Improving the Efficiency of the Angel Finance Market: A Proposal to Expand the Intermediary Role of Finders in the Private Capital Raising Setting
This paper was originally published in Volume 37 of the Arizona State Law Journal, and was made available as Paper 10 in the Pierce Law Faculty Scholarship Series by the New England Law Library Consortium (nellco.org).
The angel finance market is of critical importance to the financing and creation of rapid-growth start-ups, whose continuous creation plays a substantial role in the success of the U.S. economy. Unfortunately, the angel finance market suffers from systematic problems, including information and agency problems and high transaction costs, that limit its ability to adequately finance these rapid-growth start-ups. One reason for the angel market's inefficiency is the lack of meaningful financial intermediaries that operate in the market. One logical group that could serve a meaningful intermediary role in the angel market is finders. The current regulatory treatment of finders, however, substantially limits their ability to take on a meaningful intermediary role. While finders are currently tolerated by the existing regulatory regime, their use can raise serious problems if the finder's role is deemed to be that of a “broker-dealer,” which would subject the finder to a substantial array of federal and state securities regulations.
This Article examines the role of finders in the private capital setting and considers the impact of allowing them to operate under a reduced regulatory burden with the assumption that they will play a more meaningful role in private capital raising. This Article concludes that the potential benefits of an empowered class of finders for the private capital raising process outweigh the potential problems. This leads to the main proposal of this Article: rather than regulate finders who assist private companies to obtain start-up capital as a sub-category of broker-dealers, this Article proposes a new class of federally registered “finders” whose activities would be exempt from federal and state broker-dealer regulations. This tailored regulatory regime for finders in the private capital raising setting would be aimed at expanding their use based on a principle of improving the efficiency of the private capital markets. Specifically, the focus of the regulatory treatment of these finders should be to encourage their ability to reduce market problems (e.g., information and agency problems and high transaction costs) in the private capital markets, while discouraging their ability to increase existing, or create new, market problems (e.g., commit fraud). By improving the market efficiency of the private capital markets (with a particular focus on the angel market) in such a manner, this approach should improve the allocation of resources that are dedicated to creating and nurturing rapid-growth start-ups, while not exposing less sophisticated investors to undue investing dangers.