SEC Regulations Prohibit Anyone Without a Stockbroker’s License From Helping Find Investors and Raise Funding

Building a startup is tough. Fundraising is no fun. If you’ve never done it before, just getting up to speed can be overwhelming.

Wouldn’t it be great if there was someone you could hire to handle the fundraising for you? Or at least connect you to receptive investors, help prepare a killer pitch deck, and handhold you through the process? You’d happily pay them a commission since without their help, you’ll struggle to raise at all.

The answer is that of course such services exist. If you’re the CEO of Canva preparing for an IPO, there will be any number of investment banks happy to assist in return for a modest retainer of $100k per month plus a 7% commission. Unfortunately, even the smallest investment banks are uninterested in any deal under $100M.

Umm. So what should an early-stage startup do? We’re raising $2M. Can anyone help with that?

Plenty of people will offer to help. They’ll promise to introduce you to their rich friends, to their extensive network of investors, to the venture partners they play tennis with and the family offices they meet on the golf course. They might even have experience in your industry, know everyone worth knowing in your space, and be willing to help you. For a fee, of course. They won’t even charge a retainer, just a nominal 20% commission on any investment they bring in.

Ah, that seems like a godsend. The answer to your prayers. Now you can relax, focus on building the product and finding customers, and leave the fundraising to people who know how to do it.

Unfortunately, you have absolutely no choice but to decline the offer and do the fundraising yourself.

Unlicensed Fundraising Advisors are Illegal

If you want to hire someone to introduce your product to potential customers and pay them a commission or a finder’s fee, there’s no problem with that.

But if you want to hire someone to introduce your company to potential investors in the U.S., they need a Series 7 stockbroker’s license.

When you’re pitching your startup to potential investors, you are asking them to buy stock, a SAFE, or a convertible note in your business. Those are all financial securities. And only a licensed stockbroker is legally allowed to sell, promote, or advise on the buying and selling of financial securities.

That means the folks at Goldman Sachs or Morgan Stanley can help you. I cannot. Nor are 99% of the people offering to help with your fundraise. Even though, let’s be honest, we’re more qualified than any bank to help with an early-stage fundraise in your specific niche.

But the law is the law, and though it’s an ass, there’s no ignoring the law, no matter how much we wish we could.

The requirement for a stockbroker’s license to assist with fundraising sounds like a technicality that’s mostly ignored. Let me assure you it isn’t.

The Securities and Exchange Commission (SEC) hates startups. Okay, I take that back. They don’t care one way or another about startups. What they hate are thousands of startups selling unregistered stock to tens of thousands of individuals like me.

The primary job of the SEC is to prevent fraud, scams, and other financial crimes around the sale of stock and securities. Before stock can be registered and sold to the public, the company has to spend months filing reports and paperwork proving they’re legit. Every quarter, the company has to issue financial reports to the SEC and investors. It’s a formal, rigid, time consuming, and expensive process.

To sell stocks, the SEC requires you to prove that you know all the regulations and requirements, and understand your fiduciary duty to your clients. Licensed stockbrokers need to register with FINRA where all complaints and penalties against the stockbroker are listed for public consumption. (Look up your stockbroker here.)

Startups drive the SEC crazy. Instead of registering their stock with the authorities and using licensed stockbrokers to sell it, startups take advantage of an exemption that allows unregistered stock to be sold to “accredited investors” (mostly rich people and venture funds), bypassing the SEC.

There’s a lot of fraud among startups that the SEC would like to squash if it could. A few like Theranos are egregious and get prosecuted; the vast majority (like 10–20% of startups) are the kind of positive, optimistic exaggerations of sales prospects and product status that Silicon Valley is famed for, but the SEC would consider untruthful and misleading. That revenue projection of $100M from zero today based on…nothing but wishful thinking would have to go. Those projected 70% profit margins would generate guffaws in around the SEC’s water coolers…and subpoenas.

There’s nothing the SEC can do about startups selling unregistered stock to accredited investors. However, if the startup sells stock to unaccredited investors or uses an unlicensed agent to assist with the raise, the SEC can and will clamp down.

Penalties for Sales of Stock without a License

Under federal law, if you use an unlicensed agent to help with your fundraising, the investment agreement is invalid. Those investors have the right for 3 years from the date of the investment or 1 year from the date the violation is discovered, to demand a return of their money.

The startup is also subject to state securities laws of both the company and investors. In Washington and Oregon, the founders are personally liable for hiring an unlicensed stockbroker. That means that if I’m an investor in your company and when it fails I discover you were using a consultant to help raise funds, I can grab your personal assets like your home, car, and wedding ring to repay my investment, plus interest, plus my attorney’s fees. Beware!

In addition, if the SEC is in a particularly unforgiving mood, the founders can be charged with aiding and abetting the crime and the company prohibited from future fundraising.

The consultant himself will be charged with operating as a stockbroker without a license and hit with huge fines or, at least in theory, sent to prison.

Don’t do it. It’s not worth it.

The Truth Will Come Out

There’s a strong temptation to do whatever it takes to get through the pre-seed round. Most angel investors aren’t sophisticated, and individuals are unlikely to do much diligence before signing a SAFE and handing over a check. So who cares if you pay someone to help you find investors? Maybe compile a list of potential investors? Do some initial prospecting for you? Who will ever know?

The answer is the next round investors, or perhaps the following one, will conduct a detailed diligence process that will include extensive legal diligence. The lawyers have a checklist of common issues to confirm: proper registration of the business, audited accounting, taxes paid, no lawsuits or criminal charges against the company or founders, etc.

The two most likely problems to crop up in legal diligence are early employees who left without signing an IP rights assignment agreement, adding a cloud over the ownership of the company’s crown jewels, and payments for fundraising in earlier rounds. Investors will be looking carefully, if not now, then later.

The illegal payments from earlier rounds will be found (if you try to hide them, you’ll be committing fraud and perjury, making a bad situation much, much worse). That will be the end of fundraising because nobody wants to invest in a startup where the earlier investors have the right to demand a refund of their investment. Plus, the founders look incompetent, which is exactly what investors want to avoid.

For these reasons, if you apply to my angel group, part of the application process requires signing a statement that no third parties are being paid as part of the fundraising round. You have to answer truthfully.

Ways to Get Around the Restriction

Instead of paying a commission to the consultant, how about if I pay them in stock? Nope. Both the SEC and IRS don’t care whether you pay someone in cash, equity, bitcoin, or dirty socks; if they’re receiving something of value, they’re being paid.

How about if I pay a success fee instead of a commission? Or an hourly wage? Nope. Only a licensed stockbroker can be paid to assist in selling stock.

So there’s no way around it? That’s a question for your attorney.

Can I hire a stockbroker? Legally, yes. If you can find a stockbroker who knows the startup world and is willing to work on a tiny deal. But it’s a moot point anyway since investors aren’t interested in early-stage startups that approach them through third parties.

Investors Want to Interact with Founders

If I receive an email from a friend introducing me to a startup they invested in, I pay close attention. Warm introductions are great.

If I receive an email from a consultant working with startups, I automatically hit delete.

Early stage investing isn’t about writing checks. It’s about building relationships. It’s about finding founders I believe in.

The founders need to reach out to me directly and tell me why they want an annoying curmudgeon like me to invest in their startup. What value do I bring beside writing a check? Because frankly, if it’s just about money, I’ll invest in S&P 500 index funds or real estate.

When I get a generic message from a 3rd party telling me about some great startup that I ought to be interested in, it’s spam. I’m just a name on a giant mailing list. They’re just looking for money. They might be selling an investment in a startup, a real estate deal, or bad art. Sorry, not interested.

To attract investor interest, the founders have to do the outreach themselves. Not a 3rd party, not a marketing assistant, not an admin. Yes, you’re busy; I’m busy too. VC firms have interns and associates to sort through the 99% of deals that don’t meet their requirements — I don’t. And like most angel investors, I have a full time job outside of startup investing. If you don’t have time to reach out to me personally, then sorry, I don’t need to know more.

So founders, reach out to investors individually and tell them why they should be interested in investing in your startup. You have to be able to do it yourself if you want to succeed. Shortcuts to fundraising are tempting, but they’re a dead-end.

Disclaimer: Lest I be accused of lawyering without a law license, let me make clear I am not a lawyer and this should not in any way be considered as anything more than background information. If you are considering hiring someone to help with your fundraising, absolutely talk to your attorney first. If you rely on free advice from random people on the internet to make important decisions, I take no responsibility whatsoever for whatever fate befalls you.

With their new teleporter technology, SüprDüpr, doesn’t need any help raising $1B in funding. But they’ll need good lawyers to help with the murder charges against the founder when the company’s Chief Elephant Officer goes missing. Read what happened in the Silicon Valley mystery novel, To Kill a Unicorn.