Founders, who are desperate for financing, debate whether the faucet will turn on if they engage a placement agent. This is a question to be addressed in a real-world context. In the first place, the great majority of first-round financing is not economically interesting to an investment-banking firm. The fee for a placement is usually in the range of 2 to 5 percent of the amount raised. Assuming a $1 million first-round financing, a fee of $20,000 to $50,000 is not likely to attract many takers in the investment-banking fraternity, when fees for acting as financial adviser in contested merger-and-acquisition transactions run into eight figures. There are exceptions to this, as in any other proposition. Encore Computer, because of the splendid reputation of its founders, attracted a high degree of interest from major-bracket investment bankers in the seed round; William Poduska, on leaving Apollo Computer and organizing Stellar, was able to titillate investment-banking appetites to a fever pitch. (Neither firm, it should be noted, remains as an independent entity.) However, the traditional founder is wasting his time beating down the doors of the elite investment bankers to help raise money in the early rounds. Smaller investment-banking houses sights are set lower than Morgan Stanley or Goldman Sachs, are more likely candidates, but even they are not enthusiastic about hitting the pavement to arrange a first-round investment because the amount of work is enormous and the payoff is often uncertain.
If an agent is engaged to place securities privately, he will surely act only on a best-efforts basis. A firm commitment in the early stages of a company's history, indeed a firm commitment on a private placement of any kind, is encountered only in special circumstances. Moreover, the founder should understand that the agent is not obligated to sell an untried security; that task remains the responsibility of the founder. The agent is engaged to do the following:
Purchasers in early rounds are not interested in discussing the merits of the investment with a salesman. The founder, and only the founder, has that reservoir of knowledge about the technology and its potential application which potential buyers are interested to hear. Moreover, the agent will look to the founder for a so-called friends list, that is, potential investors already known to the founder.
More importantly, the placement agent will usually insist on a right, in the nature of a first-refusal right, to lead subsequent rounds of financing, a provision that should be approached thoughtfully. If an investment-banking house known only to a few loyal adherents on Wall Street is willing to help out in a first-round financing but at a cost of controlling subsequent rounds, the founder may find that price too stiff. On the other hand, it is unrealistic to expect an investment banker to work enthusiastically on the most difficult financing, that is, the earliest, and then simply take his chances at being remembered with gratitude when subsequent, more lucrative rounds are being discussed.
One value of a placement agent at an early stage is it will, in all likelihood, impose some important imperatives upon the founder, in some cases to his consternation. For example, experienced corporate financiers save time by introducing founders to the real world of early-stage finance and some of the "rules," such as that all moneys raised go into the company (and none of it leaks out to the founder). Often the founder has built up a debt from the company to himself for accrued and unpaid salary, money loaned, and so forth. With his own creditors knocking at his door, the founder may approach a financing with an eye to intercepting some of the money for himself, to pay his urgent bills. A placement agent will rapidly disabuse a founder of that notion.
Joseph W. Bartlett, Special Counsel, JBartlett@McCarter.com
McCarter & English, LLP
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