Bankers and placement agents are a red flag for venture investors
The pitch is tempting: I’ve got lots of connections to investors looking for great startups like yours. Let me introduce you to people I know, and you only have to pay me a commission on whatever investment I bring in.
What could be wrong with that? We take advantage of resellers’ connections to customers and pay them a commission on sales. Why not pay someone to introduce us to investors if they have connections? Worst case, if they don’t bring in any investors, we haven’t lost anything.
The answer is: don’t do it. It’s a deal killer for experienced investors.
Even if it raises funds in an early round, it’ll kill the company when it gets to diligence in later rounds.
Here are the 5 reasons experienced investors avoid startups that use agents for funding.
Reason 1: It’s Usually Illegal
The U.S. SEC has somewhat stupid regulations that prohibit anyone other than a registered stockbroker (the technical term is broker/dealer) to get paid for helping a company find investors.
Technically, “finding investors” means a private sale of company stock. And only a registered stockbroker who has passed all the tests is allowed to broker the sale of stock, whether the stock is public or private.
This sounds like a minor technical violation, but the SEC is serious about enforcing it. This means when the company registers for an IPO, it’s one of the things they look at, which makes it one of the things that the lawyers at VCs review when doing diligence on a potential investment.
Anyone offering to introduce you to investors in return for a commission or finder’s fee is breaking the law unless they’re a registered broker/dealer. Few early-stage startups are aware of the regulation, nor are many of the people who are offering to introduce you to their network.
As for the registered broker/dealers who are allowed to offer you this assistance, in the early stages, the small amount startups raise makes the commission too small to be worth a professional’s time.
In later stages, the raises are larger, but if the company is doing well, the investors from earlier rounds reinvest together with bigger funds they collaborate with. If you need a banker to find new investors at that stage, it means earlier investors are abandoning ship, and no agent will be able to help.
Reason 2: It’s All About the Hustle
There are thousands of VCs firms and even more angel investors. I doubt a single one of us is short of deal flow. What we’re short of is good deals that match our stage and interests.
For any startup, there’s only a handful of investors who are the right fit. We expect the CEO to do her homework, figure out who the right people are, and pitch us personally. You don’t need an agent for that. It’s part of the CEO’s job description.
It’s not hard to find out who you should be pitching. We make it as easy as possible. VCs list their industry focus, stage, and check size right on their website. We attend conferences, pitch events, and panel discussions. We’re on LinkedIn, Angel List, Pitchbook, and Crunchbase. We’re not hard to find. We even take cold calls.
We value warm introductions, of course, but from supporters and other investors in the company who know us and think we’re a perfect fit. Those intros are free from people trying to help the company succeed, not someone spamming the universe to try to hustle a commission.
Reason 3: It’s All About the Relationship
Especially in the early stages before the product is fully validated, we’re investing in the CEO and the founding team.
We don’t need a banker to send us the business plan. We need the CEO to reach out personally and tell us why we should be building a relationship with her.
I want to hear directly from the CEO why she wants me as an investor. I’m going to invest because I believe in her, not because someone I’m connected to on LinkedIn sent me a pitch deck.
If I get an outreach from an agent, it’s clear the startup is looking for cash from anyone and that’s not how startup investment works.
Reason 4: The Entire Investment Needs to Go Into Building the Business
In the early stages of building a startup, cash is the most valuable resource. Investors want to see their investment put towards building the business, not going into agent commissions.
Reason 5: You’re Clueless About How to Build a Startup
Admittedly, this logic is circular. But the most important reason why using an agent is a red flag is because that’s not how the system works.
Anyone who’s been part of the startup world knows it’s a dead end. Therefore, according to our thinking, anyone who hires an agent doesn’t know how to build a startup.
Once the company has significant customers and revenues and is growing quickly, investors can look at the real results to decide whether to invest. But in the earlier stages, we’re betting on the founders and trying to guess if they know what they’re doing.
It’s a good assumption that founders who don’t understand the venture fundraising system also don’t understand many other critical aspects of how to build a startup, making the odds of success low.
As tempting as it might seem to hire an agent to help you find investors, don’t do it. Not only are they unlikely to bring in investors, but they’ll scare off other investors.
At the very minimum, if you decide to ignore this advice, make sure you follow the law and ensure that anyone you pay to introduce you investors is an SEC registered broker/dealer.
Subscribe to receive your weekly insights