Sorry, Finders...
25.02.2018
A founder-CEO (let's call him Tom) just arrived at his first tech conference, together with his team. The company has been in stealth mode for the last 4 months developing VShopper, a platform that allows brands to create virtual shops on a template VR shopping experience, "Wix for VR" if you will.
Tom has worked on his elevator pitch for a couple of weeks in preparation for this conference, he knows exactly who he wants to approach and what to say. The goal is to get 5-10 meetings and eventually raise $2-3 million. While there's no booth for VShopper, the team is walking around with company shirts and a couple of Samsung Gear VRs for demonstration. While everyone's excited about this conference, there's also some real pressure here. The team was supposed to be well into its funding round by now, and a few development glitches delayed the process. There is now pressure from spouses and parents "to get a real job", so in essence, this actually needs to work for VShopper! This is a startup's experience throughout its cycle. Even when you're hot, you're subject to existential threat.
Two hours into the conference, the team is feeling like it's not going so well at all. The finger food is great, but nobody can seem to make his or her way to the investors, who are all surrounded by founders and unavailable to talk. Once Tom gathers any courage to interrupt, another more eager founder simply butts in and takes the cake. The investors are like bouncers in a night club. They're not making any eye contact and you can't even signal to them that "you're next". Tom feels like he literally might have to grab someone by the hand or push a few founders out of the way.
Finally, a chance. One of Israel's most sought after angels is by the bar, alone in the corner, and Tom can see that a conversation is winding up with no other vultures in sight. Timing wise, Tom can make it exactly when the investor frees up.
10 steps away.
7 steps away.
3 steps away.
"That's a really nice shirt" says a suited man who has just stepped smack in between Tom and the money. "Let me give you my card. Our law firm represents many startups and we're developing a VR niche especially for you. We recently represented VirtualDancer Ltd. in its acquisition by Oculus. And we have great deals for startups." Tom heart sinks. His stomach turns. Another lawyer just approached him and he has missed his chance. The investor has disappeared from the bar.
The team huddles. All have the same accounts. They were hounded by accountants and lawyers and made no quality contact with any of the targets, all of whom were within arm's reach. The dream is literally fading away over this debacle.
Enter Steve. Steve catches the founders as they huddle. "I've watched you guys today and was really impressed. It really looks like you guys have done an amazing job with the product, and finally I can see a big one for VR. You're probably looking for an investment. What's it gonna be? Like 2-3.5 mil? I wanna help you find one."
At this point the founders are thinking "Wow. Steve really gets us! He is literally the solution to all our problems right now."
So what's the deal? Steve is an investment finder, and he wants to connect VShopper to his contacts. "My terms will be market standard. I'll be taking five percent of the cash invested plus an option for 5% in equity. I'll send you my agreement." Within an hour of the conference ending, Tom has the agreement in his inbox. Tom asked around, and indeed "five plus five" seems to be what everyone is calling market standard and the agreement, well, it refers to 5% in cash and 5% in equity. No reason not to sign and proceed, right?
Well, in my experience representing startups for the past 10 years, this simple finder agreement is the one agreement that founders sign the most without consulting a lawyer first, exactly because of the lead up described above, and while the agreement usually presents the market standard percentages, that (the figure "5") is literally the one entry in the agreement that is right. The rest presents the absolute biggest dissonance between what is good for the company and its interests, what makes business sense and what will prevent the founders from regretting the day it was signed.
Here is an attempt to list the items that a company must make sure appear in a finder agreement before signing it. To shed some light on the dissonance mentioned above, we have also listed for you what Tom probably will have found in the agreement served to him.
1. Who can the finder approach?
What the company needs the agreement to say and why: The agreement needs to show that the finder can't just approach anyone in his rolodex. The finder needs to approach the company prior to every single approach and ask for written approval to introduce the company to this or that person. The company needs to have full control over who is approached and by who. Imagine what could happen if you had a few finders working in parallel (this actually will most likely happen…). Imagine if a finder approached an investment entity with which you had a very solid connection that wouldn’t have cost you a finder fee.
What the finder's agreement usually says: The finder wants to be able to approach everyone and to have freedom to do so. An email sent increases chances for a fee.
2. From which transaction is a fee paid?
What the company needs the agreement to say and why: The company is looking for an equity investment right now. It's not looking for a repayable loan. It's not looking for clients. It would be nice to get clients, but we don’t have capital to support them, so getting them might actually be bad for business. And the company is most certainly not looking to get acquired at this point. The dream is still to be a billion dollar company… The agreement must say that the fee is payable only from equity investments (cold hard cash that was actually received (not subject to milestones) in exchange for securities of the company). The agreement also needs to state that fees will be paid from the entity connected to the company or an entity that is controlled by the introduced entity. Finally, the finder shouldn’t be getting fees forever. The fee should be paid from the first investment and if the company is feeling generous, from any follow on investments made within a fixed "tail period" of 12-24 months.
What the finder's agreement usually says: These agreements are horrible in this regard. Finders usually draft it so that they get a fee for anything at all paid to the company by their contacts, in cash or in kind. Imagine this: if the investor for some reason acquired the company, you will have just given an undiluted 5% of your company to the person who made an intro here. It makes no sense. Moreover, finders like their agreements to credit them for a fee from investments made by third parties introduced to the company by the entities that they introduced. This is unacceptable as well. Would your investor like to know that when he makes a call to his mates to follow on with him, they will all have to pay a fee to a third party that didn’t play a role in this?
3. Are there any conditions for payment?
What the company needs the agreement to say and why: The company needs the money right now. It is not looking for money to be invested in 2 years and it needs the finder to really be pushing for the deal right now. Therefore, we recommend that the fee be payable only if the investment is closed within a few months of the introduction (this can be negotiated). Otherwise, what good did the finder do and what quality was the connection? In Israel (and in every startup capital, for that matter) you can get to anyone within a month or two, so what added value did the finder bring to the company if the investment was randomly closed 18 months later?
What the finder's agreement usually says: From a finder's perspective, he or she will get the fee whenever the investment is made and all that matters was the intro. Business development work, attending meetings, helping with the due diligence process are all nice to have. The fee is paid if the investment was made by an introduced party, period.
4. What about the equity component? Are we issuing shares for free?
What the company needs the agreement to say and why: This one is tricky, so we will give you the bottom lines here. First, the finder should be getting options and not shares. Second, the options should be for ordinary shares (this is because the finder is not an investor and requires no downside protection or the type of control that preferred shares provide and as a side note, investors will prefer that the finder not be a part of their share class). Third, the finder should not vote the shares and should provide an irrevocable power of attorney to the company. Finally, the finder should actually be paying for the shares the same price per share of the financing round (i.e. using the cash fee to exercise all or part of the options). This is the true meaning of "five plus five".
What the finder's agreement usually says: From a finder's perspective, it's the other way around. The finder gets shares. If he has to get options, the exercise price is zero. The class is that of the shares issued to the investor. There is no mention of a proxy.
Our tip: even after the great intro with Steve, make sure to send Steve your template finder agreement (by the way, YTech Runway will be sharing one real soon). Remember, if you're not signed with Steve, Steve will never get 5% of any investment made in your company. If you're signed with him, he has a chance and all he needs to do is provide deal flow to his contacts, something they would actually thank him for anyway. For Steve, in all honesty, signing almost any finder agreement is a Pareto improvement in equilibrium (i.e. when all agreements reflect normal standards as described above).
Finders can be a really good asset for a company. Indeed, the term "finder" has racked up some slack over the years. This has to do with finders being paid out of the investment first – something that the investors who they introduced actually don’t necessarily like doing (the money doesn’t go to hire more people and increase the value of the company in which they just invested). When the company pays it out, Tom suddenly looks back and says "wow, I just paid this person $50K for work that I know took maybe 20 hours". By the way, some finders do a lot of business development for the company, but even at 100 hours (around what the lawyers spend on the entire deal), that's $500 per pop. But paying in accordance with the terms of a signed agreement is something we must all feel good about doing. Otherwise bad business karma will come back to get us later (more on business karma in future articles to come). We should just make sure the agreement, in the first place, reflects what is right and fair.
Nimrod Vromen is a Partner at Yigal Arnon & Co. with 10 years of experience in representing Startups, and is CEO of YTech Runway Ltd.
Tom has worked on his elevator pitch for a couple of weeks in preparation for this conference, he knows exactly who he wants to approach and what to say. The goal is to get 5-10 meetings and eventually raise $2-3 million. While there's no booth for VShopper, the team is walking around with company shirts and a couple of Samsung Gear VRs for demonstration. While everyone's excited about this conference, there's also some real pressure here. The team was supposed to be well into its funding round by now, and a few development glitches delayed the process. There is now pressure from spouses and parents "to get a real job", so in essence, this actually needs to work for VShopper! This is a startup's experience throughout its cycle. Even when you're hot, you're subject to existential threat.
Two hours into the conference, the team is feeling like it's not going so well at all. The finger food is great, but nobody can seem to make his or her way to the investors, who are all surrounded by founders and unavailable to talk. Once Tom gathers any courage to interrupt, another more eager founder simply butts in and takes the cake. The investors are like bouncers in a night club. They're not making any eye contact and you can't even signal to them that "you're next". Tom feels like he literally might have to grab someone by the hand or push a few founders out of the way.
Finally, a chance. One of Israel's most sought after angels is by the bar, alone in the corner, and Tom can see that a conversation is winding up with no other vultures in sight. Timing wise, Tom can make it exactly when the investor frees up.
10 steps away.
7 steps away.
3 steps away.
"That's a really nice shirt" says a suited man who has just stepped smack in between Tom and the money. "Let me give you my card. Our law firm represents many startups and we're developing a VR niche especially for you. We recently represented VirtualDancer Ltd. in its acquisition by Oculus. And we have great deals for startups." Tom heart sinks. His stomach turns. Another lawyer just approached him and he has missed his chance. The investor has disappeared from the bar.
The team huddles. All have the same accounts. They were hounded by accountants and lawyers and made no quality contact with any of the targets, all of whom were within arm's reach. The dream is literally fading away over this debacle.
Enter Steve. Steve catches the founders as they huddle. "I've watched you guys today and was really impressed. It really looks like you guys have done an amazing job with the product, and finally I can see a big one for VR. You're probably looking for an investment. What's it gonna be? Like 2-3.5 mil? I wanna help you find one."
At this point the founders are thinking "Wow. Steve really gets us! He is literally the solution to all our problems right now."
So what's the deal? Steve is an investment finder, and he wants to connect VShopper to his contacts. "My terms will be market standard. I'll be taking five percent of the cash invested plus an option for 5% in equity. I'll send you my agreement." Within an hour of the conference ending, Tom has the agreement in his inbox. Tom asked around, and indeed "five plus five" seems to be what everyone is calling market standard and the agreement, well, it refers to 5% in cash and 5% in equity. No reason not to sign and proceed, right?
Well, in my experience representing startups for the past 10 years, this simple finder agreement is the one agreement that founders sign the most without consulting a lawyer first, exactly because of the lead up described above, and while the agreement usually presents the market standard percentages, that (the figure "5") is literally the one entry in the agreement that is right. The rest presents the absolute biggest dissonance between what is good for the company and its interests, what makes business sense and what will prevent the founders from regretting the day it was signed.
Here is an attempt to list the items that a company must make sure appear in a finder agreement before signing it. To shed some light on the dissonance mentioned above, we have also listed for you what Tom probably will have found in the agreement served to him.
1. Who can the finder approach?
What the company needs the agreement to say and why: The agreement needs to show that the finder can't just approach anyone in his rolodex. The finder needs to approach the company prior to every single approach and ask for written approval to introduce the company to this or that person. The company needs to have full control over who is approached and by who. Imagine what could happen if you had a few finders working in parallel (this actually will most likely happen…). Imagine if a finder approached an investment entity with which you had a very solid connection that wouldn’t have cost you a finder fee.
What the finder's agreement usually says: The finder wants to be able to approach everyone and to have freedom to do so. An email sent increases chances for a fee.
2. From which transaction is a fee paid?
What the company needs the agreement to say and why: The company is looking for an equity investment right now. It's not looking for a repayable loan. It's not looking for clients. It would be nice to get clients, but we don’t have capital to support them, so getting them might actually be bad for business. And the company is most certainly not looking to get acquired at this point. The dream is still to be a billion dollar company… The agreement must say that the fee is payable only from equity investments (cold hard cash that was actually received (not subject to milestones) in exchange for securities of the company). The agreement also needs to state that fees will be paid from the entity connected to the company or an entity that is controlled by the introduced entity. Finally, the finder shouldn’t be getting fees forever. The fee should be paid from the first investment and if the company is feeling generous, from any follow on investments made within a fixed "tail period" of 12-24 months.
What the finder's agreement usually says: These agreements are horrible in this regard. Finders usually draft it so that they get a fee for anything at all paid to the company by their contacts, in cash or in kind. Imagine this: if the investor for some reason acquired the company, you will have just given an undiluted 5% of your company to the person who made an intro here. It makes no sense. Moreover, finders like their agreements to credit them for a fee from investments made by third parties introduced to the company by the entities that they introduced. This is unacceptable as well. Would your investor like to know that when he makes a call to his mates to follow on with him, they will all have to pay a fee to a third party that didn’t play a role in this?
3. Are there any conditions for payment?
What the company needs the agreement to say and why: The company needs the money right now. It is not looking for money to be invested in 2 years and it needs the finder to really be pushing for the deal right now. Therefore, we recommend that the fee be payable only if the investment is closed within a few months of the introduction (this can be negotiated). Otherwise, what good did the finder do and what quality was the connection? In Israel (and in every startup capital, for that matter) you can get to anyone within a month or two, so what added value did the finder bring to the company if the investment was randomly closed 18 months later?
What the finder's agreement usually says: From a finder's perspective, he or she will get the fee whenever the investment is made and all that matters was the intro. Business development work, attending meetings, helping with the due diligence process are all nice to have. The fee is paid if the investment was made by an introduced party, period.
4. What about the equity component? Are we issuing shares for free?
What the company needs the agreement to say and why: This one is tricky, so we will give you the bottom lines here. First, the finder should be getting options and not shares. Second, the options should be for ordinary shares (this is because the finder is not an investor and requires no downside protection or the type of control that preferred shares provide and as a side note, investors will prefer that the finder not be a part of their share class). Third, the finder should not vote the shares and should provide an irrevocable power of attorney to the company. Finally, the finder should actually be paying for the shares the same price per share of the financing round (i.e. using the cash fee to exercise all or part of the options). This is the true meaning of "five plus five".
What the finder's agreement usually says: From a finder's perspective, it's the other way around. The finder gets shares. If he has to get options, the exercise price is zero. The class is that of the shares issued to the investor. There is no mention of a proxy.
Our tip: even after the great intro with Steve, make sure to send Steve your template finder agreement (by the way, YTech Runway will be sharing one real soon). Remember, if you're not signed with Steve, Steve will never get 5% of any investment made in your company. If you're signed with him, he has a chance and all he needs to do is provide deal flow to his contacts, something they would actually thank him for anyway. For Steve, in all honesty, signing almost any finder agreement is a Pareto improvement in equilibrium (i.e. when all agreements reflect normal standards as described above).
Finders can be a really good asset for a company. Indeed, the term "finder" has racked up some slack over the years. This has to do with finders being paid out of the investment first – something that the investors who they introduced actually don’t necessarily like doing (the money doesn’t go to hire more people and increase the value of the company in which they just invested). When the company pays it out, Tom suddenly looks back and says "wow, I just paid this person $50K for work that I know took maybe 20 hours". By the way, some finders do a lot of business development for the company, but even at 100 hours (around what the lawyers spend on the entire deal), that's $500 per pop. But paying in accordance with the terms of a signed agreement is something we must all feel good about doing. Otherwise bad business karma will come back to get us later (more on business karma in future articles to come). We should just make sure the agreement, in the first place, reflects what is right and fair.
Nimrod Vromen is a Partner at Yigal Arnon & Co. with 10 years of experience in representing Startups, and is CEO of YTech Runway Ltd.
