Determining the right approach to fundraising can be challenging, which is why companies across industries often seek assistance and guidance from fundraising experts. Various professionals specialize in helping companies raise capital, but for startups and growth companies, the two most common options are fundraising consultants and broker-dealers. The question remains: which professional figure is best suited for each specific endeavor?

Startups and early-stage companies often seek external assistance when it comes to raising capital, commonly relying on fundraising consultants and broker-dealers. While there are similarities between these two figures, it is crucial for startup founders to comprehend the differences and determine their suitability for specific situations.

This post aims to provide context, examine the features of both service providers, evaluate the pros and cons, and showcase real-life examples where one type of provider proved more effective than the other.

Understanding the Distinction: Fundraising Consultants vs. Broker-Dealers

Fundraising Consultants

Please note that when conducting a Google search for "fundraising consultant," the results often pertain to raising money for political, non-profit, or educational causes through donations. However, in this post, we will specifically address fundraising consultants who work on projects where capital donors contribute funds with the expectation of financial returns. It is worth mentioning that consulting organizations such as McKinsey, Bain, BCG, and others may also engage in capital raising campaigns. Nevertheless, the focus of this post is on individual consultants, often working on a freelance basis.

A fundraising consultant is responsible for raising funds for a company by creating necessary materials such as investor-marketing collateral. This includes documents like teasers, executive summaries, business plans, placement memorandums, and pitch decks. Additionally, consultants may provide financial projections, models, and valuation analyses, as well as organize data rooms. They often assist with articulating strategy, supporting business development efforts, and making the company more attractive to potential investors. Consultants also define the target investor base, handle initial outreach and follow-ups, review term sheets, and document final deal terms.

However, it is important to note that while the fundraising consultant provides guidance and advice, the ultimate responsibility for driving the capital raising process to a successful conclusion lies with the founders or the executive team.

Typically, a consultant is compensated in cash for their services based on a predetermined timeframe, whether it be hourly, daily, weekly, or monthly. The compensation structure may include baseline thresholds, regardless of the actual time commitment. These terms are established and outlined in an agreement at the beginning of the engagement. Hourly rates vary depending on factors such as the consultant's experience, track record, availability, and location.

• Rates can range from as low as $30 per hour to $150 per hour. Weekly or monthly rates are often linked to hourly rates by setting a minimum number of hours.
• For instance, a consultant with a rate of $150 per hour would have a weekly rate of $6,000 ($150 x 40 hours) and a monthly rate of $24,000 ($6,000 x 4 weeks).
• The highest monthly consulting rates have been observed around $50,000.
• It is relatively uncommon for companies to provide bonuses to consultants unless they aim to incentivize specific milestones. However, attaching compensation to certain success-related events may be deemed unlawful.

Broker-dealers

Defining a broker-dealer can be intricate due to the legal intricacies involved. Although the terms "broker" and "dealer" are commonly grouped together as "broker-dealers" or BDs, each term has its own distinct legal definition as outlined in the Securities Exchange Act of 1934. The Securities and Exchange Commission (SEC) plays a crucial role in clarifying these distinctions.

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[A broker is] any person engaged in the business of effecting transactions in securities for the account of others.

While

[A dealer is] any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.

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To operate legally, both brokers and dealers are required to register with the SEC and become members of FINRA, a self-regulatory organization responsible for licensing securities professionals. In the past, financial service providers often performed both broker and dealer functions, which led to the combination of the two under the term "broker-dealer" or "BD." Individuals who pass licensing exams, known as "Registered Representatives," and maintain their affiliation with registered broker-dealers can lawfully receive compensation for facilitating securities transactions. This means they can be rewarded with a success fee if a transaction successfully closes.

Although it may seem that these definitions primarily pertain to publicly-listed companies, it is important to note that securities laws in the US also extend to the sale of securities by private startups through private processes, unless specific exemptions are met. As a result, private capital raises are also subject to regulation by the SEC, and individuals involved in executing such transactions must possess the necessary licenses and registrations. This ensures that proper oversight is maintained even in the context of private fundraising activities.

In 2017, there were a total of 630,132 registered representatives affiliated with 3,726 broker-dealer firms in the United States. Broker-dealers come in various forms, ranging from large and sophisticated securities firms like Fidelity, Charles Schwab, or TD Ameritrade, to full-service investment banks such as Goldman Sachs, JP Morgan, or Morgan Stanley. Additionally, there are smaller regional firms that may have only a handful of employees. The diversity in size and scope reflects the wide range of entities operating as broker-dealers in the financial industry.

The responsibilities of a broker-dealer (BD) closely align with those of a fundraising consultant working with startups. The sale of securities essentially involves the process of raising capital, and as such, BDs help companies by preparing appropriate marketing and due diligence materials. In essence, BDs support companies in effectively navigating the capital-raising process, ensuring that all necessary documentation and materials are in place to attract investors and conduct thorough due diligence.

One notable difference between broker-dealers (BDs) and fundraising consultants lies in their compensation structures. BDs often receive retainers as their remuneration. The size and frequency of these retainers vary significantly and are subject to negotiation between the client and the BD. While BDs may argue that retainers are necessary to cover their fixed costs during the transaction process, they may choose to waive the retainer entirely if they consider the client highly desirable or believe they can swiftly close the deal. Retainers for early-stage and growth companies can range from $10,000 to $150,000, either as a one-time payment upon signing the engagement letter or as a monthly payment throughout the capital raising assignment. It is common for high retainers to be credited against the success fee, which is explained below.

The primary component of a broker-dealer's (BD) compensation is the success fee, which varies and is typically a percentage of the total funds raised. It is not uncommon for the success fee to include equity in the company. The success fee is calculated by multiplying the fee rate by the proceeds from the capital raise, excluding any expenses. For instance, a 5% success fee on a $5,000,000 raise would result in a $250,000 fee for the BD. Success fee rates generally range from low single-digit percentages to low teens, with the specific rates determined by factors such as the size of the offering and the desired total compensation. Most BDs aim for a minimum compensation of $250,000-$300,000 per deal and target several million dollars over the course of the relationship, which may involve multiple capital raises, M&A transactions, or advisory engagements. It is common to encounter success fee rates in the range of 4% to 8% for fundraising engagements.

In addition, equity compensation is also a component of the overall compensation structure for capital raising activities. Typically, the rates for equity compensation are similar to, or slightly lower than, the cash success fee, although this is not a strict rule. This form of compensation is usually provided in the form of warrants, which grant the BD the option to purchase securities of the company at the same terms or a slight premium as offered in the transaction, within a timeframe of approximately five years. For instance, if the company sells 100,000 shares in the offering and the BD has a 5% warrant, the BD would be granted 5,000 warrants if they choose to exercise them when the warrants are in-the-money.

Comparing Fundraising Consultants and Broker-dealers: Similarities and Distinctions

When it comes to fundraising consultants and broker-dealers (BDs), there are both similarities and differences in their roles and compensation structures.

Similarities:

1. Capital Raising: Both fundraising consultants and BDs assist companies in raising capital by preparing marketing materials and conducting due diligence.
2. Financial Expertise: Both professionals possess financial expertise and knowledge of the securities industry.

Differences:

1. Compensation: Fundraising consultants typically receive retainers and success fees, while BDs often receive retainers, success fees, and equity compensation in the form of warrants.
2. Scope of Services: Fundraising consultants focus primarily on capital raising strategies and advisory services, while BDs offer a broader range of services, including securities sales, trading, and investment banking.
3. Regulatory Oversight: BDs are subject to extensive regulatory oversight and must comply with securities laws and regulations, while fundraising consultants may not be subject to the same level of regulatory scrutiny.

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Fundraising consultants and broker-dealers share certain similarities. For instance, both entities serve as agents for their clients, representing them and acting on their behalf when engaging with investors. However, as agents, they do not have the authority to make decisions without proper client authorization. Additionally, they typically do not bear liability for their actions during the engagement. In contrast to lawyers, whose agency is considered "universal," fundraising consultants and broker-dealers do not owe a fiduciary duty to their clients. Consequently, their actions may not always align with the best interests of the client.

Consequently, both consultants and broker-dealers may be motivated by self-interest, aiming to maximize their financial gains from the client engagement. This could result in prolonging the consulting relationship unnecessarily or prioritizing closing deals over securing the best possible outcome. Additionally, consultants and broker-dealers often handle multiple engagements and clients simultaneously (although individual consultants may have fewer concurrent projects). The ultimate and significant similarity lies in the fact that neither consultants nor broker-dealers work with a long-term alignment to the company's interests.

However, there are significant differences between the consultant and the broker-dealer. One major distinction lies in the available resources. As the name suggests, an individual consultant usually operates as a sole practitioner. In contrast, a broker-dealer is typically an organization that offers the advantage of a team, providing a diverse range of expertise across various areas and a deeper understanding of the market. This includes insights from both the financial and strategic investor perspectives, giving them a broader perspective and greater depth of knowledge.

Another notable distinction is the individuals responsible for executing the work. In the case of a consultant, it is highly likely that they will personally handle the tasks, providing the client with direct interaction and representation from a senior professional. On the other hand, broker-dealers often involve junior team members as the primary contacts and drivers of a deal. It is important to note that this may not be the case universally, and in smaller broker-dealer firms, the transition from a "senior" to a "junior" role may be less pronounced.

The most notable distinction, as mentioned earlier, lies in the realm of compensation. Consultants are prohibited from receiving compensation based on the success of a transaction. This is to prevent the risk of potential legal consequences, such as the SEC annulling a successfully closed deal and requiring the return of funds to investors. In contrast, broker-dealers can be compensated on a success-fee basis, and many prefer this business model as it enables them to charge higher fees for their services.

Comparing the Advantages and Disadvantages of Engaging Fundraising Consultants and Broker-Dealers

Advantages and Disadvantages of Hiring Fundraising Consultants

One advantage of hiring a fundraising consultant is the ability to choose a highly tailored skill set. While it may be more challenging to find, clients have the opportunity to recruit specialists who possess the specific expertise required to achieve their objectives. For instance, as an example, a former client hired me as their interim CFO due to my experience in reverse-mergers and subsequent capital raising, which I had successfully executed on multiple occasions before. This allowed me to bring a unique combination of transactional knowledge to the table.

Another advantage of collaborating with a consultant is their direct engagement with senior management. As seasoned executives themselves, they are capable of providing the level of advice and guidance that typically only senior-level professionals can offer. A few years ago, I provided consultation services to a generic biologic drug manufacturer, specifically in the field of biosimilars. They were seeking substantial funding, in the range of tens of millions of dollars, for a new insulin manufacturing facility. Their strategy involved pursuing FDA approval and securing plant financing simultaneously to expedite market entry. However, I recommended a phased approach: first, meet with the FDA to confirm the approval process, raise equity for FDA clearance, and then seek alternative funding options for the manufacturing plant. While this strategy would have extended their path-to-market by six to nine months, it would have prevented significant dilution for the scientific founder.

Consultants offer additional advantages, such as cost-effectiveness and access to a wide range of resources. The costs associated with consultants are transparent and can be monitored in real time, as they are typically based on the number of hours worked or a similar metric. In absolute dollar terms, these costs tend to be lower than success fees. Smaller clients can leverage fundraising consultants as flexible human resources to assist with non-fundraising tasks. They can be quickly onboarded and separated without significant obligations or restrictions. When it comes to the next funding round, the company has the option to rehire the same consultant or choose a different one. Furthermore, consulting engagements are adaptable, allowing companies to recruit multiple contractors simultaneously with complementary skill sets. For instance, I once consulted for a blood products company where I focused on securing angel and early VC funding, while another consultant worked in parallel to secure grant funding.

One significant drawback of engaging a fundraising consultant is the financial cost. Consultants are generally more expensive to hire compared to traditional employees, as their rates often account for the idle periods between clients. This can make them up to three times more expensive than a part-time or full-time employee. Moreover, cash payments made to consultants do not guarantee a successful capital raise, and there is no refund available if the consultant fails to achieve the desired results.

Another disadvantage is the unproductive onboarding time required when working with a fundraising consultant. Each consultant needs to invest time in understanding the company's history, culture, and management style. Unfortunately, this period of familiarization can be less fruitful and may result in additional expenses for the company. I once consulted for a Canadian healthcare IT company that decided to hire three consultants simultaneously to drive their capital raise. However, after one month, one consultant was still in the process of asking the CEO diligence questions and had not yet made any investor calls. It became evident that this consultant was not a good "cultural fit," and their engagement was terminated in the fifth week. Nevertheless, the company was still responsible for paying the billable hours of this consultant. This risk also applies to future engagements, as there is no guarantee that the same consultant will be available, forcing the client to bear the cost of another consultant's learning curve.

In addition to the points mentioned earlier, it's important to note that unless there is a clear "success-based" incentive structure in place, the alignment of incentives may be lacking. In the case of hourly or retainer-based consultants, their motivation to expedite the deal may be limited. This is because their compensation is not directly tied to the successful completion of the project. It is crucial to establish explicit contractual arrangements to ensure that consultants are incentivized to work towards achieving the desired outcomes in a timely manner. Failure to do so may result in a misalignment of goals and potentially slower progress towards the desired goals.

Finally, it is worth noting that the relationship with a consultant is often non-exclusive. As a result, it is not uncommon for consultants to work with multiple clients simultaneously. This can make it challenging to ensure the consultant's full dedication and focus on a particular project. Enforcing strict commitment from the consultant can be difficult due to their other obligations and commitments. It is essential to establish clear expectations and communication channels to maximize the consultant's availability and attentiveness to the project at hand. Regular check-ins and effective collaboration can help mitigate this potential drawback and ensure a productive working relationship with the consultant.

Advantages and Disadvantages of Hiring Broker-dealers

The majority of broker-dealer firms are relatively large in scale, even the smaller ones tend to employ multiple professionals. To illustrate, during my tenure in the Equity Private Placement Group at Cowen, our deal teams would consist of up to seven individuals from various product and industry teams. This presents a notable advantage as it brings a wealth of experience and expertise to the table. The size of the broker-dealer team also means that there is often support staff available to handle time-consuming, arduous, and costly tasks such as conducting industry research or creating visually appealing management presentations with high-quality graphics. This resource availability can greatly enhance the efficiency and effectiveness of the overall process.

A broker-dealer's reputable standing can have a positive impact on a company by bolstering the credibility of its capital raise efforts. Regulatory requirements necessitate broker-dealers to undertake a substantial amount of due diligence before engaging with a client. Consequently, when a company engages a broker-dealer for a capital raising endeavor, it implicitly signifies to the investor community that the broker-dealer has thoroughly assessed key aspects of the business. This may include rigorous testing of the technology, validation of existing or potential customer relationships, market analysis, and other essential evaluations. Such actions affirm that the business has a viable chance of success, strengthening investor confidence in the capital raise.

By collaborating with a broker-dealer (BD), a company can reasonably anticipate a broader outreach to potential investors. Logically speaking, a deal team consisting of two or three individuals can engage with a greater number of investors within a given timeframe compared to a single fundraising consultant. Additionally, BDs maintain regular contact with investors across multiple deals, enabling them to receive faster responses and have the opportunity to pitch investors directly instead of leaving voicemails. While challenging to quantify, investors are aware that BDs offer a continuous stream of investment opportunities and are more likely to cooperate to maintain access to new prospects. During my time as an interim CFO, I once requested our investment banker to leverage the quid-pro-quo approach and ask investors to increase their investment in the deal. As a result, the financing size grew by $2.3 million. I had hoped that investors would respond positively, expecting favorable treatment on future promising deals from the BD. Fundraising consultants, who typically work on only a few deals annually, are unlikely to yield such influence over investors.

Another advantage of partnering with broker-dealers is that, due to the specific dynamics of their involvement and the associated conditions, they may adopt a long-term perspective on the capital raising process. As a result, broker-dealers can assist companies in raising capital in multiple stages. This approach involves securing a smaller funding amount initially to support the business in reaching the next value-creation milestone. Subsequently, after a span of several months, the broker-dealer can help facilitate a larger funding round, ideally at a higher valuation. This phased approach to capital raising allows companies to strategically align their funding needs with their growth trajectory, maximizing their chances of securing optimal investment terms.

However, it is important to acknowledge that there are certain drawbacks to working with broker-dealers. Institutional broker-dealers are adept at marketing themselves and often excel at presenting performance metrics and league table statistics in a favorable manner. Clients must exercise caution and carefully scrutinize the sales techniques employed by broker-dealers. It is crucial to look beyond the surface-level facade and evaluate the suitability and competence of the team. This entails assessing the actual quality and capabilities of the broker-dealer rather than solely relying on their outward image and marketing tactics. By conducting thorough due diligence, clients can make informed decisions and ensure they are partnering with a broker-dealer that aligns with their specific needs and objectives.

Working with a broker-dealer can also present challenges in terms of limited flexibility in marketing and deal structures, despite claims of tailoring solutions to individual client circumstances. Broker-dealers primarily operate on a transaction-based business model, where their earnings are directly tied to the volume of transactions executed. As a result, customization and tailoring of solutions often require substantial time, effort, and persistence with investors, which can conflict with the broker-dealer's bottom line. While they may advertise personalized services, the focus on flow and transaction volume can hinder their ability to provide truly customized solutions that require additional time and resources.

Broker-dealers often include clauses in their engagement letters that grant them implicit influence over the choice of financing structure. These clauses may consist of exclusivity agreements, which require the client to work exclusively with one agent, tails that guarantee payment to the broker-dealer even if they were not involved in arranging the financing, and ROFRs that grant the broker-dealer the right of first refusal for future financing, advisory, or M&A engagements. During my time as an interim CFO for an immunotherapeutics company, I was negotiating with an investment bank known for their preferred convertible debt with warrants structure. However, I made it clear that we would not agree to provide them with tail and ROFR if they proposed any financing structure other than common stock. As a result, they chose to walk away from the engagement.

Collaborating with broker-dealers can be a costly endeavor. Apart from the upfront retainer, cash payments, and equity success fees, the inclusion of tails and ROFRs can potentially bind the client to the broker-dealer for an extended period. While the success-based compensation model may be seen as a way to offset the higher costs, it also creates an incentive for broker-dealers to prioritize closing deals quickly rather than securing the most favorable terms for the client. Unfortunately, this often results in terms that are more expensive than necessary. It's important for clients to carefully consider the potential drawbacks and weigh them against the benefits before engaging with broker-dealers.

Conclusion

The decision to choose between a fundraising consultant and a broker-dealer is influenced by a range of objective and subjective factors. The management team and the company's board of directors must assess the available information and make a decision, acknowledging the inherent limitations of the information at hand. It's important to consider both the short-term implications and the long-term consequences, including the company's ability to switch broker-dealers if needed. In many cases, the stage of the company plays a significant role in driving the decision, with early-stage companies often favoring individual fundraising consultants, while later-stage companies tend to lean towards traditional broker-dealers.

Choosing between a broker-dealer and a fundraising consultant requires careful consideration of short-term implications, long-term ramifications, and the stage of the company, as each option brings its own set of advantages and limitations.