Skip to main content

Photo by Josh Woroniecki via Pexels.

Startups and emerging companies often require large amounts of capital to get off the ground or to scale.  With a lack of significant revenue and traditional financing options, entrepreneurs often rely on private investors for funding.  Early-stage investors play a critical role not only by providing capital but also by contributing time, experience, and connections.  Not every entrepreneur, however, has access to these investors. In fact, founders from underrepresented groups (e.g., female or minority founders) or located in regions with underdeveloped investor networks, such as Tennessee, often lack meaningful connections to early-stage investors.

This has resulted in the exodus of promising ventures to more traditional VC centric regions (e.g., the Bay Area, Boston, New York, and more recently, Austin and Salt Lake City) in hope of obtaining meaningful funding.  Conversely, those that choose to stay local and take advantage of the less restrictive regulatory regimes and lower cost of living, often turn to the few connected or experienced individuals (e.g., successful entrepreneurs) within their network for connections to potential investors (“Finders”).  Although Finders may be happy to share their insight and experience, they may be reluctant to open up their rolodex and send a company’s pitch deck to potential investors.  Even when compensation is on the table, the company and the Finder have to navigate the complexities of the SEC’s broker-dealer regulations.

Under the Exchange Act, a “broker” is “any person engaged in the business of effecting transactions in securities for the account of others.” The receipt of transaction-based compensation (i.e., payment (whether in cash or securities) based on successfully finding investors to invest) is a key indicator that a person is acting as broker. If a company engages an unregistered broker, then the investors involved in the round may have the right to rescind the transaction and receive their money back. Not only can rescission have catastrophic consequences when an investment goes sour, it may scare off future investors who do not want their money being used to pay back an earlier investor.

Registering as a broker-dealer, however, is an onerous task that is generally only worthwhile for those involved in more lucrative transactions.  In turn, this creates a hole in the market for early-stage investors and entrepreneurs–the individuals in the best position to connect startups with investors are prohibited from doing so, and those that are permitted to do so are reluctant given the more lucrative opportunities.

The SEC has acknowledged that Finders play a crucial role in a startup’s ability to connect with investors and raise capital. In turn, the SEC has proposed to address the gap by allowing Finders to engage in certain activities on behalf of a company without registering as a broker.

Specifically, the SEC has proposed a framework with two different exempt classes of Finders–Tier I and Tier II. Generally, the exemption is only available to private companies that are conducting an offering in reliance on an exemption from registration under the Securities Act.  The Finder and the company must enter into a written agreement that sets forth the services the Finder will provide and the terms of compensation.  Moreover, the Finder may not engage in a general solicitation and must only pursue accredited investors.

Although Tier I and Tier II Finders may receive transaction-based compensation, there are significant differences between the permissible activities and requirements.  For instance, Tier I Finders may only provide a list of potential investors in connection with a single capital raising transaction by a once every 12-months and cannot have any contact with potential investors about the company.

On the other hand, Tier II Finders may identify and contact investors, distribute and discuss offering materials and information about the company, and even participate in meetings with the company and potential investors. Prior to or at the time of the solicitation, Tier II Finders, however, must disclose to investors:

  • Name of the Finder.
  • Name of the company on whose behalf he or she is acting.
  • Description of the relationship between the Finder and the company.
  • Description of the Finder’s compensation arrangement.
  • Any material conflicts of interest.
  • Statement that the Finder is acting as an agent of the company, is not acting as an associated person of a broker-dealer, and is not acting in the investor’s best interest.

Notably, neither category allows a Finder to engage in traditional broker-dealer activities such as structuring a transaction, conducting due diligence on behalf of an investor, negotiating offering terms, preparing offering materials, or providing investment advice.

This proposal is well overdue and will better connect early-stage investors and emerging growth companies–particularly in regions with underdeveloped capital networks.  Additionally, the proposal provides Finders with peace of mind that was previously missing in the broker-dealer regulations.

The proposal, however, is not without its fair share of critics questioning the need for expansion of the private capital markets, whether appropriate investor protections are in place, and the overall procedures undertaken to effectuate these actions.  As the last point, the SEC acted through an exemptive order rather than the more extensive notice and comment rulemaking process, which generally requires obtaining and analyzing market data to further understand the needs and how the proposed action would address market inefficiencies.  Other than the collection of comments, the SEC has not taken further action or provided further guidance on this exemption notice.

About Shayn Fernandez

[avatar user=”Shayn” size=”medium” /]

Shayn is the corporate lead at Rockridge Venture Law, offering seed-to-scale-to-sale corporate counsel to entrepreneurs, emerging companies, and investors in all stages of a corporate lifecycle–from formation and fundraising to exits through M&A or IPO. Shayn’s practice areas include corporate law, finance and fundraising, securities, and mergers and acquisitions.  Read more about Shayn, connect with him, and Calendly him.

RVL recommended reading by Shayn:

Anatomy of a Seed Round: Understanding the Key Terms of Early Stage Investments

Aligning Stakeholder Interests: Employee Equity Compensation

Perfecting IP Rights in SBIR Funded Innovations

SECsy for the Sharks: Tips on Creating and Delivering Startup Pitches that Meet Federal Regulatory Requirements


About RVL®

Rockridge Venture Law® is a certified B Corp law firm embracing the mantra of technology lawyers for good. Rockridge® services include corporate, intellectual property, litigation, M&A, privacy, technology, and venture capital law. Rockridge has been recognized as a B Corp Best for the World and Real Leaders Top 150 Impact Company, and has been featured by Conscious Company Magazine, Forbes, and other top media focused on industry leaders in impact and innovation.

The Rockridge team has worked with Grammy winners, Nobel Prize winners, and world champion athletes to create and monetize distinctive intellectual property assets. Rockridge clients include founders, investors, and multinationals scaling disruptive technologies and iconic brands. Rockridge is headquartered in Tennessee, with satellite offices in Durham, New Haven, and New York.

We’re Building Today’s Company for Tomorrow’s Economy® by leading clients through the dizzying array of information controls, by helping them to develop and monetize proprietary assets, and by enabling their impactful products, programs, and principles.

See case studies on how we’ve helped transformative companies at Rockridge Case Studies.

Kevin Christopher

Author Kevin Christopher

More posts by Kevin Christopher

Leave a Reply

Close Menu

Historic James Building
735 Broad Street, STE 1001
Chattanooga, TN 37402

Nashville Entrepreneur Center
41 Peabody St.
Nashville, TN 37210
(For client and partnership meetings only)

The Yale Club
50 Vanderbilt Ave.
New York, NY 10017
(For client and partnership meetings only)


RVL® is a business, intellectual property, and technology firm, building today’s companies for tomorrow’s economy.