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The following is from Ask The VC, where Brad Feld and Jason Mendelson of Foundry Group answer questions related to venture capital investment and startups: Q: My lawyer is asking for a "success fee" for a referral to a potential investor in my business. Since he'll be doing the legal work, he's offered to charge only 3% on the amount funded (solely from this one contact) as opposed to a 5% that a typical investment banker would charge (even though he's not an investment banker himself). As this is the first venture I'm actually raising capital for, I am simply unfamiliar with this practice in the legal world. Is this a common industry-wide practice? Should I be wary of this offer? Although I don't feel like he is trying to take advantage of me in any way, it does feel a bit like he's trying to double-dip. A: (Jason) Without sounding too unprofessional, I want to vomit. This is egregious behavior by your lawyer and you should not accept paying ANYTHING to him for introducing you to potential investors. First of all, it's part of a lawyer's job to introduce you to any investor contacts he may have. If you get funded, he gets paid and gets to bill you throughout the lifetime of your company. If you don't think he is already making enough money, see my post on start-up lawyer compensation from my personal blog. Second, while investment banks may offer you a deal at 5% (and in my experience this can be negotiated down), individuals who find money for you (normally called "Finders") normally charge in the 1-2% range, so his quote is at least 50% too high. Lastly, venture capitalists prefer to invest in deals without finders. We don't like funding a company that has to pay someone part of the deal proceeds. We want our money to be used to operate and grow the company. You will see many VC term sheets that have provisions that specifically call out the absence of finders fees. So yes, your lawyer is double dipping. And that is stating it very nicely.
Comments
From: Bruno Mitchell,
Startups typically use the "Lehman Formula" for finders fee ... 5% of 1st million raised.
Posted on:
July 28, 2008 6:40 PM
From: RM,
As an Investment Banker trained as an Attorney who works with firms ranging from start-ups to middle market firms of $200 million in revenue my view is your lawyer may be creating problems for himself and clearly creates a conflict of interest. While success fees can be earned for an introduction to a Venture Capital firm (and notwithstanding that these Venture Capitalists do not like to pay fees)to do so and then do the legal work would in many states violate the Attorneys professional responsibilities. He must be objective in representing his client and if in fact the VC is paying the success fee and the client is paying for his legal work, there is a conflict of interest, as the Attorney cannot represent both sides of a transaction without disclosing it. As for the Investment Banking fees, I have been in this business for over 20 years and have always used an incentive based success fee, which has no relation to any Lehman Formula, which we have not seen in years, except for the smaller, business brokerage type firms. Regarding finders, we have never found them to be of value, as we believe to make an introduction or referral to a financing you must first conduct your own due diligence and understand the company, it goals and future in detail. Only then can you make the proper referral and understand what the Company is looking for and work towards making it happen. The problem with the finder relationship is you must do all the negotiating yourself and this takes valuabel time away from running your business and is a lengthy and time consuming process, and usuaullyu not very producxtive as you may need to meet with 20 sources or more, before you find the right one that offers terms and conditions that you will find acceptable. Additionally, one buyer is no buyer. Whetehr it is a company looking for funding or looking to be ac cquired if you have are only talking to one interested party, you have nothing to measure that offer against, therefore you are at their mercy. As investment Bankers it is our job to find multiple interested parties and this comes from having a deep understanding and appreciation for your firm and its operations and hard work in researching those parties that may have an interest in what you have to offer. In almost every case we obtain multiple interested buyers and then professional deal with each and every one to negotiate the best overall deal for our clients. (Seldom is the winner the highest bidder, as other terms and conditions are just as important as the financial arrangements. We want the client to continue to run the business and leave the rest to us. You do what you do best and let us do what we do best. This is why investment bankers, in most cases, earn their fees and have higher success rates than finders. RM Esecson
Posted on:
July 29, 2008 8:08 AM
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Yes he deserves the compensation, it is normal