Should friends charge finder's fees?
by JEANNE FLEMING, PH.D. and LEONARD SCHWARZ
Question: A good friend is investing $25,000 in an alternative-energy deal that looks very promising. He says he can arrange for me to get into it, but in exchange he wants 10% of whatever profit I make. I think he's being incredibly greedy, but he says that he deserves to be compensated for opening an otherwise closed door. Does he?
Answer: If the dealmaker's name is Madoff, run. And even if it's not, remember: While alternative-energy projects have a certain cachet these days, so did hedge funds and Las Vegas real estate not that long ago. In short, caveat investor.
Should you still decide you want in, however, it's not unethical in the business world to compensate someone for opening an otherwise closed door (bribes are another story). But to flip Michael Corleone's famous phrase, this isn't business, this is personal. And in the personal arena, friends don't charge their friends fees. Unless your pal is a professional financial adviser – that is, someone who earns his living finding and vetting investments – what he deserves for a favor like this is your sincere thanks and a nice bottle of wine. If the deal turns into a jackpot, then a more substantial gift – some nice green cash, perhaps – is in order. And if it goes belly up? Well, don't say we didn't warn you.
Questions? Email Money Magazine’s ethicists – authors of “Isn’t It Their Turn to Pick Up the Check?” (Free Press) – at FlemingandSchwarz@right-thing.net.
If the friend is asking for 10% of the profits (not revenue), there is nothing wrong with that. It's nothing personal, it's a business. Any time you put friendships or personal feelings ahead of money, you're setting yourself up for trouble down the road. If you don't believe me, ask a divorce attorney. If it wasn't for this friend, this person wouldn't have an opportunity to make a profit, albeit at 90%. A lot of the comments are missing that point. This guy isn't out anything until he starts making money. A lot of people don't know how venture capital funds are run and in some extreme situations, they're charging for operation costs plus 25% of the revenue, not the profits. Charging 10% of the profits, not the revenue, is pretty insignificant in comparison to that.
The author shouldn't have compared this to a hedge fund, but rather a venture capital fund, which is what this is, and done the appropriate homework. Also, in response to the accusation that is obviously a fraud by how the question was asked, it's obvious that Matt doesn't run or participate in a venture capital fund. I am currently working in the oil patch in Oklahoma and the article is pretty much how it works for small companies here. We call up friends and business partners and get people we know involved on every deal we make. Even with really great deals, a partner may have to drop out because of money problems, getting stretched too thin, a divorce, or *insert random problem here*. A partner may drop out at a really bad time and send us scrambling to find other partners to meet a deadline. That doesn't make the deal a scam.
Run, do not walk, away from this so-called friend.
There are just so many things wrong here.
How did he get into this field with such a low investment?
How many others is he contacting for the same $25K?
How will anyone determine when there is a profit? Will he be holding your money until then?
Why not go to a bank/credit union/credit card advance for the funds? Why you?
This is a very touchy subject matter. Investment Bankers charge a fee for finding capital for companies. What greater rights do these people have than your ordinary person. The ordinary person may not be in the business of finding capital. Perhaps, they should consider that a career and find the legal solutions to be able to carry out or provide those services. If the person introduced them and the deal was executed, they should be compensated for it. In the end, the business owner obtains the capital. The investor will get a return and the person who introduced them just got a a pat in the back. Should friends charge friends a fee? I will always remember this quote from a friend: before you make a stranger money give the business to your family or friends and help them make money. I agree with that statement. If my cousin is a dentist or an attorney, I will give my cousin the business before I give it to a stranger. Gil Zapata, http://www.kgfacapital.com
Pardon my grammar – I meant "your relationship with him"
Also, by "private funding" I meant to say "individuals."
I did not mean to say that seeking private funding is a bad idea, but for a start-up, especially in the alternative energy area, to seek $25k investments sounds very shady. Seems to me that $2.5M would be more appropriate, and that they are turning to invidivudals and smaller investments because they got turned down everywhere else.
I however mean every word when I say that your friend seems to have no clue.
Hey, I have some real estate in Florida I want to sell. Mind putting me in touch with your friend? I'll give you a 10% cut on the money I scam him out of 
I think your friend is mentally challenged. Actually, I don't know if "friend" is the right word to qualify what your relationship with seems to be.
I'm going to assume that he is going in as an individual.
1) He is investing $25k as an individual in an alternative energy company. Hello? Why would a start-up resort to private funding? Seems to be that unless their model is flawed and their executives are felons with 300 credit scores, they'd get a much better deal at the bank? That kind of company requires a lot more funding than this, and having to report to investors who put in 25k is just too much of a pain. I tend to think that they have no idea what they are doing and you should stay away. Furthermore it seems your "friend" is a retard for investing $25k in that company.
2) Your "friend" is asking you to invest. You did not disclose the amount that you were thinking about putting in, but assuming you put $10k and make a 20% return (hey, you never know…) then you would owe him 10% of 2k which is… $200? So you are telling us that your "friend" is willing to put his "friendship" with you at stake so he can make $200?
I say run. Fast.
I would gladly give him the fee if it is a sound investment, if he is willing to absorb the same percentage if it fails.
It would appear that even Fleming can't read the question posed.
The ask is for 10% of whatever profit is derived from the investment.
Greedy? Not so sure about that – such fees are common in the first place, and in the 2nd the recommending friend IS giving up something (that is, faces a true cost). That something is the danger that YOU, Potential Investor, turn out to be a putz and harm your friends relationship with his (presumably) business partners.
Accept or reject this deal on the basis of EXACTLY that – a business deal, not a friendship, not a pat on the back.
For more on my views – read Ayn Rand (Atlas Shrugged will do), get over it, stop freeloading and coattailing, and find your own deals if you don't want this one.
10% seems like a pretty steep fee for a risky investment. If he wants 10% of your profits then he should agree to cover 10% of your losses if the investment goes south. Otherwise like they suggested in the article he deserves a nice bottle of wine or something as a thank you. If it pays off big then he deserves something extra.
The first red flag is that an alternative energy deal needs funding; with oil prices low, folks are burning up energy and not worried about alternatives, and the return will be in the tank for years; going green does not make economic sense at current oil price levels; as for paying someone a percentage of profit for a lead, forget it, friend or no friend; maybe a one time finders' fee of 2-3%
No, Scott. You and Bill aren't the only ones who read this correctly.
Yes, even 10% of the profit is too much to ask a friend for. I would find a new friend and learn to better vet my investments, as well.
Anyone who acts in his professional capacity in a manner to benefit you generally deserves some form of compensation. However, if the scenario described accurately represents a real transaction, it is likely fraudulent in some way. Perhaps the 'good friend' doesn't even know this. To put things simply, this isn't a standard way to conduct business, it is however a standard way to rip someone off. The con is that there is a great business project out there that desparately needs several people to chip in some money. The money amount is something you can come up with, but is significant. Your "friend" won't let you in for free, and it's an exclusive opportunity– this makes you think that it's even a better investment because your friend thinks it's so good he can justify charging you for it. Bernie Madoff reportedly initially refused prospective new clients, then reluctantly agreed to let them in on his great investments– it's a technique to make you more interested. The investment isn't available to everyone, and you don't want to be excluded. Generally there's also a time constraint involved– you must get in soon, or the opportunity will be gone forever. Your 'friend' charging you on the profit seems to legitimize things, because to those unfamiliar with investing this seems like it could be a standard business practice. Your 'friend' tells you he's invested too. The money gets collected and is never seen again. Your 'friend' also seems to anguish because he lost money too– his own investment, and his cut of your profits. The relationship with the friend is distanced, seemingly because of the bad investment, but really it's because he took your money, and doesn't want to see you anymore.
The truth is the scenario described isn't how legitimate business is conducted. In a legitimate opportunity your 'friend' will be acting in what you can clearly tell is his professional capacity, and you will clearly understand that this is how he makes a living, and it won't seem weird to compensate him for it (though he might cut you some sort of break, OR he might not). All of your dealings will be documented with contractual agreements or similar legal instruments, and you will hire an attorney with relevant experience to review the documents prior to signing. In fact, if it's really a 'secret' investment, your friend likely would have had you sign a confidentiality agreement before even revealing the details to you. Your accountant and/or attorney will advise you on how to structure the investment in a manner to limit your liability, if necessary (investor can also mean part-owner, and part-owners can sometimes be sued and found liable– how's that sound for an investment return?) The words "whatever profit" will be replaced with terms like "percentage of distributed dividends." There will be parts of the contract that you don't understand, and you'll have your attorney help you understand what is being proposed. The whole thing will follow a process and strangely not seem rushed, elusive, or vague, and you will learn a tremendous amount while going through the process.
Really think about this: if it's truly a GREAT alternative-energy project, why are they not using standard funding methods: grants, loans, venture capital, etc… Your friend isn't the only one with an interest in funding great projects. A legitimate energy project would likely need a larger sum of money. Why do they only want $25k from you? Is that really all they need to launch a successful venture? Most venture funding requests are for much larger amounts, and with a clear plan for how much money is needed, when and why it is needed, and when it is to be paid back. In the con, they want $25k because they know you can get it. In real life $25k investments are generally for a minority interest in a business such as a restaurant, or perhaps a loan to help someone get a new professional service established– generally not an "alternative-energy deal". $25k does not go very far in running a business. Why does the company want you to be an investor with $25k– Often it would be in the company's interest to simply borrow the $25k from you as a loan with deferred interest. From the company's perspective a loan allows them to simply pay you back the principal and interest and entirely free of you– free to do whatever they want with any future profits. As an investor they would have to buy out your interest in the venture, and you could ask for more than your initial $25k back, unless there was an appropriately structured buyout clause, and as an investor you would generally have some level of claim to the company's current and future profits.
Sounds to me like your friend is a turd!!
No true friend would ask for a finders fee.
Good luck on your potential investment.
Why would you invest in something where you need a gatekeeper and "normal" people can't invest in? Aside from your friend being greedy, the elusiveness of the investment should be a major red flag. Think about the implications of elusive investments – no SEC supervision, usually low levels of control and accountability. You need to spend more time picking friends and investments.
It seems to me that the greatest risk in start-ups these days is remaining well enough capitalized to see a profit. In that respect, you're doing the friend a favor by injecting more cash in a venture where he's already at risk. Maybe he owes you a capital rescue fee.
A couple of questions come to mind:
1) Is your friend in the business of marketing private investments to qualified investors? If so, then it is customary for him to receive some sort of placement fee for putting clients in the fund. However, my experience as someone who has marketed private investments to institutional investors is that compensation for placement services is either paid by the manager (not the investor) or there is a provision in the prospectus for a placement fee.
2) Is your friend licensed by the SEC to represent and market these types of investment strategies? If not, then it may be against the law for him to collect compensation for doing so.
If the answer to either question is no, yet your friend insists on a cut of your profit, I suggest you refine your definition of "friend".
People,
Read the article. The friend is asking %10 of PROFIT. If he does not make profit, he is getting nothing!
If you make 10% profit on $25000 investment, that is $2500 and the friend makes $250. Still a lot?
I guess it is a sign of the times when your friends start asking for a cut of your pie. I mean, heck, if the government is going to take a huge cut, why shouldn't your friends? Unless you are a fiscal conservative, you have no right to complain about this because you are all about the government taking everyone else's pie to give it to someone else and that includes your friends' pie as well. So in reality, it looks alright to me, it's the kind of example our government is setting. Don't earn it, just take it.
I agree with the author…..a 12 pack or a bottle of wine for your friend should be good enough! Not sure his "commission" charge would even hold up in a court of law. A broker would probably do it for 2-3%. He/she might even give YOU the 12 pack for doing business with them!
If you don't want to participate don't pay the 10%. People these days are always looking for a freebee. Don't be such a tightwad.
To the Author:
Why would you lump hedge funds into the discussion with Las Vegas real estate and 'alt energy' deals? It's becoming apparent that people ignorantly place hedge funds in this grouping of 'failed ideas'. The markets tanked and from what I can see, hedge funds on the whole were significant outperformers for 2008 and so far in 2009 (see the HFRX index, et al). Time to open up your eyes and realize that hedge funds have and continue to deliver on their value proposition.
It may be illegal for him to act as a "promoter" for a fee. Your friend could be violating your state's securities laws.
Why is this an issue? This is how true players on both sides do business. Like Gib in Houston wrote earlier, if you don’t like the terms, then say no. My recommendation is to get financially educated and create your own deals, pay this guy for the hook-up (in which you MAY potentially lose all of your invested funds) or put your money under a mattress and hope and pray for things to get better while the purchasing power of your dollar decreases.
If this person wants 10% of your profits, what are you getting in exchange, i.e., what portion of your losses will he cover. If you are taking all the risk, you are entitled to all the returns.
If the only thing this person is doing is "opening a door" to a transaction, then a 1-time fee might be appropriate, but a percentage of profits is ridiculous.
The question that should be asked of the "good friend" is "How much of a finder's fee did you pay?"
Also, no finder's fee until the entire principal is returned – with the profit. It's not profit if the principal disappears, it's a loss. Will the friend return the finder's fee if there is a loss ?
My memory is a little rusty here, I think in Texas it is illegal to charge finder's fees for some business transactions. Real estate comes to mind, that only licensed real-estate agents can receive finder's fees.
The question that should be asked of the "good friend" is "How much of a finder's fee did you pay?"
Also, no finder's fee until the entire principal is returned – with the profit. It's not profit if the principal disappears, it's a loss. Will the friend return the finder's fee if there is a loss ?
My memory is a little rusty here, I think in Texas it is illegal to charge finder's fees for some business transactions. Real estate comes to mind, that only licensed real-estate agents can receive finder's fees.
It's not an unreasonable request. Your are entering a business deal as an investor which ultimately means you will expect some kind of return. Your friend suggested this investment to you. Had you went to a financial advisor they would charge an "advisory fee" or "commission" for the security you invested in. If you want in but feel 10% is too much, negotiate to some other percentage. Otherwise, don't take the deal at all. In this day, a request such as this is not that unheard of or out of this world.
Wow, 10% seems steep. When you consider taxes and other costs that might come along with the investment, and paying your "friend" 10% of the GP, your risk is not worth the potential reward. 3% is probably fair.
What is your true relationship with this person? Is he a friend or financial advisor. Also in this market investment opportunities are a dime a dozen….what do you mean by closed door? For 25 thousand, the alternate energy company might also throw in a GM car for free….
SO I would give him 10% of the profits if he is willing to pay you 10% if there is a loss! Hey it has to work both ways!
Simply put, your "friend" is a douchebag. Now the real question is….why are you friends with a douchebag?
What if your friend gets a finder's fee from a third party, for having recommended you for a job (or whatever)? Is that acceptable?
An example would be you're a consultant and a firm needs your skills. Seems to me everyone wins…so what's wrong with your friend getting paid for making the connection. Thoughts?
John