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Crowdfunding – Preparation, Do’s and Don’ts

Crowdfunding through sites like Kickstarter, IndieGoGo, Crowdfunder, and the like, is an increasingly popular method of funding a project, product or company. Those approaching a crowdfunding effort should prepare from a legal perspective long before they kick off their campaign.

These are a few critical things to do, and not to do.

Let me first note that this post is intended for the “professional” crowdfunder – someone who is taking this option as seriously as any other method of funding their genuine BUSINESS. Make no mistake. Crowdfunding to gain the finances you need to produce a product, entertainment project, or other prospect – is part of advancing your BUSINESS. And should therefore be treated with equal seriousness and professionalism.

Here are a few “must do’s” before and as you engage in your crowdfunding effort. And a few “don’ts.”

1. Form your entity and get your entity the bank account it needs to operate independently of personal funds.

This may seem like a no-brainer, but often crowdfunders don’t take the time or spend the relatively small amount of money to fund their LLC or company BEFORE they engage in there crowdfunding effort.

The problem is that the crowdfunded money should go directly to the company that is going to produce the product or project. It should not go to an individual, or an individual’s bank account, only to then be pushed on to an LLC, divided among partners, or other inappropriate handling of the funds.

Why? Quite simply because commingling personal funds and company funds may jeopardize the liability protection of an LLC or corporate entity.

Best practices would be to form the LLC, company, or whatever legal entity, and then get your entity bank account – before starting the Kickstarter, IndieGoGo or other crowdfunding effort. That way, any funds raised through the crowdfunding effort can be properly deposited directly into the entity’s/company’s account.

It should go without saying that other “corporate formalities” should be followed to preserve the liability protection of the company or legal entity, and to insulate the personal assets of the company founders from claims and liability of the company. That’s the main point of the separate legal entity.

?? “Do I really need a separate legal entity?”    Hell yes!

I don’t mean to sound like a lawyer, but … I am one. So … Let’s talk about liability.

Regardless of your crowdfunding campaign, you are making a product or producing some sort of project. With that comes liability.

-Funding the world’s greatest potato salad? The litigator in me thinks of salmonella – consumed by thousands of supporters.

-Making a pen? That kind of thing usually has multiple parts. The litigator in me thinks of a choking hazard from a child devouring one of the parts.

-Making an ultra cool ice chest with battery power and built in devices? The litigator in me notes that many electronic devices end up with battery heat and fire problems, or parts that can be taken off of the device and, again, consumed by kids, stuffed up their little noses, etc.

It is an unpleasant fact of our litigious world that every product that can be imagined has a potential liability that can also be imagined. A separate legal entity through which you produce your product or project separates your personal assets from the liability of the company and the product or project being produced.

A separate legal entity also demonstrates to the world, your vendors, your suppliers, and future purchasers, etc. that you are acting in a professional and businesslike manner.

There’s no question about it. You absolutely should form a separate legal entity as would be appropriate for your product or project. Do it. And do it before your Kickstarter campaign.

2. Get insurance! Before you produce anything.

Many start ups and new entrepreneurs do not want to suffer the expense of liability insurance before they know that the product, project, or company will have an actual life. Or they perceive the risk of liability from their product or project to be minimal. So they skimp on what may well be as little as $1000 for liability insurance.

What many entrepreneurs fail to recognize is that the primary benefit of liability insurance is not necessarily the insurance company paying a liability judgment. Perhaps the greatest benefit is the insurance company paying for a legal defense against a liability claim.

The other fact of our litigious society is that defending – even successfully defending – against a liability claim or lawsuit can cost tens of thousands of dollars. Easily $30,000 or more. To win. Relatively quickly.

Appropriate liability insurance provides your legal defense at no cost above the insurance premium (terms and conditions will apply). It may therefore be some of the “cheapest money” you ever spend.  Or perhaps the most “expensive” money you don’t spend.

Get it. ASAP.

3. Incentives only – no ownership!

For a number of reasons, it is strongly recommend that you not offer shares of ownership in exchange for crowd sourced funding. First and foremost, offering ownership, shares, interest, etc., in exchange for funding and pledges probably constitutes the sale of “unregistered securities” according to the U.S. Securities and Exchange Commission.

Seal of the U.S. Securities and Exchange Commi...

Seal of the U.S. Securities and Exchange Commission. (Photo credit: Wikipedia)

In other words, its probably against the law. (Read how the SEC shut down the effort to crowdsource the purchase of PBR here).

While the JOBS Act may allow for an exception to that lawbreaking fact, that remains to be seen. Nevertheless, there is an overarching practical reason not to offer ownership shares or interest, even if it is not illegal. VC’s, angel investors, or other professional investors will likely not be interested in your company if you have hundreds or thousands of “mom-and-pop,” non-accredited investors that are owners of your company.

Therefore, it is likely a best practice to only offer “thanks and things” in response to financial pledges.

4. Don’t promote or broadcast your unprotected idea!

Be careful not to broadcast your idea until it has been appropriately protected through copyright, trademark, patent law or other means. Ultimately, an “idea” cannot be protected through copyright or patent law.

It is therefore critical that you actually have something produced, recorded, or made, so that your intellectual property – your actual, specific execution of your idea (which is protectable) – can be registered through the appropriate means.

Songs, stories, scripts, graphic design, and the like can be registered with the U. S. Copyright office. Devices and physical products may be protectable through a combination of copyright law, trademark registration, and or patent registration.

Once again, many early stage entrepreneurs do not want to pay the money to pursue these registrations. But revealing your unprotected idea through a crowd funding effort is essentially giving away your idea. Anyone else is free to execute their own iteration of your general idea. You may be creating your biggest competition.

Also, for you would be writers and filmmakers, the writers Guild of America is not the same as copyright registration. Copyright registration with the US copyright office provides far more protection and benefit than does WGA registration.

5. Pick your company and product name carefully.

Imagine a scenario where you picked your company and/or product name, held your Kickstarter campaign, produced your product, and a year or two into your company’s great success, you are contacted by a company that previously registered the same or similar names through the US Trademark Office. Guess what – they have the right to force you to stop using your same or similar name.

You are then forced to start rebranding all over again, losing all of the name recognition and goodwill that you have developed through the lifecycle of your company and product.

Choose names that are unique, but easily identifiable and found, and research those names appropriately before putting them into use.

Once again, best practices would be to register those names with the trademark office asap so that you are “first in line” in the use of such names or phrases, and therefore you have the legal authority to force others to stop using such things in competition against you.

6. Honor your commitments!

In running a crowd funding campaign, know that you have promised to provide “thanks and things” in exchange for a pledge by a supporter – and that is a contract!

Subject to the terms of whatever crowdfunding site you use, your failure to produce and deliver as promised, or to provide whatever incentives and “thanks and things” you have promised, constitutes a breach of contract.

While it may be unlikely that one $20 supporter will sue if you fail to send them their T-shirt or other swag, several hundred supporters, or several thousand, can easily be pulled together as a class action lawsuit.

Avoid such problems. Live up to your promises.

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If I may be of assistance to you, friends or colleagues in advancing your business or creative endeavors, I would welcome the opportunity to speak with you.

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The foregoing does not constitute legal advice, nor does it create an attorney-client relationship between you, the reader, and Gano Lemoine or the Lemoine Law Firm. The preceding has been for general information purposes only. It is strongly recommended that you seek appropriate legal counsel regarding your particular situation and needs.