If you’re considering crowdfunding a capital raise, here are 10 things to keep in mind.

It’s October 2018. By now, most everybody knows or should know what it means to crowdfund an idea. By its own account, Indiegogo has launched over 800,000 ideas through a network of over 9 million users throughout 235 countries. And that’s just one platform.

As we’ve written before, there’s a difference between donation-based, or ‘rewards’ crowdfunding, and securities-based crowdfunding. With donation-based crowdfunding, you may be able to launch a new company or new product line by more or less enticing donors through promises of first distribution; to early adopters, nothing is sexier. With securities-based crowdfunding, you look to scale your company through debt or equity transactions offered through similar mechanisms as donor funding, but with additional strings attached.

As entrepreneur-attorneys who have lived the valley-of-death experience, we love the reformed securities laws and the technological advances that encourage greater funding potential for more small businesses. Notwithstanding, we can’t stress enough that securities-based crowdfunding should be pursued patiently and with sound counsel. The Securities and Exchange Commission (SEC) offers a number of investor-facing guidelines for responsible crowdfunding investing.

Note: Based on our recent review of FINRA regulated securities-based platforms, we offer the following additional cautions. As you may have expected, we offer the customary legal disclaimers that what we say is nonsense not legal advice, that we’re not your lawyers, you were never present with this document alongside Colonel Mustard and a candlestick, and that basically you should forget you ever read this.

Now, here are those 10 things to consider when crowdfunding a capital raise.

1) Be careful of direct communications with potential investors.

A typical equity raise may involve a handful of direct, often in-person talks in pre-scheduled, dedicated if not formal environments. When crowdfunding a capital raise, this could involve responding to questions through your smartphone while little Jimmy with a bucket on his head chases littler Sally around the kitchen with a plunger. (Just lifesourcing here.) And by setting low buy-ins, e.g., $1k, you may be inviting dozens or even hundreds of inquiries channeled through the platform. Take every question and response seriously. Try not to answer anything through your smartphone. Think of every communication as a regulated communication.

2) Be careful of communications with potential and actual investors that can be accessed by third parties.

We recently heard a crowdfunding employee on a panel mention reviewing a communication history between an investor and investee upon completion of a raise without any particular legal purpose. That, in my mind, is scary. Investor communications should be private affairs, and not accessible by platform employees without direct and explicit authorization. Make sure you are abundantly aware who can access your investor communications and the purpose of such access.

3) Be careful of misleading representations caused by popularity type indicators.

If you are reading this, you are probably human. You could be a bot, but I’m sure as a bot you have better things to do. We humans all engage in groupthink, and we are all wooed by the power of the herd review. Amazon, Facebook, Google, Yelp, and many others exploit this star lust to unprecedented profit margins. You can see it operating in crowdfunding platforms through the percentage raise indicators. Who wants to be the first investor in a company when others on a given site have 10%, 50%, even (gasp) 90% funded status? We heard a platform owner recently state publicly that she had kicked off a couple of the platform’s newest companies with seed investments. We find this concerning, with great potential for manipulation. If companies are receiving anonymized contributions by platform owners, future investors could argue that they were misled as to the soundness/popularity/demand/viability of the company. While the gazillion risk disclaimers (but see below) of crowdfunding sites are designed to prevent claims like these, this is nevertheless new territory in securities law.

4) Be careful of click-wrap due diligence processes.

The Jobs Act allows the Average Joe to invest a small amount of money in your start-up throughout your various capital raising phases. The SEC opened this door accompanied by stringent disclosure requirements to protect the new onslaught of unaccredited investors. This means you (and the portal you choose to run your campaign on), need to be cautious as to how your disclosure materials are conveyed. Make sure your documents are easily accessible and presented in a way that encourages their careful review. For instance, we’d suggest thinking twice before allowing investors to scroll through your page and invest on their phone.

5) Be careful not to herd too many cats as shareholders.

Angel and Venture fund managers do the business of aggregating investors. You are assuming this duty in securities crowdfunding. You may be tempted to offer a low buy-in of $1,000, thinking that a few early adopter $1k investors will prime your campaign for a $100k investment from a corporate champion or trust fund baby / passively supported entrepreneur. You may be wrong. You may end up with 250 new shareholder friends, many of whom will be clueless as to officer-shareholder degrees of separation. What you start with, you stick with, and being stuck with a large group of investors could require large legal and/or newly created employee fees to administer the corporate responsibilities to such shareholder. Additionally, under traditional corporate law, each equity shareholder represents an opportunity for shareholder suit or other distracting activity.

6) Be careful of negotiations that can drive up your legal costs.

Ideally, you’ll be using a tried and true debt/equity instrument like a KISS or SAFE agreement to close an investment. (Of course, SAFE agreements may have their drawbacks.) However, if you open that agreement to negotiation, you risk increasing your legal costs on the front end during negotiation, or on the backend, if you decide to DIY it. There may be even more legal back-and-forth stemming from traditional promissory notes or other customized agreements.

7) Be careful of negotiations that can significantly impact the validity of your contracts.

If you’re working from a KISS or SAFE, it’s only as good as its terms and structure that you respect and maintain. If you are using any other form agreement, be careful of negotiating its terms without the advice of your attorney. We regularly cross paths with startups who bootstrapped themselves right into various agreements they downloaded from anonymous or unreliable sources. (We’ve even seen an agreement between two Tennessee individuals who agreed to resolve any dispute in New York.) You must take this seriously from the beginning, using a genesis instrument that is fair and enforceable. Beyond that, don’t create a house of 100 calico cats by negotiating terms arbitrarily with too many small-time investors.

8) Be careful about creating a cap table that can adversely affect future fundraising.

When issuing convertible notes through securities crowdfunding, you are effectively diluting your ownership position(s). Crowdfunding a capital raise creates the potential for abnormally large groups of early-stage investors, and you will need to recognize these interests on your cap table and have a good narrative built around this table for downstream financing.

9) Be careful of risky disclosures.

Should you fail when crowdfunding a capital raise, you can’t simply erase the fact that it happened. Any unnecessary and unrealized disclosures you made will be relied upon in your next, perhaps better-positioned capital raise. You should have a firm understanding of your value proposition, operations, markets, risk, etc., before creating a permanent bookmark.

10) Be careful about being too careful.

Sometimes you have to ignore everything that the experts say, including attorneys. Dr. Seuss was rejected by dozens of publishers before reinventing childhood. The North Face, Patagonia, and Royal Robbins were all launched by passionate homeless guys innovating from a van. Burt of Burt’s Bees put in his time living in a chicken coop.

Probably one of the biggest complaints against lawyers involves the phrase “it depends.” Another popular one involves lawyers who identify a million risks in a given scenario but summarize with “of course, every situation is different, and you may determine these risks are acceptable blah blah blah.” In other words, “we’ve met our malpractice requirements by highlighting the risks, now please disregard so we can have your business.”

That’s not really what this is. We’ve identified possible consequences of using securities crowdfunding sites, or at least in deviating from best practices of using such sites. If you are a certifiable, wouldn’t-miss-it-for-the-world crowdfunder, be sure to shop the different FINRA platforms mindful of our careful-crowdfunder-checklist before committing to any particular one.

Happy selling!

Kevin Christopher

Author Kevin Christopher

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