Life just got more complicated: One of the challenges of crowdinvesting
We all know what a start-up’s “normal” life cycle looks like: you set up in someone’s garage, you raise a bit of money from your family, you get to proof of concept, you get a bit more money from angels, you work out what regulations you are subject to, you file the paperwork with the government, you maybe hold some directors’ meetings (or maybe not) and eventually after a few years of chaotic operations you get to the point where you are ready for an initial public offering.
In my old life as a securities lawyer, I did a lot of IPOs. And one of the tasks that counsel to the company must perform in an IPO is what we used to refer to as “housekeeping”. AKA- Getting all the paperwork in order. Plenty of conversations along the lines of: “Where are the minutes for your annual shareholders’ meeting for two years ago? When you say that Uncle Bill is a shareholder, do you mean you actually issued him shares? Did you pay franchise taxes for last year? Where is your stock certificate record and what are all these bits of paper in this shoebox?” Of course, the entrepreneurs would get tremendously frustrated because who has time for details when you are building THE Next Big Thing?
Over a couple of beers I discussed this issue with someone who advises start-ups. He said, “If the company makes it, then it will be able to afford people like you to come in and sort it all out properly. If they don’t make it, who cares?” And of course, much as I hate to admit it, he was right.
With crowdfunding, though, that old model doesn’t apply. Companies seeking crowdfunding are going to have to get “sorted out” much earlier in their lives. Crowdfunding exposes companies to regulatory complexity much earlier in their lives than would otherwise be the case.
First, disorganized companies are not going to attract investors. Uncle Bill may be perfectly happy to invest in you without getting the proper stock certificate and without being sure that you have filed the proper paperwork with your state of incorporation. He knows you’ll get it done eventually. But the family, friends and total strangers who are looking at your company on a crowdfunding portal are going to want to know that you have all the paperwork done and that their investment is a legal, valid, binding investment. The crowdfunding portal is going to want to know the same thing.
Second, if your paperwork is sloppy, you could be exposed to legal liability, and so could the crowdfunding portal. If you are offering shares representing a certain percentage of the company, and you’ve forgotten to account for the shares you owe to Uncle Bill, then you could end up making a “misrepresentation of a material fact.” And your company and its officers could get sued for that.
So while crowdfunding is going to be a fine way to accelerate an entrepreneur’s access to capital, it will also accelerate the entrepreneur’s obligations to outside investors. Companies seeking crowdfunding can seek help from service providers such as CrowdCheck, Inc., or lawyers, but they can’t access this new world without being properly prepared. Start now!- Sara Hanks is CEO and co-founder of CrowdCheck, which provides disclosure and due diligence services for online offerings. CrowdCheck helps entrepreneurs through the disclosure and due diligence process, giving crowdfunding investors the information they need to make an informed investment decision and avoid fraud. email@example.com www.crowdcheck.com @crowdcheck