Who Wouldn't Want a Licensed Broker-Dealer?

Unlicensed investment brokers across the country are scurrying to Kaplan and Sylvan Learning Centers in order to pass required exams and become registered with FINRA. Those who, for years, have said that they didn't need the license in order to get clients, fund deals and collect commissions have concluded that now, they do. Why? Certainly in the wake of financial scandals and investor mistrust, both public and private companies are undergoing more rigorous scrutiny.

In addition, both investors and entrepreneurs have become much more savvy about the protection that policing organizations like FINRA and the SEC afford them, and those organizations are vigorously pursuing complaints, perhaps in part to rebuild public trust. The resulting penalties for offending investment bankers including fines, jail time, and bans from working with any other broker-dealers. See www.finra.org and www.sec.gov for details of recent judgments.

What is the value of a license? Perhaps a better question is, what are the dangers for any or all parties (the investor, entrepreneur, and investment banker) if the latter is not licensed?

1. Right of rescission: Melinda LeGaye, President of MGL Consulting Corporation in The Woodlands, Texas, provides FINRA-required compliance auditing services for broker-dealers. She recommends that “entrepreneurs seeking equity capital in the form of a private placement...utilize the services of a broker-dealer firm that is registered with FINRA, the SEC, and with the states where the offers will be made. “Otherwise”, she warns, “there are potential rescission issues associated with sales by non-registered dealers.” In other words, a deal can be revoked and funds returned, even after it has closed.

2. No back-end fees: According to the SEC and FINRA, unlicensed fundraisers, who, therefore, have not agreed to be bound by the code of ethical conduct, are not allowed to be paid a percentage of funds raised from investors. They can be paid a retainer or a consulting fee, but not a “back-end fee” or commission. In the past, many entrepreneurs did not know this so they paid the successful, unlicensed fundraisers anyway, pleased to have the capital. Now, however, the word is out. An unlicensed money-raiser could walk away from a closing with no commission at all.

3. Deal transparency: Licensed broker-dealers and their representatives swear to interact with clients according to a code of ethics outlined for the public on FINRA's website. These rules pertain to both internal and external conduct. For example, the list addresses what can/cannot be promised verbally or in writing, reasonable fees, what services can and cannot be rendered, and full disclosure of deal terms, personal involvement, and timely introduction to “promised” investors. At the office, all records must be accessible and audited, and even a complaint log must be kept available for any clients who request it. Unlicensed money raisers may determine their own higher or lower standards of ethics. Warning: if a fundraiser sounds too good to be true, s/he probably is (unlicensed).

4. Public records: The public can check for free the professional background of any FINRA-licensed representatives or broker-dealers (http://brokercheck.finra.org/Search/Search.aspx), as well as the backgrounds of people who used to be licensed and left the industry for one reason or another. This resource includes such information as prior employers, number of licenses, and any sanctions or complaints. All entrepreneurs and investors should check out all investment bankers they consider. If the names are not on BrokerCheck, the people are not licensed. Why hire them? If they are listed then look at the back of the report for any disclosures that might discourage you from hiring them.

5. Recourse: If disgruntled investors or entrepreneurs seek recourse against an unlicensed investment banker, they have access to the court system, of course, but that process is often expensive and time-consuming. Sometimes the legal fees alone are larger than the amount disputed. In increasing numbers, thousands of clients have availed themselves of FINRA arbitration (see www.finra.org for statistics and information). Clients have access to one to three arbitrators in a binding process that is reasonably-priced from the very organization authorized to punish, ban, and publicize the offences of the broker-dealer – a powerful ally.

How much does it cost to become a licensed broker or registered representative? Are financial considerations alone prohibitive enough to discourage ethical “finders” or unregistered investment bankers from becoming FINRA licensed? Consider the following prices to become a registered representative in Texas: $100 to $265 for each licensing exam (Series 63 – state; Series 7 or 79 – national; Series 24 – supervisor); $150 to $500 for each study guide or class; $285 to sell securities in Texas; $50 to $500 for annual continued education courses, and $20 to be fingerprinted. Cost: about $800 and up. Why wouldn't someone do this to protect himself, his clients, and the deal!

Furthermore, just as in the Real Estate profession, a newly-registered representative cannot work alone, but must affiliate with a broker (firm) that assumes liability for supervision of the representatives by experienced professionals with more licenses (at least a Series 24) and experience. This supervision includes the representative's correspondence, accounts, sales, contracts, and fees.

A broker-dealer firm must conform to additional requirements designed to protect clients, which cost money that unlicensed fund-raisers do not incur. For example, registered broker-dealers must have independent annual financial audits ($10,000+), an internal or external Compliance Officer and a Financial Operations Principal ($50,000+), FINRA fees ($10,000), fidelity bond ($450+), SIPC fees ($1500+), and a minimum net capital requirement ($5,000 - $250,000+). Additional fees for scrupulous firms include e-mail supervision and background checks of employees, as well as background checks and anti-money laundering checks of potential investors and clients. The range of fees reflects the number and types of investment banking services and transactions. To open a minimal service, two person broker-dealer requires an initial investment of thousands of dollars intended to ensure competency and client protections – costs not incurred by unregistered “investment bankers” or “financial advisors” because no one requires them to do so.

The costs, examinations, scrutiny, and background checks surely deter unscrupulous unlicensed service providers from becoming licensed, and may serve as a disincentive for honest folks who just don't want the trouble. Buy, why on earth wouldn't an investor or company manager seeking investment banking services engage FINRA-licensed investment bankers who are willing to undertake such scrutiny and additional education in order to provide deal transparency, public records, arbitration services, and a published code of ethics? Caveat emptor.

TOP TEN MISTAKES OF PUBLIC SPEAKERS

The speech is poorly prepared:

1. Too long for designated time, resulting in skipping information or rushing.

2. Unsuitable for audience: too simplistic or too advanced or different than what audience was lead to expect by organizers or publicity.

3. Is unfamiliar with audio-visual equipment, resulting in problems with volume, visual display, timing, CDs or disks that can’t play on equipment, etc.

4. Poorly organized- flow is illogical, points are not supported with evidence or examples, it has no introduction or conclusion.

5. Too detailed. People can only remember a few points.

The speaker’s delivery is unintelligible:

6. Spoken to the screen or to the podium.

7. Too fast or too quiet.

The visuals are indiscernible:

8. Too small to read.

9. Too busy.

10. Indiscriminantly colored: dark on dark, light on light, or clashing.

TOP TEN WAYS TO ENSURE A GOOD PRESENTATION

Prepare for the audience:

1. Be respectful of your audience: their level of knowledge, interest, and time.

2. Send descriptive information to your organizer for introductions and publicity.

3. Answer a “what’s in it for me” question for the audience.

Prepare for the location:

4. Know the audio-visual equipment, lighting, room size, number of people, location.

5. Bring a back up, like a printed copy of your speech, in case the AV fails.

6. Have a contact person’s name and phone number. Give that person your cell phone number.

Plan a clear, easy-to-remember structure for the speech

7. Introduction, a few points with supporting evidence, Conclusion of main points.

Plan visuals

8. Create simple visuals that reinforce, rather than compete with your verbal delivery. Humor is usually an effective mnemonic device. 10% of men are color blind, and colors are not consistent from screen to screen. Favor patterns rather than color to differentiate in graphs.

Practice the speech

9. With a timer and an outline, in the car, with the slides, with the written speech.

10. Find holes in your speech and prepare for logical questions by asking yourself “who, what, when, where, why, how” questions. Do you answer in one paragraph a question posed earlier? If not, you will lose your audience.

“Reality Check” Financial Planning for Entrepreneurs

Entrepreneurs are, by nature, visionary and optimistic. Their company valuations are high and prospects are rosy. Perhaps as a result, many may be wooed by pie-in-the sky investment discussions that never result in bona fide term sheets while discouraging realistic but less complimentary offers, which, in their estimation, undervalue the business and their management skills.

For these reasons, I recommend that the entrepreneurial management teams discuss the following five tough questions amongst themselves and update a file of written answers for their eyes only as the company fortunes wax or wane. This “reality check” will help them ask investors and investment bankers discerning questions earlier than they might otherwise do, and will enable them to determine in advance the value of particular offering terms at various points in the company’s future.

Question 1: If the company has no other clients or revenue sources other than those currently active, how long can it sustain its burn-rate?

Analysis: Entrepreneurs may project fantastic valuations after “this” or “that” milestone, but investors and other financial sources also evaluate the present, so entrepreneurs should, too. The more immediate a company’s need for money, the less sense it makes to spend time and effort seeking private equity and the more sense it makes for the company to spend time hawking its widgets to paying customers, increasing its profit margin, and cutting costs. Due diligence by investors will ALWAYS take longer than a financially strapped company wants, and its financial vulnerability will be obvious to the investor, who will either regard that deal as risky enough to (a) abandon or (b) offer less than the entrepreneur needs or (c) propose terms that the entrepreneur may regard as onerous.

To Do: Figure out how long the company can remain in business with no investment and nothing other than organic growth. Calculate the cost of the number of months required to turn a profit and repay debt. This is the amount of money the company needs (vs. wants). How much of the company would you sell to an investor or how much interest would pay on a loan that carried you through this time period?

Question 2: How time sensitive is your financial need?

Analysis: Some companies face seasonal or cyclical highs or once-in-a-blue-moon marketing or sales opportunities they must hit or they are doomed. Others enjoy a short term competitive advantage that is significant, so they could make more money expanding rapidly now than growing organically later. In such cases, money invested or loaned now is worth much more than money invested or loaned later. Calculate a bonus value for the money.

To Do: Look at a calendar and identify a date before which investment is highly valued and after which it is valued less. Determine what you are willing to give up or pay to get an offer by that date.

Question 3: Under what investment terms are you willing to sell 51% of the company, step aside from a management role, or give up a Board seat?

Analysis: Many investors have a clear and public preference for roles, such as majority or minority control, a Board seat, their own management team in place. Many investing firms identify this on their websites or will let you know in a timely manner so no one wastes time.

Know their preferences. Know what you will accept. Also, smart money is worth more than “dumb” money – that is to say that investors who know the industry, and have sales, merger, or vendor contracts can bring terrific value in addition to needed dollars. So the value of the money may vary according to the source.

To Do: Think about all the RESOURCES your company needs to grow – not just money. Calculate the time/cost to achieve goals on your own vs. inheriting professional resources with investment dollars. What is that worth to you – what percentage of the company or what management role?

Question 4: What upcoming milestones will make the company cash flow positive? How much time and money are required to meet the minimums?

Analysis: Most private equity sources will not invest all promised funds up front. Rather, they will release a portion to be followed by later tranches if the company meets identified milestones, usually in sales revenue or development. These increments and goals should be negotiated in the contract.

To Do: Figure out various fast and cheap tracks to profitability. Calculate the bare bones cost to each and add some pertinent allowance for extra time and costs. Read the term sheet carefully. If accepting less money in a first tranche decreases the likelihood of meeting the milestone, you could lose your company to that investor. Some unsavory characters have written contracts in such a way that they can acquire control of your company for the cost of that first tranche from non-detailed entrepreneurs who were starry eyed about the big number at the end of milestones they were ill equipped to meet.

Question 5: If all goes well and the company grows, at what point will expansion exceed the competency of current management?

Analysis: Many entrepreneurs are great at starting companies but weaker at maintaining or growing them. The success of the company may depend on recognizing management’s strengths and weaknesses. For example, running a public company is different than running a private one or merging with a competitor.

To Do: Develop a graceful transition and departure plan based on realistic self and company-assessment.

CONCLUSION:

You will notice that several of these questions approach the same question from different perspectives. The gist is this, “if you cannot achieve your goals without investors or additional capital/skill resources, then the most important valuation to acknowledge is not how much the market will value your company when it is successful, but rather, how much you value the early money that takes you the first, steep step to get there.