to a few success stories, when you dig under the surface, you will find those are exceptions rather than the rule because fundraising success is rare. Of course, you may have all the critical elements of success, and if you do, whether you participate in an accelerator or not is likely not the pivotal element, even if the accelerator sprinkles in a nominal investment so they can have a stake in their winners to help fund their continuing operations. Remember, accelerators must fund their own operations, and accelerator participation costs can be significant in terms of time, money, and equity for a startup. I wish I did not know so many regretful entrepreneurs who pinned their hopes on a fancy accelerator.

Some Do’s For Fundraising Success

1. Ensure the Startup CEO Leads Fundraising for the Startup:  Early-stage investors weigh the strength and experience of the startup’s CEO as a critical success factor for a startup. Therefore, a critical part of their due diligence is getting comfortable with the CEO’s skills, experience, and vision. That means that the CEO needs to be front and center engaging with potential investors – and while others on the team can play supporting roles, a missing-in-action CEO is deadly for fundraising. If a startup’s CEO cannot develop and sell its story to investors and inspire their confidence, you need a different CEO. The work involved in fundraising is tremendous, so be sure to plan for it.
   
   
2. Engage an Experienced Corporate Attorney:  Because the sale of securities is highly regulated, my first and foremost recommendation to all fundraising founders is to be sure you have hired knowledgeable corporate attorneys with extensive experience advising fundraising startups to help you. Corporate attorneys know the legal requirements, exceptions, and standard approaches to ensure you stay within the regulatory lines and advise you on the terms and conditions you negotiate with investors.
   
   
3. Know and Comply with the Rules/Regulations: The SEC is a potent and attentive regulator, and sophisticated early-stage investors do not want to run afoul of them, nor do they want to invest in startups that play fast and loose with the rules since the consequences can be dire. Run a clean corporate operation since investors will worry that a CEO who is willing to bend the rules in one area is more likely to bend them in other areas (and not be investable as a result!) Learn the ropes and, when unsure, ask your corporate attorney for advice.
   
   
4. Ask Your Investors to Invite Their Friends to Join Them. There are no finder fees involved here; investors are just joining others they trust to co-invest together in an exciting opportunity. This often takes the form of informal investor networks sharing good leads with each other – and helping the startups they are excited about get the capital they need to succeed. A good lead investor can often bring their co-investing network into a fundraising round they believe in.

I wish I could tell you that raising money for a startup is easy or that someone out there can do it for you. But I can’t. For many high-potential startups, fundraising is foundational. And no one can do it for you and your team. Yet, it can be done successfully if you have the right fundamentals in your identified opportunity and execute on them well. Just do not sabotage your chance by getting suckered by those who cannot or are not allowed to help you even as they siphon off what precious little cash you have.

If you are seeking to raise money, check out my many other fundraising posts for more insights. All are available free at www.StartupCEOReflections.com because I was once that early-stage founding CEO trying to figure it out, and some generous souls helped me learn along the way, and I want to pay their generosity forward. Always remember that I am sharing my experiences, however, I am not a lawyer or accredited investment advisor, and my blogs should not be relied upon as legal or investment advice.