Staying Legal: Crowfund Investing from the Lawyer’s Experience
This information is provided in conjunction with Doug Ellenoff of Ellenoff, Grossman & Schole (EGS). Consider EGS the leading crowdfunding law firm. They have over 30 years of experience working with startups, small businesses, and capital raising.
They’re sponsors of the Crowdfunding Professional Association (CfPA), speakers at most events on crowdfunding, and representatives of the industry in front of the SEC, as well as at Financial Industry Regulatory Authority (FINRA) meetings.
The following is a general guideline and should not be considered legal advice about crowdfunding.
Proceed with caution
Although crowdfund investing is trendy and happening, and it may facilitate your raising much-needed capital, make no mistake about it: You’re engaging in a securities transaction subject to many federal and state anti-fraud laws. Even though you aren’t staging an IPO, you’re engaging in a private placement of securities.
Crowdfund investing requires a commitment on your part that is similar to your commitment to an IPO; you must fully, fairly, and accurately share all meaningful information about your business opportunity with the crowd — the good, the bad, and the potentially ugly.
Aim for full disclosure
A balanced presentation of what you’re offering to the crowd must be your primary objective. People in the securities bar refer to this effort as full disclosure, which obligates you to share all details of your business opportunity as it actually exists at the time you’re raising money. You can’t portray the opportunity as it may exist in the future assuming that you have already raised and used the requested funding.
Don’t misunderstand this important point. You should certainly make clear what your intentions and hopes are for the use of the proposed funding and where you’ll be in your projected business model if all goes well, but be very careful about any promises that you make.
You’re required to clearly distinguish where you are versus where you hope to be. You must include all relevant and meaningful information and associated risks about the opportunity and not intentionally or unintentionally forget to include something that the crowd should know about in order to make an informed investment decision. Achieving full disclosure requires a lot of thought and possible research on your part.
And you should consult other experienced entrepreneurs who have been through the process previously, as well as securities professionals such as lawyers, accountants, and bankers.
All this effort will not only reduce your concerns about potential liability but also cause you to better think through your business and how to describe it in a manner that will increase your likelihood of successfully raising your funds. Your concerns for the crowd to truly appreciate both the risks and benefits of participating with you should be equal to your need for obtaining the funds for your business.
Whether you choose to do it yourself or with professionals, you need to fully acquaint yourself with the type of information that is normally associated with raising debt or equity securities. This information includes the risks involved with investing in any crowdfund investing campaign generally, along with the particular risks of your business and the type of securities you’re offering.
Don’t be afraid to be loud and clear that this is not only high-risk investing but that the investor may very well lose all or a portion of what he invests. This necessary disclosure will better safeguard you later if your business opportunity fails and the investors claim that they didn’t know the risks of investing in your opportunity.
Find your way to an SEC-registered portal
After you assemble your offering materials, including your business plan, terms of your offering, risk factors, subscription documents, and a purchaser questionnaire, you need to identify the appropriate funding portal to determine where your particular offering will most likely raise the required capital.
Visit the FINRA website to confirm which websites are actually registered with the SEC and licensed to operate as funding portals or broker-dealers by FINRA. Do not invest with any other website.
You want to locate the portal that has the most visibility and online recognition. More likely than not, the better-known portals will have the most registered investors. Because neither you nor the portal will be able to market your financing external to the portal, the more active a portal community, the more fertile ecosystem it will be for you to accomplish your funding.
Take your responsibility seriously
Between you and the funding portal/broker dealer, you have a responsibility to educate possible investors about crowdfund investing, generally, and your opportunity specifically.
You also want the crowd to appreciate that the securities you’re offering in exchange for their investment are unable to be sold or transferred anytime soon, if ever, except in specific circumstances that may or may not present themselves.
The rules as currently written provide for a one-year holding period, but that presupposes that a market for such securities develops and that someone else wants to purchase them, which in reality may not be so easy to accomplish.
This reality and the other characteristics of your offering are your obligation to make clear. You must educate your potential investors about the type of securities you’re offering (notes, preferred stock, common) and the other relevant terms associated with those securities and any other contractual rights, privileges, or obligations that they may be subject to — good or bad.
It’s your responsibility to know what you’re offering to the crowd and to explain everything in a simple and easily understandable way.
When your campaign is live on the funding portal, avoid reacting privately to communications from and with the crowd. Your responses, if any, must be publicly available to the crowd and become part of your offering materials, so be thoughtful and measured.
All investors and potential investors are entitled to all your shared ideas and responses. You need a current and future communications strategy for developing and fostering your image and relationship with the crowd. Don’t just react; you may very well regret a quick emotional and reckless posting. You may also compromise your funding.
One posting is just that: one. Hopefully, there will be many other positive shared views. If not, you may learn the hard way, no differently from guests on reality shows, that your opportunity isn’t as attractive as you may have believed.
Communication is key
Keep in mind that communication skills are also necessary to comply with your post-funding obligations, both under the laws (annual report requirement) and per your duty to create ongoing transparency. You must update your actual investors (who, per the legislation, you have a legal responsibility to) about all the worthwhile milestones that you reach as you execute your plan. Again, don’t forget to share bad news and developments as well.