The Big Idea and how to fund it

Woodbridge corporate and securities lawyer, Joseph Chiummiento, of Core Lawyers, provides information for startups faced with choosing the best way to raise funds for proving out their business plans or ideas.

At some point, every startup has to determine what is the best way to raise money and should understand the implications each choice bears for their business, their intellectual property, their future wealth and exit strategy.

Brokers or Exempt Market Dealers

There are companies registered with the securities regulators (like the Ontario Securities Commission) that make their living by helping startups raise funds. Known as Exempt Market Dealers (“EMD”), these companies are known on Bay Street as “brokers” to some, and can be a division of a law firm, accounting firm, or small to large money management firms.

There are many other “consultants” available on Bay Street that will try to make their services available to startups and dangle the proverbial carrot of being able to raise funds. Most companies realize the distinction. When choosing a relationship moving forward, any startup should ensure they are dealing with a “registered” exempt market dealer as “registration” is required for any company looking to make a living by helping others raise funds.

Using a consultant (without the required registration) to raise funds and paying a finder’s fee or otherwise, could jeopardize or compromise your compliance for audit or legal purposes. Remember, if it looks like a duck, walks like a duck and quacks like a duck, it will be difficult to tell the securities regulator that you were dealing with a chicken.

Brokered vs. Non-Brokered Private Placements

A brokered private placement happens when a registered EMD signs a contract to raise funds with a startup, completes due diligence (reviews all your books, records, assets in detail), and agrees to arrange meetings with institutional (big funds) and retail (individuals with high net worth) investors.

A non-brokered private placement is a money raise being managed fully by the startup, without the help of an EMD, and typically involves the startup reaching out to its founders’ network of contacts to arrange meetings with retail and institutional investors.

Generally, a brokered private placement increases the credibility of the startup raising funds as it communicates the confidence of the EMD in a particular group, which can be a positive in the eye of the investor. The advantage of going with the brokered option lies withing the fact that there is a greater likelihood of completing a raise with good feedback. The downside is the raise will take longer and come at a higher cost for the startup.

How to Choose a Broker or Exempt Market Dealer

A relationship with an EMD typically contains the following elements in one form or another:

• A term of 12 to 18 months.
• A right to be the lead broker on any future raises – ie. have the largest book participate in a future raise.
• Contain a right of first refusal to be the broker for a future raise.
• A fee of no less than 6% in cash and 6% in warrants (rights to buy your shares for up to 24 months at a set price) or payment in stock.
• a clause confirming the startup will pay all costs of the broker, including its legal costs.
• An indemnity clause ensuring the startup will fully indemnify the brokerage in the event of a lawsuit of any kind (including from a securities regulator).
• A success fee or a penalty provision in the event future financings are not fulfilled – used primarily to protect the investors they bring to the table who are looking for a liquidity event.
• In some ways, choosing a broker can be like choosing to live with someone for a year. Understanding the language, the typical negotiation drivers and the reputation of the group you are dealing with is important when choosing a broker/EMD to work with.

Most lawyers can help you understand the difference between value creation in the contracts versus fear and greed sales pitches designed to push you to blindly sign a broker’s engagement agreement. This valuable assistance will give you the confidence you need to make the right choices having obtained all the right information.

Please feel free to contact me directly for more information or to discuss your individual situation.

Direct Line:905.851.8180  ext. 2
Email: joseph@corelawyers.ca