As is the case with most innovative forces in the digital space, crowdfunding became shrouded in hype and high expectations soon after its inception. With the rising stardom of platforms like KickStarter and GoFundMe in the late 2000s, sensationalist headlines boasting of sudden entrepreneurial success became staples of business and tech publications. While the immense opportunity offered by crowdfunding cannot be denied, often too little attention gets paid to what happens when things go wrong.
Unfortunately, some fail to realize that a crowdfunding page is a business site, not a Facebook profile. Approaching it in a casual, haphazard manner is not only a recipe for failure, but also runs the risk of opening you up to significant legal peril. As this form of fundraising has matured into the mainstream, federal and state laws have begun to catch up. This makes it essential for budding entrepreneurs to engage in thorough legal preparation before launching their campaigns. Below, you will find several tips that will prove useful in this endeavor.
Avoid a Sole Proprietorship
Before launching a crowdfunding campaign, it is important to take the necessary steps to ensure that you are legally recognized as a business entity. Failure to do so results in your company defaulting to the status of a sole proprietorship, thereby putting your home and other personal assets at risk should a lawsuit arise. Two common business classifications used by startups include limited liability companies and corporations. Which of these you choose is largely dependent on the unique circumstances of your business.
LLCs are by far the most popular option for startups, as they are relatively easy to obtain and tend to offer adequate protection. However, an entity like a C-corp can provide significantly more flexibility when it comes to certain tax issues, so it is highly advisable to consult a tax accountant about which option is best for you. After you register your business, the next critical step is acquiring an Employer ID Number from the IRS, something that is required for you to open up a business bank account (which is also critical, as using your personal bank account would defeat the purpose of forming an LLC or C-corp).
Understand the Differences Between Rewards Crowdfunding and Equity Crowdfunding
When entrepreneurial crowdfunding began to pick up steam a little over a decade ago, the concept was relatively straightforward. Entrepreneurs would pitch their ideas and offer some sort of incentive for support, and those who found these ideas enticing enough would pitch in to help make them a reality. Although technically considered investors, these backers never actually receive any sort of ownership in the company. Instead, their financial support is rewarded by items like shirts and access to early prototypes.
While the above form of crowdfunding remains the most prominent, certain legal developments have opened the door for more complex methods of raising capital. In 2016, for instance, the JOBS Act was signed into law. As a result, crowdfunding campaigns can now offer equity in exchange for contributions. However, this form of debt financing carries with it a whole host of advanced legal considerations. Unlike traditional crowdfunding, campaigns that offer equity are subject to the watchful eye of the Securities Exchange Commission. As a result, you are highly advised to research these regulations before offering up equity. A great place to start would be this excellent guide created by Fundable.
Take Intellectual Property Laws Seriously
Given the fact that crowdfunding platforms possess an abundance of inexperienced entrepreneurs, they prove to be a ripe target for those looking to make a quick buck off the work of others. These individuals scour crowdfunding platforms in hopes of finding hidden gems that have not yet received some form of legal protection. They then either incorporate these concepts into their own products or simply file a patent and extract licensing fees from the intellectual property's rightful creator. To avoid this nightmare, you need to go about filing a provisional patent. While this can be done independently with enough research, complex concepts and inventions are best left in the capable hands of attorneys that specialize in intellectual property laws.
Of course, you are also going to want to trademark company logos and copyright material such as music and animations. Quite often, lawyers will offer packages that include all of these elements for a single fee. Another added benefit of hiring an IP attorney is that they have the resources necessary to quickly and efficiently scan pre-existing patents for any potential conflicts. While this can also be done independently by entrepreneurs, it is a painstaking process that often involves records that haven't been digitized.
You also must ensure that you do not violate the intellectual property of others. Unlike a tweet or Facebook post, content posted on a crowdfunding site is inherently used for the purpose of generating money. As such, you can find yourself on the ugly end of a lawsuit if you utilize music or artwork that you do not own or have not received a license to use (such as using a pop song in a promotional video).
Avoid False Promises and Misleading Claims
Crowdfunding campaigns are essentially a contract between you and hundreds (sometimes thousands) of people. While equity crowdfunding undoubtedly comes with more clear-cut obligations, all forms of crowdfunding are subject to the jurisdiction of state consumer protections boards. Deception and failure to deliver on promises can lead to criminal charges, hefty fines, and even a prison sentence. As an example of the consequences of this, consider the case of Asylum Playing Cards. This campaign raised over $50,000 from a Kickstarter campaign, but then quickly vanished without honoring even a single commitment. In 2015, The Washington State AG prosecuted the case, and in doing so made history by filing the first ever criminal lawsuit against a crowdfunding campaign. Since then, other prosecutors have followed suit, making it essential for entrepreneurs to research relevant state laws and avoid making any commitments that they cannot fully follow through on.
In conclusion, crowdfunding remains a godsend for budding entrepreneurs, so long as they do not make the mistake of treating it like a magic Internet money machine. Remember, raising large sums from a crowdfunding campaign does not make someone a successful entrepreneur. In order to earn that title, they must actually roll their sleeves up and do the hard work required to bring their great idea to life. Still, seed money and a built-in base of support certainly make things easier, so be sure to launch your campaign on a strong legal foundation to avoid squandering such a golden opportunity.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2020 Travis Wolfe-Schiestel