As any lay student of economics will be aware, in times of market dislocation, “cottage industries” will pop up to fill the market need. In college, the dearth of available and affordable student housing created a seedy underworld of apartment brokers that would charge fees to students to secure them housing. Often times, these were hardly outside “finders” at all – they were often the apartment managers themselves. Rather than simply offer the apartment to the best applicant, as their job description would suggest, these managers carved out a nice little side business for themselves by effectively auctioning off the available apartment to the student — or typically, the student’s parents — most willing to pay the highest finders fee.
Fortunately, while securing funding remains challenging in the current environment, I have yet to hear of angel groups charging finders fees to invest in companies. Let’s hope it doesn’t come to that. Instead, there seems to be a bit of a boomlet of groups and individuals offering start-ups introductions to investors and charging for the service. This is nothing new. Some angel groups have long charged start-up companies to present at their conferences and many of these angel organizations continue to defend the practice as necessary to offset organizational and event costs. I would suspect that there is merit in a few of these cases, but I do not understand why these angel organizations cannot devise another compensation model so that struggling start-ups are not footing the bill.
Jason Calacanis recently opened a new salvo in this debate by taking issue with a few angel organizations that charge start-ups to appear at their conferences. Additionally, there are individual “finders” now openly offering introductory services to start-ups for upwards of $7,500. This fee is not a success fee, mind you, it is simply for the introduction to a venture fund or angel investor. Whether that introduction leads to an investment in the start-up or not is irrespective of the fee burden to that company.
Like most in the venture community who have opined on this, I take issue with any group or individual that charges companies simply for an introduction to a potential investor. However, where I part company with the other critics is that my opposition to the practice is not based upon some discomfort I have in fee-based services for start-ups as a whole. There are lots of good advisors and consultants out there that work with start-ups. In the course of a year, I see many pitches for potentially promising companies that are a mess and could really benefit from an experienced set of eyes to refine them. This can be quite valuable. Refining a set of documents or helping on a young company’s strategy is enormously time-consuming and these advisors should be properly compensated. Equity is best, but one cannot pay the mortgage on equity alone given the high failure rate of young companies. Painting these professionals with the same brush as “angel finders” is quite unfair as many do good work helping young companies grow their businesses and attract funding. Rather, where I find the whole “fee-based introductions” that angel finders practice objectionable is that it seems to completely undermine itself with bona fide investors. Let me explain.
“Finders” come in all shapes and sizes and even the most reputable professional services providers often either directly or implicitly dangle the carrot of investor introductions to secure their start-up clients. Some of this is legitimate; much of it dubious at best. The most common complaint I hear comes from start-ups themselves who engage high-priced Silicon Valley law firms for their legal work based upon the assumption that the law firms will tap their VC networks to help the young companies secure required funding. While this does happen in some instances, I would submit that this is more the exception than the rule. Many on the investment side receive daily email blasts from these kinds of firms hocking their latest clients and often times these cold pitches are a quick one-way trip to the deleted items folder.
Bottom Line: While many high-priced, pedigreed law firms do good work and are a value to the community, if you are a young, cash-strapped start-up and you’re hiring a $500/hr law firm to do your most basic corporate formation work mostly because you think that that law firm can get you in front of ivy league venture firms, you’ve already proved to me that you’ve flunked Entrepreneurship 101.
As to the looser confederation of intro-only finders out there, common sense should prevail here. Never pay for just an intro. If an angel finder or other intermediary loves your company so much that they feel it is fundable among their “network of angels and VCs” then they should either (1) prove that conviction by putting their own money in the deal; or, (2) get involved as a board director or in another capacity where they have equity and, hence, a stake in the company being funded.
Think about it this way: when a venture or angel fund is sent a deal referral from an intermediary, the first thing that is considered is the value of that relationship. If this is someone the fund has known for some time and that generally refers interesting deals, the fund will give that deal more consideration that if the opportunity came from an unknown person or “over the transom.” The second factor the investor looks at is what the interest of this person is in showing that investor this particular deal. The VC partner or angel fund deal manager would ask: Is he/she an investor? Why are we getting it? Why our firm versus the hundreds of other firms out there? However, If the VC or angel gets a deal from someone who is being paid just to make the intro, it’s pretty much a dead issue. For a referral relationship to be valuable, it has to be based upon reputation and reputation is only built over time by being associated with quality companies and quality entrepreneurs. A Rolodex of top venture firms can be wrecked almost overnight by sending out low-quality opportunities. If the angel or VC intermediary is being paid for an intro, that intermediary is not discriminating because it implies that any company that pays the fee will secure the intermediary’s services, which means the value of the referral to reputable investors is just about zero. Indeed, the intro from this kind of intermediary could be more damaging than no intro at all because the venture and angel community is very small and no investor wants to feel they are looking at an opportunity that is being shopped simultaneously to everyone else in the community from someone being paid to do so.