Managing The Risks Of Crowdfunding

By Evan Bundschuh, RPLU  & CrowdFund Beat Guest Editor,

For new ventures looking to raise capital or test their market/product, crowdfunding has proven to be the go-to solution with an ease and excitement that other methods of funding lack. With that excitement though comes challenges. As a fairly young platform with a legal landscape that has yet to develop, the risks of crowdfunding are often overlooked. While the risks may seem invisible, mistakes are inevitable, as are the lawsuits and damages that follow. The challenge is forecasting when and where the potential dangers/disasters will arise (before they do) in order to protect your business, its directors, and its newly formed brand. We outline these risks not to discourage the usage of crowdfunding but to bring risk concerns to the forefront so that they can be properly assessed, managed and mitigated.

  1. Poor communication and lack of transparency. When it comes to describing the performance/effectiveness of your product, prices, associated fees, turn around times, etc. be as descriptive and transparent as possible. In a well published recent case, a disgruntled buyer filed a lawsuit over the failure to disclose a simple shipping fee, ultimately bankrupting the company which could not afford to issue full refunds to its purchasers.
  2. Lack of solvency and reserve capital: The same case example above also highlights the importance of having enough reserve capital on hand for the unexpected. The unexpected can come in the form of disgruntled backers demanding returns, expedited fulfillment costs following unexpected success, or attorney’s fees to defend your IP to name a few.
  3. Poor customer support & upsetting dissatisfied customers. Whether or not you are contractually required to provide a full refund, consider erring on the side of generosity when encountering dissatisfied backers. Dissatisfied customers are, without saying, the most vocal and the most likely to take action, whether that be taking to social media to inflict brand damage or taking legal action. Most crowdfunding backers are also of the tech generation and know how to effectively utilize social media outlets to voice dis-taste for a company.
  4. Failure to qualify and diversify: In order to help ensure business continuity, attempt to source from multiple suppliers/manufacturers and diversify your supply chain when possible. Dependence on any single supplier/manufacturer can prove financially damaging if/when they encounter a loss. Losses can range from natural disasters to political unrest to bankruptcy. The inability to obtain your product is only the tip of the iceberg. It’s the inability to fulfill orders and deliver on your goods sold that can quickly escalate financial damages sustained. Developing and maintaining vendor qualification checklists also help ensure manufacturers, suppliers, vendors and outside parties meet certain risk criteria to ensure product quality and business continuity.
  5. Exposing your (unprotected) intellectual property: For companies planning on filing patents, it’s wise to discuss this with a qualified IP attorney as early in the process as possible and before beginning any campaign. Beginning a crowdfunding campaign also begins a one year “time to file” clock, as it is considered public disclosure. If any patents are planning to be filed, that have not been already, they must be filed within that one year clock. Once expired, the ability to file can be lost. In addition to working with an IP attorney to protect your own IP, it is equally important to do so early in the process to ensure that you are not infringing on others. Without thorough trademark searches, you are exposing your company to potential trademark infringement claims.
  6. Overlooking a proper insurance portfolio: When it comes to placing insurance, companies will often only place what is either being requested of them, or seek out the coverage that is believed to be “standard”, but may fail to listen to the advice of their actual broker. The most commonly requested insurance is general & product liability. While this is often a good place to begin, securing only the most basic insurance leaves many of your exposures still exposed. For companies without excess capital and an in house risk manager, this can be particularly problematic. Placing insurance protections for: cargo (during shipment), the directors & officers of the company, product recalls and cyber liability for data breaches is equally important. Considering that many of policies require careful review, coordination and negotiation further highlights the importance of working with a knowledgeable broker that can help you assess your risk and craft a proper portfolio.
  7. Compliance & accusations of fraud: With crowdfunding bypassing any meaningful reporting/oversight, the threats of fraud accusations are increased. A recent FTC Alert warns companies engaged in crowdfunding to: 1) ensure crowdfunding promises be kept, and 2) utilize crowdfunding funds only for the purposes advertised. The SEC has also issued a recent alert (among others) adressing acceptable donation limits. Understanding the compliance environment and implementing best practices & strong internal controls can help avoid accusations of fraud.
  8. Lack of sufficient R&D: It is important that sufficient R&D has been performed under varying conditions before bringing any product to market. Will this product cause electrical shocks? Is this product mixed or bottled in a factory that contains allergens? Is there any potential for injury? Is the product properly labeled? Is it in compliance with all US customs laws? Are the claims that we are asserting, properly supported? Purchasing product liability insurance does offer protection, but it’s no substitute for sufficient R&D, internal controls and legal counsel. For higher risk products a product liability audit may also be recommended.
  9. Implementing outside ideas: It’s important to read the platform’s user agreements and understand exactly what implications they have. There has been much talk about the concern of companies implementing product feedback from users/backers. Whether it be in the form of comments on the platform or elsewhere, implementing ideas provided by users/backers can create a potential legal issue.
  10. Overlooking tax liability & implications: Complete tax compliance can be deceivingly difficult. Crowdfunding poses many tax questions and areas of concern including applicable securities laws, differing state laws, and requirements of 1099’s to name a few. Before launching any campaigns be sure to contact an accountant or financial advisor that understands the crowdfunding sector.  Source @ http://www.gbainsurance.com/

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