In developing an alternate-fuels engine, I came across a transportation and fuels consultant who says he can help me raise the capital to prove my design. He proposed a three-year contract for $15,000 up front and 25 percent of the first round of funding. I declined, so he has agreed to 25 percent of money raised, nationally or internationally, and 5 percent of second-round funding. How do I know if this is standard? —D.C., Napa, Calif.
A success fee of 25 percent of capital raised sounds "extraordinarily large," says Scott R. Singer, a managing director at The Bank Street Group, a boutique investment banking company based in Stamford, Conn.
"Something like 25 percent is not standard, even if your consultant is not taking any retainer or equity in your business," says Singer. "In a typical private placement, the bankers get 5 percent to 7 percent of the total raised. Sometimes it's a little less if the deal is particularly large and sometimes it's a little more if they take part of their fee as an equity stake in the business."
It may be that this consultant expects to work intensively on your project, particularly if you are at an early stage in product development. For instance, if you have nothing more than an idea and some rudimentary drawings, the consultant may need six months or a year to help you create realistic financial projections, write a business plan, and develop a presentation for investors.
"In that case, this person would be taking on the role of a partner for all intents and purposes, not just an adviser. If you're raising $1 million and he's getting paid $250,000, that's more like a salary than a success fee," Singer says. You may want to talk about whether a partnership is a more appropriate form for your relationship with this consultant.
sooner, rather than later: a lawyer
In terms of the $15,000 originally requested, it's not unusual for an investment banker or consultant to ask for a retainer. Typically, that money is deducted from the fee that the consultant is ultimately paid. Let's say a consultant raised $100 million and her percentage was agreed on at 5 percent. During a 10-month course of fundraising, she was paid $10,000 a month. At the deal signing, the consultant would get $5 million, minus the $100,000 she'd already been paid on retainer.
Before you do anything else, have an attorney look over the proposed contract and help you negotiate the percentage down or find a better deal, says John Calvert, administrator of the Inventors Assistance Center at the U.S. Patent & Trade Office. You will need an attorney at some point to review investor agreements and help protect your intellectual property, so it's a good idea to form that relationship now.
You should also thoroughly vet any consultant you consider hiring and get a list of other inventors for whom he has done similar deals. Don't just rely on canned testimonials posted on a website, Calvert says: "Get references from the people he is contracting to work with and contact those references," Consultants should show ample proof that they have relationships with and access to investors who have put money into ventures in your industry. "If you're hiring someone to make cold calls for you, that's not going to be very effective," Singer notes.
Unfortunately, inventors are often targeted by con artists. Don't fall for someone who promises "government grants" or "easy money." More information on scam prevention is available at this section of the patent office website. Good luck.