As an advisor to multiple entrepreneurship centers, I see a lot of pitches. Consistently they overstate markets and often undistinguished total addressable markets; this is to be expected. Increasingly, they seem to overstate intellectual property (“IP”) potential and/or position. Recently, after the umphundredth time I’d fact-checked someone about their IP mischaracterization, I decided to investigate the potential liabilities for securities violations triggered by errant assertions in pitch competitions.
[Side note: if you are for some inexplicable reason unprepared to adequately address someone’s question about a patent, trademark, or license, simply say you don’t know but you’ll be happy to follow up with that information. It’s a lot better than saying your “international patent” was issued and having the IP guy in the room call you out upon a 30-second search showing your U.S. application never made it to a PCT filing and was actually abandoned three months ago.]
Let me string together for you an example of my concern. Millenialco A enters a competition at Bigsexy U and wows the judges through pitch prowess and a little white lie about the development stage of the company’s technology. Based on winning a small amount of $$ and a greater amount of prestige at the Bigsexy pitch comp, Millenialco A upgrades its pitch deck, buys some new pitch threads, and launches a tour of regional comps and one or two virtual accelerators maintaining that little white lie about the development cycle. [What exactly does proven mean, anyway?] Eventually, Millenialco A winds up in front of Mr. Dangleangel who is beside himself with excitement about M-A’s pitch prowess and comp awards which are littered over a slide. Mr. Dangleangel offers a $50k seed pledge on the spot with little investigation under the hood, reasoning that Millenialco A had been thoroughly vetted as proudly displayed through its digital deck flare.
What exactly did Millenialco A do wrong, if anything? Was there a public offering, a mischaracterization, or any other event triggering the watchful eye of the Securities and Exchange Commission? This may seem like a stretch, but hypotheticals happen.
[Under the Securities Act of 1933, as amended, every offer and sale of a security is required to be registered with the Securities and Exchange Commission (the “SEC”). This includes not only corporate stock offerings but most forms of membership interests in limited liability companies. Registration of a securities transaction with the SEC is cumbersome and expensive, and most companies seeking investment through limited private placements elect to avoid SEC registration through one of the registration exemptions available to small businesses. See What Constitutes a Security and Requirements Relating to the Offer and Sales of Securities and Exemptions from Registration Associated Therewith; see also Exempt Offerings.]
Here are a few ways to SECsy up before broadcasting your next big shark-tank-worthy idea. Yes, you’re rightfully focused on refining the pitch deck and perfecting your cadence for the big day, but getting in touch early with your inner federal and state securities regulator will serve you the rest of your entrepreneurial career.
Avoid Fraudulent Misrepresentations
As you’re delivering your pitch, you should err on the side of caution when it comes to any representations that could trigger SEC rules. One goal is to avoid making statements that could be construed as “fraudulent misrepresentations.” In order to achieve this, it’s useful to consider what courts have deemed “fraud” and what they have deemed the equivalent of “mere puffery.”
As far as I know, there isn’t a line of cases exclusively alleging fraud in pitch competitions, but extrapolations can be made from a few noteworthy cases alleging fraud in product sales.
What is considered fraud in sales pitches?
The Alabama Supreme Court found a company that made copying machines strayed beyond mere puffery and into fraud during its sales pitch for a copying machine. The company described the copying machine as “good quality,” that would not need “much service,” and would “compete well” with its major competitor. Sharp Elecs. Corp. v. Shaw, 524 So. 2d 586 (Ala. 1987). The court found these statements were fraudulent because the advertised machine had not been tested properly and ultimately had serious performance and maintenance problems. Thus, the claims were misrepresentations of the actual condition of the machine, and the company’s claims went beyond just enthusiastic sales terms. (hmmm, Theranos anyone?)
Though there are many contextual differences between a traditional corporate sales pitch and a shark-tank-style pitch competition, there are also legal parallels that can be drawn. You are motivated as an entrepreneur to make your fledgling product or service look as great as possible at a pitch comp in front of judges, an audience, and, most problematically, mom. Avoiding fraudulent statements may be as simple as adequately preparing your deck/video/media and maintaining your cool during delivery. One trick is to think in terms of F.R.A.U.D. (fantastical representations alleged under duress) to keep your responses grounded during a Q&A session.
What does NOT amount to fraud?
What about when a maker of aluminum storm doors, awnings, and windows claims to have the “world’s lowest price” as in In the Matter of Better Living, Inc., 54 F.T.C. 648, 653, 1957 WL 16282 (1957)? The precedential court in that case found that “the representation as to ‘the world’s lowest price’ is a statement of an objective actuality, the truth or falsity of which is not variable and can be ascertained with factual precision” (which is a fancy way of saying, eh, it’s fine).
Words such as “best” and “finest” when used in sales pitches and ads have generally been found to be generic statements that are not actionable as misrepresentations of fact. Consumers are expected to see these as just hyperbole since likely they are not able to be substantiated or proven.
More recently, the Sixth Circuit considered whether securities investors could recover damages resulting from misleading statements made by a major corporation. See Ind. State Dist. Council of Laborers v. Omnicare, Inc., 583 F.3d 935 (6th Cir. 2009). The court found that the forward-looking statements were not material because they were mere “corporate puffery.”
Those Awkward Non-Soliciting Solicitations
Whether communication is considered a general solicitation under federal and state securities laws is important on multiple levels, perhaps most importantly for this audience in relation to Regulation D registration exemptions. Unfortunately, the SEC has been somewhat coy on the standard of “general solicitation.”
Considering that pitch competitions usually involve entrepreneurs hoping to woo at least seed investors, should entrepreneurs be afraid to participate in pitch events? No, but they should exercise caution and tailor their pitches appropriately (i.e. focusing on actual products and services rather than offering investment opportunities and financial details).
Is a “demo day” or “pitch contest” a general solicitation?
In 2015, the SEC indicated its position that a demo day usually does not constitute a general solicitation, specifically if the companies involved are not offering potential investment opportunities to the attendees. According to the SEC, whether such an event constitutes a general solicitation is a fact-based analysis of each particular event, not a general rule applicable to all. I am not altogether comfortable with this guidance, and encourage conservatism when it comes to “the ask” of what the entrepreneur wishes to express to the audience.
What are practical tips to limit exposure to claims of general solicitations and misrepresentations in pitch comps?
- Draft your pitch and practice it in front of friends or colleagues prior to public dissemination.
- Draft answers to frequently asked questions during such practices so you can stay on track and avoid instances where you could shoot from the hip; shooting from the hip increases potential to go beyond mere puffery towards fraudulent misrepresentation.
- If you choose to use a slide deck during your pitch, include a disclaimer that clearly states you are not soliciting any investment from the people who attend your pitch.
- Have your attorney review your slide deck beforehand to make sure none of your content could be construed as a general solicitation of investment to the public at large.
- Limit your presentation to business concepts and products you have available or will have available soon.
- Do not include any slides or other information regarding financing or fundraising.
- Do not distribute any investment materials, including business cards or pamphlets that contain links to crowdfunding sites you are on.
- If a list of attendees is available before the event, try to identify any potential investors and guard against publicly wooing them from the stage.
- Think through your actual purpose for entering the pitch comp. The focus should be informational or educational. If your true purpose is fundraising or promoting the efforts you are making toward fundraising, it might be best to reconsider your approach.
- Since the SEC has not provided a lot of guidance and has made it clear that these situations are reviewed on a case-by-case basis, the best thing an entrepreneur can do to limit exposure is to work closely with a knowledgeable attorney and have him or her review all of the materials the entrepreneur plans to use in light of the conditions of the scheduled event. This includes presentation notes, answers to frequently asked questions, slide decks, and any business cards, pamphlets, or other materials the entrepreneur plans to hand out or otherwise make available to the event’s attendees.
LASTLY, THIS IS NOT LEGAL ADVICE. I AM NOT YOUR LAWYER. NOTHING IN YOUR REVIEW OF THIS ARTICLE OR ACTIONS YOU TAKE IN FURTHERANCE OF IT ESTABLISHES A LEGAL RELATIONSHIP BETWEEN YOU AND ME. I PROBABLY DON’T EVEN KNOW YOU, THOUGH WHO’S TO SAY WE CAN’T BE FRIENDS? NOTHING IN THIS ARTICLE IS WARRANTED TO BE ACCURATE IN ANY WAY, AND THOUGH PRACTICALLY UNLIKELY, IT IS POSSIBLE THAT THE SUBSTANCE OF THE ARTICLE CAN KILL, HARM, MAME, OR OTHERWISE DEFEAT YOU, PARTICULARLY IF YOU ARE READING IT WHILE ON A SCOOTER. YOU SHOULD NOT RELY ON ANYTHING IN THIS ARTICLE WITHOUT INDEPENDENTLY DISCUSSING IT WITH YOUR LAWYER. YOU PROBABLY SHOULD HAVE ALREADY BEEN IN TOUCH WITH A LAWYER BEFORE READING THIS ARTICLE. LAWYERS ARE A GOOD THING – ALSO NOT LEGAL ADVICE.