The Unlocking Capital for Small Businesses Act of 2019 (H.R. 3768), introduced by Rep. Ted Budd, R-N.C., would provide a safe harbor for finders and a reasonable regulatory regime for more active private placement brokers. It would have a substantial positive impact on the ability of Main Street entrepreneurs to raise capital.

A “finder” is a person who is paid to assist small businesses to find capital by making introductions to potential investors either as an ancillary activity to some other business (e.g. the practice of law, public accounting, insurance brokerage, etc.), as a Main Street business colleague or acquaintance, or as a friend or family member of the business owner. They are sometimes called private placement brokers. They are typically paid a small percentage of the amount of capital that they helped the business owner to raise.

Finders play an important role in introducing entrepreneurs to potential investors, thus helping them to raise the capital necessary to launch or grow their businesses. This is particularly true for entrepreneurs who have a limited number of pre-existing relationships with affluent accredited investors or who live in cities or states where relatively few people are affluent enough to qualify as accredited investors.  

Neither finders nor private placement brokers should be treated the same for regulatory purposes as a Wall Street investment bank.

The Securities and Exchange Commission’s Regulation D is a regulatory safe harbor which allows companies to raise capital without having to incur the massive expense of going public. In 2018, $1.7 trillion of investment capital was raised using Regulation D, more than any other method.   

Investment in Regulation D offerings is generally, although not exclusively, limited to “accredited investors.” Accredited investors must have an income of $200,000 annually ($300,000 joint) or a residence exclusive net worth of $1 million or more.

In 2000, the Securities and Exchange Commission created a regulatory cloud surrounding finders and issuers that use finders by revoking guidance permitting finders. Then, the commission’s staff, in a series of speeches, argued that finders should have to register as broker-dealers just like a Wall Street investment bank.

The Securities and Exchange Commission’s regulatory position impedes small firms’ ability to access needed capital both by restricting the availability of finders and by causing potential problems when successful small firms later seek venture capital or public financing and encounter counsel raising questions about their prior use of finders.

The commission’s current stance makes the market less efficient by increasing transaction costs considerably and has a disproportionately adverse effect on small firms trying to raise small amounts of capital. Furthermore, whether it is intentional or not, the impact of the commission’s current policy is to protect broker-dealers from competition and to force business owners to use broker-dealers rather than finders to find investors.

The Unlocking Capital for Small Businesses Act of 2019 would enable entrepreneurs to use finders to introduce them to affluent accredited investors without incurring regulatory risks. It would provide clarity and reasonable rules in an area of the law that the Securities and Exchange Commission has allowed to remain in disarray for nearly two decades.

The bill would exempt finders from registration, and private placement brokers would be more lightly regulated than broker-dealers. All anti-fraud laws would remain in place and apply to finders, private placement brokers, and broker-dealers.

Both finders and private placement brokers would be permitted to introduce issuers to prospective buyers. Both would be prohibited from handling or taking possession of customer funds or securities and from engaging in an activity requiring registration as an investment adviser. Private placement brokers would be required to make various written disclosures to all parties to the transaction.

The legislation would provide that finders do not have to register as broker-dealers. It would define a finder as a person that received transaction-based compensation (1) of equal to or less than $500,000 in any calendar year, (2) in connection with transactions that result in a single issuer selling securities valued at equal to or less than $15 million in any calendar year, (3) in connection with transactions that result in any combination of issuers selling securities valued at equal to or less than $30 million in any calendar year, or (4) in connection with fewer than 16 transactions that are not part of the same offering or are otherwise unrelated in any calendar year.

Those that engage in activities beyond the scope of the finder safe harbor would be required to register as private placement brokers under a registration regime that would be substantially less burdensome than the broker-dealer registration regime.

Private placement brokers would be required to be members of a national securities association, which in practice means the Financial Industry Regulatory Authority. Finders would not.

The legislation provides that transactions cannot be voided simply because a finder or private placement broker was involved in the transaction, and would ensure that state regulators may not impose a greater burden on finders or private placement brokers than does federal law.