Avoid Crowdfunding Lawsuits: Use Intermediaries Cautiously

When you start crowdfunding, you won't see many articles or discussions about the importance of intermediaries for small businesses. It isn't as flashy of a discussion as startups or finding a target market, but it's just as important.

This FindLaw article explains legal issues to be aware of when using intermediaries with wholesalers, distributors, or in real estate transactions.

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Types of Intermediaries

It's easy to think of intermediaries as middlepeople (middlemen). Each intermediary has specific duties and legal requirements for acting with business owners. The intermediary works on marketing channels and with interested buyers. Their goal is to make business sales for the company's product or equity.

All intermediaries must register with the SEC. The types of intermediaries you might encounter during crowdfunding are explained below.

Finders

There is no shortage of self-proclaimed crowdfunding and social-media experts. These people or companies offer to assist you with your crowdfunding offering. Securities offerings often attract unregistered finders. These people offer to introduce an investor in exchange for a finder's fee. The fee is usually contingent on the sale. It's like commissions or success fees in other industries.

These persons' activities are promotional activities under federal law. If you must abide by Securities and Exchange Commission regulations, this is a violation.

Promoters

Under the Securities Act of 1933, which is still law today, a promoter is:

• Any person who directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer
• Any person who directly or indirectly receives 10% or more of any class of securities or proceeds from the sale of securities

In the last several years, the Securities and Exchange Commission (SEC) has taken the position that a person receiving transaction-based compensation in connection with a securities transaction indicates that the person must register as a broker-dealer.

Legal Liabilities To Look Out For Using Intermediaries

There are many advertising rules to follow under federal law for crowdfunding.

Investor plaintiffs will scrutinize the activities of any person promoting your crowdfunding campaign. This will be an attempt to hold the issuer and you responsible for the actions of the third-party promoter.

If you choose to work with third-party promoters, there are liabilities you can avoid with careful planning:

• Adopt reasonable procedures to ensure that the promoter includes their compensation disclosure in any communication.
• Document the procedures you have in place to show you complied with federal law. Document the steps you took following those procedures. These procedures are essential if you hire third-party promoters. You won't have complete control over their conduct.
• Have reasonable procedures and agreements to show that any third party speaking on your small business's behalf does not make any misrepresentations about the issuer or the offering.
• Do not pay commissions, success fees, or other transaction-based compensation to third-party promoters or finders. This is true even if the finder introduces prospective investors to the issuer and does nothing else.

A securities lawyer can help you create these procedures.

How Intermediaries Can Be Compliant

Before financing your business with crowdfunding, you should understand what you can and can't do on distribution channels. Failure to abide by federal law can land you and your business administration in legal trouble.

Below are ways to protect yourself when engaging third parties to help in your sale process.

Drafting Contract Clauses

Include clauses in the promoter's contract, such as:

• Indemnification provisions, which provide some assurance that the promoter will comply with your instructions. If they don't, they must pay your legal damages and fines
• Procedures to monitor the promoter's communications on e-commerce sites, marketing channels, and other channels of distribution
• Confirmations or affidavits from the promoter regarding compliance with your instructions and policies

A written contract is crucial to show you followed SEC rules.

Following Your Procedures

You and your small business must follow your own procedures. An attorney trying to discredit you and your marketing intermediaries will use it against you if you don't. Not following internal procedures shows your business may have glossed over required regulations.

Paying Intermediaries

If you're not using a registered broker-dealer, only pay a flat or non-contingent fee for their promotional efforts. Compensation shouldn't depend on whether a sale occurs. It can't be based on a percentage of the sales (i.e., a commission).

Hire a Securities Lawyer To Help

Considering the advertising rules and securities regulations to follow, small businesses should hire a securities lawyer to clarify intermediaries and crowdfunding use.