Put Your Head on my Shoulder

It’s hard to believe that a famous songwriter could cause so much heartache in the entrepreneurial community. Paul Anka is probably the most recognized name in the small company investment community, not because he is a successful entrepreneur (although some would disagree, since he has had a long and successful career as a singer and songwriter), but because of a letter written to him many years ago.

In 1991 Paul offered to open his Rolodex® (a strange term to the under-30 generation) to a company trying to raise money in exchange for a “commission” on sales of securities to people in his network. He asked the Securities and Exchange Commission (SEC) if they would consider him a broker-dealer as a result of this. Being a broker-dealer has significant regulatory effects, including licensing requirements and monitoring by FINRA or other similar organizations. The SEC sent him a “no-action” letter stating that it would not take action against him if he was not a registered broker-dealer. So he opened his Rolodex® and was paid for his contacts. 

Since that time, in my capacity as both a lawyer and an investment banker, I have run into a number of people who have opened their contact databases (for the new generation) in exchange for a percentage of the sales to such people. In the past the SEC has been relatively lax with regard to these “finders,” but recently it has taken a very hard line on them. The SEC has essentially rescinded the views it expressed in the Paul Anka letter. Today, many securities lawyers (including me) would argue that there is no “finder” exception to the broker-dealer registration requirement under the securities laws.

Most executives ask me, “So what if I do this anyway?” Well, here’s the answer: If the SEC investigates and finds that you and your company retained an unlicensed broker-dealer, your company may lose the securities law exemption that it relied on in offering its securities. This essentially gives a put option to all the investors who purchased securities in the offering. It also opens up both your company and its management to civil penalties under the securities laws.

Invariably, their next question is, “Well, how am I supposed to get the offering done then?” It’s not easy, and that is why, in my opinion, there are so few successful companies. Every time someone asks me this I think about a poster I got from one of the big six accounting firms back in 1991. The poster shows a guy sitting in a rowboat in the middle of the ocean; all around him are these huge waves. The caption? “You always wanted to start your own business.”    

A lot of politicians and lawyers are trying to solve the problem. The American Bar Association has suggested that the SEC establish a special “finder” registration procedure that is less onerous than the broker-dealer standard. A number of members of Congress have proposed bills relaxing the exemption standard most companies rely on. However, until one of these solutions is put in place, we all have to deal with the tough reality of the current standard.

As someone who has also started a number of companies and run corporate finance for an investment bank, I sympathize with anyone trying to raise money in today’s tough environment. All I can offer is advice on legal methods and ideas on how to raise capital...and a shoulder to rest your head on.

A Post by Frank Vargas, Guest Blogger