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Thursday, August 6, 2009

Optimizing The Entrepreneur/Broker Fund Raising Relationship

Entrepreneurs engaged in a fund raising effort have a number of options at their disposal when seeking funding. Entrepreneurs are usually familiar with friends and family, angel investors and venture capitalists as sources of funding. Another way to obtain funding is to engage a broker. Broker/entrepreneur relationships are commonly used to bridge the gap between investors and entrepreneurs. Broker relationships come in many forms creating a need to fully understand the relationship to maximize the potential for fund raising and to decrease the possibility of misunderstanding between the entrepreneur and the broker.

The following are important pieces of information that should be known before a broker is contracted.

  1. The broker's operational mode.
  2. The range of services provided by the broker.
  3. The compensation model of the broker.
  4. The tasks expected of the entrepreneur in the broker/entrepreneur relationship.
  5. The term of the contract.
  6. How the entrepreneur funds will be used (if funds are being transferred).
  7. References for the broker.
  8. Funding sources to be contacted by the broker.
What Does A Broker Do? Brokers can provide a number of services including document preparation, consultation, deal negotiations and raising capital. The range of services provided by the broker influences the compensation that the broker receives. It also influences what is expected of the entrepreneur during the funding process. A funding broker acts in a similar manner to a mortgage broker. The funding broker usually (not always) is not the funding source. They make a connection between the entrepreneur and the funding source. There are exceptions to this rule. Brokers may decide to invest their own funds in a venture. However, this usually occurs after the broker has negotiated a relationship with the funding source. It is rare for a broker to take a primary or first mover position in a funding effort.

When Should An Entrepreneur Use A Broker? - There are a number of reasons why a business owner may use a broker.

  1. Identify Funding Sources - Newly minted entrepreneurs frequently do not have contacts in the investment community. It certainly is possible to contact funding sources directly and is advisable even if you do use a broker. However, a broker will usually have long standing relationships with investors. Using a broker can give you a quick introduction to a range of investors that you would normally not encounter as a free lance entrepreneur.
  2. Document Preparation - Investors frequently want to see a number of documents explaining the business in a way that allows them to evaluate the business from their vantage point. These documents can range from a reasonably brief overview summary (PowerPoint elevator pitch) to a complex business plan providing multiyear sales projections and operating budgets. If an entrepreneur is uncomfortable preparing these documents they may call upon the broker to create these documents.
  3. Negotiations and Deal Closing - Raising capital is not much different from negotiating any large commitment financial transaction. Something is being exchanged for a significant amount of money. If you are unfamiliar with negotiating investment deals a broker can be a handy resource to help sort out what is best for both parties.
Sources of Capital - Brokers tap angel investors, private investors, VC's and institutional investors as sources of funding for their entrepreneur clients. Each broker will have their own collection of investors. The investors they work with will be influences by the "stage" of the company they are seeking investment for. For instance, if a company is a startup with no real revenue and still in the idea or development phase the broker is most likely to seek funding from individual or angel investors. If a company already has a customer base and a revenue history the broker may seek funding from traditional venture capitalists.

From the entrepreneur's perspective it is important to understand what funding sources are going to be tapped and why. The funding sources will have an influence on how long it will take to close a round and the viability of the funding source. The funding sources will also influence the likelihood of the business getting funding. For instance, if a broker is contacting traditional venture capital sources for a very early stage company then it is unlikely that the funding effort will be successful. The broker may not be willing to reveal the details of the funding source out of concern of revealing the funding source to another broker. However, they should be able to tell you that they are seeking funding from an individual, angel, VC or institutional investors.

Can An Entrepreneur Go Directly To Investors During The Broker Relationship? Unless the broker relationship specifically states otherwise yes you can. It is advised that you do not engage in a broker relationship that prohibits this activity. Brokers have a stable of investors that they contact. The stable has a finite amount of investors in it. An entrepreneur needs to cast a wide net out into the investor pool do not limit you investor options to just one section of the pool.
If you do decide to seek funding outside of the broker relationship inform the broker of what you are doing and who you are contacting to make sure there is not overlap of effort. An independent effort to raise funding will also have an ancillary benefit of increasing the fund raising experience level for the entrepreneur. It will also give them an appreciation for what the broker is doing for them.

How Are Brokers Compensated? - Brokers can be compensated in a number of different ways. They may receive cash, stock, stock options or a combination of stock and cash for their services. When negotiating a contract with a broker make sure you understand the compensation structure, when payment is required and specifically what the broker is being compensated for. If the broker is performing a number of functions including preparation of the executive pitch, creation of a business plan, formulation or financial projections, introduction to investors, closing funding, etc. make sure you associate compensation with each of these tasks. This makes it easier to establish the relationship of accountability and compensation.

What Is The Entrepreneur Responsible For? In many ways the entrepreneur is responsible for making the broker successful in closing funding for the entrepreneur. The fact that an entrepreneur is using a broker to raise funds does not exonerate the entrepreneur from assisting in the fund raising process. The entrepreneur has to make their business viable and marketable.

  1. Business Plan - Even if the broker is creating the documentation for the business plan the business owner has to create the content for the plan. This plan may be massaged and reformatted for an investor by the broker. The broker may provide input to the plan. However, the business owner needs to understand the business plan and drive the business plan development process.
  2. Team - A team should be assembled that demonstrates that the company cam execute on the plan when funds are raised.
  3. Executive Summary - Perhaps the most important document in the fund raising process is the executive summary or elevator pitch. It is the first impression that a potential investor will get of a company. The details for this pitch will be provided by the business owner. The broker my change the format and ask for additional information.
  4. Pitching The Company - The broker will introduce the business owner to investors and describe the business to investors. However, the investors will want to meet the business owner and the team and they will want the business owner to pitch the company. The business owner will sell the investors on the company the broker's responsibility is to establish the contact.
  5. Self Assessment - The entrepreneur should conduct a self assessment as to their preparedness for the funding road. Many entrepreneurs under estimate the commitment associated with starting a business and raising funding. The funding road can long, frustrating and expensive. Only a very small percentage of companies seeking funding receive it. In many cases the initial funding is lower then expected. Ideas are seldom funded. A demonstration of the viability of the business is required before an investor will engage. The entrepreneur will most likely have to fund the first stage of funding. Make sure you are ready for the show before you jump into the pool!!
Managing The Broker Relationship - Managing the relationship with a broker is key to the success of the funding effort. In many ways managing the broker relationship is no different than managing direct funding sources. However, there are some important difference.

  1. Legal Advice -It is suggested that an entrepreneur engage legal counsel to review a broker contract. Carve out what each party is responsible for and when control actually passes over to the investor.
  2. References - The broker should be willing to provide the client with references. This should include entrepreneurs that have used the broker service and possibly a funding source that has worked with the broker.
  3. Time Lines - Establish a start and finish time for the relationship. The funding road can be long with no guarantees that the broker can claose funding. Give the broker a period of time to close. If it does not work out move on to another source or extend the contract with a new set of objectives.
  4. Exclusivity - Is is advised that a relationship with a broker be non-exclusive. An entrepreneur should be continuously looking for funding from a number of different sources.
  5. Clarity of Tasks - the broker my perform many tasks for the entrepreneur. Make sure you are both clear what these tasks are and what the entrepreneur and broker are responsible for.
  6. Compensation - Put a price tag on each task the broker is going to perform and what constitutes a completed task and acknowledged payment.
  7. Ending The Relationship - There should be a term to the contract and a clarification of what rights the entrepreneur has to the materials created and relationships established during the funding process after the contract is terminated.
In conclusion, the broker relationship can be a useful option for an entrepreneur during the fund raising process. Broker relationships come in many forms requiring a clear understanding of the responsibilities and compensation associated with broker executed tasks. Clarity of responsibility and compensation reduces the likelihood of misunderstandings.

The entrepreneur is in control of their destiny and is the party responsible for getting the business funded. A broker is a "facilitator" and will only be as successful as the entrepreneur and business warrants.


Susan said...

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.



Anonymous said...

I am considering hiring a broker to raise capital for my start-up. I found your blog very interesting and helpful. Do you have any information as to what is the standard commission brokers take these days?

Thank you,

Anonymous said...

I am considering hiring a broker to raise capital for my start-up. I found your blog very interesting and helpful. Do you have any information as to what is the standard commission brokers take these days?

Thank you,

Kevin Flood said...

There is no single price for engaging a dealer/broker because the cost is dependent on the extent to which the broker assists the client in the preparation of the material and the amount of promotion they engage in to "sell" the deal to an investor. The more work you put into the project yourself should influence the cost of the fund raising effort.

In addition, most but not all brokers will ask for a percentage equity in the newly funded company. The ratio of equity to actual out of pocket cash influences the out of pocket cost.

In this economy it would be prudent to negotiate the price down as far as you can and potentially not outlay any cash until an actual deal is closed. Of course, this is easier said then done.