Once a private securities offering is ready to launch, issuers and fund managers must tackle the challenge of raising capital. Registered broker-dealers play a significant role in securities offerings by connecting issuers with potential investors. However, an increasing number of unregistered capital raisers, finders, agents, and individuals with similar titles claim they can assist issuers raise capital. Despite such claims, utilizing unregistered individuals to raise capital violates securities law and can subject companies to serious liability.

Registered Broker-Dealers Versus Unregistered Finders

Section 78c of the Securities Exchange Act of 1934 (“Act”) defines “broker” as any person engaged in the business of effecting transactions in securities for the account of others. The Act defines “dealer” as any person engaged in the business of buying and selling securities for his own account. Any broker or dealer facilitating the purchase or sale of securities must register with the Securities and Exchange Commission (“SEC”) and become members of the Financial Industry Regulatory Authority (“FINRA”). Such individuals must comply with certain requirements and work within the bounds of regulatory restrictions, increasing investor protection. Indicators that someone may be acting as a broker-dealer include:

Actively soliciting investors for issuers or entities raising capital
Finding investors, making referrals, or splitting commissions with registered broker-dealers, investment companies, or securities intermediaries
Acting as a placement agent for private placements of securities
Participating in negotiations between issuers and investors
Advising investors on investments
Handling funds and securities
Having a history of selling securities
Receiving transaction-based compensation or payments in connection with the purchase and sale of securities.

Transaction-Based Compensation

A common issue when raising capital is unregistered individuals offering to raise capital in exchange for transaction-based compensation. However, utilizing such individuals can result in severe consequences for issuers and its management team.

Transaction-based compensation, where compensation is directly tied to the amount of capital raised or the success of a securities offering, is a strong indicator of broker-dealer activity by the SEC. Transaction-based compensation structures include commissions based on capital raised, success fees for raising capital, or compensation calculated as a percentage of an offering. Penalties for providing transaction-based compensation to unregistered finders include civil penalties, investor rescission rights, SEC enforcement actions, orders prohibiting future capital raises, and criminal charges.

Best Practices for Raising Capital

When raising capital, issuers should adhere to the following best practices:

Engage Registered Broker-Dealers: If utilizing a transaction-based compensation structure, issuers should only work with registered broker-dealers compliant with SEC and FINRA regulations.
Avoid Using Transaction-Based Compensation: If an issuer is not using a registered broker-dealer then compensation should not be tied to the capital raise.
Conduct Due Diligence: When engaging capital raisers, the management team should thoroughly vet all individuals and entities. This includes verifying registered broker-dealer status and ensuring all regulatory requirements are met.
Clear Documentation: Issuers must maintain clear and comprehensive documentation of all agreements and transactions related to capital-raising efforts. This includes investor disclosures, communication records, contracts with registered broker-dealers, and management compensation structures.
Legal Compliance and Support: Issuers should engage experienced legal professionals to guide the securities process and related capital-raising efforts.

Ensuring compliance with securities law is critical when raising capital and conducting securities offerings. Issuers must be cautious in who they engage to raise capital and how compensation is structured. If you have any questions on the regulatory requirements and limitations when raising capital, please reach out. We’re here to help.