Be Careful about Paying Brokers to Raise Capital

by Bom Dia

There is a saying in Hollywood that "A good script gets found." The same is true in sports — if you are a good enough basketball player, the NBA will find you, whether you are playing on a Division III team in Alaska or for Duke University. I think that generally the same is true in venture capital — if you are a good startup and you make an effort, you will get an audience with at least a few decent VCs.

Therefore, paying a consultant to find you investors is usually, not always, a waste of money. Brad Feld in his blog Ask the VC had a good post about this in December 2007. I recommend reading the comments to it as well.

Personally, I feel that outsourcing fundraising to people can be of great help to a startup BUT only when those hired have relevant experience and can truly help the company. I don't agree with Brad that it is important that the founder do it themselves. I do believe, however, that the percentage of brokers/consultants that work in this area and REALLY add value is less than 10%.

Here is the major problem: almost all consultants/brokers are motivated to tell a startup that they can raise them money, regardless of whether the startup actually has a chance of successfully doing so. In other words, where the brokers/consultants really rip off the startup is in taking them on as a client when the company does not have a realistic chance of raising capital. Any fool can throw together an executive summary and email it to VCs. It takes an experienced, ethical player to make an objective appraisal and give an honest "go/no-go" to the startup before time and money is wasted. Many times the best advice to a startup is to focus on building the business and hitting milestones before looking for capital. If it is not possible to hit those milestones before raising venture capital, then the startup needs re-evaluate its business plan.

The best rule of thumb is to look at the background of someone offering these services and see if they have previously raised money for early-stage companies (perhaps for their own startup). It is not good enough just to have been in the financial services industry in general: in order to make an objective appraisal of the situation, they need experience in the early/growth stage world. Obviously, direct experience in the same vertical (e.g., consumer internet) also helps a lot, for obvious reasons, including that the broker/consultant presumably has relationships with investors in that space.

A final distinction – paying a success fee is one thing, paying a retainer is another. If someone finds you money, it is usually reasonable that they expect a finders fee or commission of some sort. Paying a retainer to a broker/consultant, however, drains critical funds from the startup and should be done only in the 10% of the cases where the broker will bring real value.