What founders and reps can do to limit liability when raising capital

Founders need capital to grow, and registered reps often help them get there – but it’s not only about the capital.  If you search “Issuer Liability” most of the results will talk about the regulations.  When you raise money from someone else (not friends and family) you are selling a security, which is a regulated activity.  When you take an investors money there is liability, they are expecting something in return.  Many founders ask what they can do to protect themselves from investor lawsuits, so we wanted to provide a short guide.  We are not lawyers and this is not legal advice, this is information about the market in general for education purposes.  Founders should always seek guidance from a lawyer and if you are planning on raising capital with or without a broker-dealer you should probably have an attorney who you feel comfortable with on retainer.

Follow the rules

This is pretty straightforward, and if you are working with a registered rep of a broker-dealer they will ensure your offering ticks all the right boxes.  Broker dealers are regulated by FINRA and their job is to understand and implement the rules.

Get a lawyer

Lawyers are like Doctors, you don’t need them when you’re healthy, you need them when you’re sick or if you just got run over by a bus (in that example you’ll need both).  If you’re raising capital as your business grows you’ll need a lawyer to create documents and to provide legal advice for a range of issues well beyond your offering.

Disclose, disclose, disclose

One of the biggest drivers of investor lawsuits is the failure to disclose material facts.  If you disclose everything, it will greatly reduce the risk of getting sued.  Investors understand that there are risks with private investing, they are taking the risk and will be rewarded if it pays off and the project works.  For example, if the company has a loan that needs to be paid off and you fail to disclose that, investors would be very unhappy about that (and so would the regulators).  Most of the regulations center around disclosure, they don’t evaluate the quality of an individual offering or sector – when you file an SEC registration statement, the SEC will verify the format, and that you have addressed all the required points, they will never evaluate the quality of the offering or tell you if it’s a good idea or not.  What they do require is that all material facts are disclosed, including the backgrounds of the principals, financials of the company (if any), audits, reports, articles, business plans, patents or other intellectual property, etc.  The reason for this is simple, investors can only make informed decisions when they have all the facts.

Target sophisticated investors

This is more about strategy; if you target investors who have experience in early stage companies, they are going to be in a better position to make a decision, and may even provide valuable feedback based on their experiences in other deals.  If you are dealing with someone who has never invested in a private offering before, that’s probably not your best investor.

Explain to investors the Use of Proceeds well

This is actually the most important requirement when doing a raise with a FINRA BD; the reason is simple.  Investors want to know where their money is going.  Things don’t always work out, and investors may be receptive to that – where they get angry is if you do something outside the scope of your plan, or something they believe to be reckless.  If you explain that with $500,000 you’re going to do A,B,C, – and then you do it, and it doesn’t work out as anticipated, there’s a much lower chance of having a problem with investors vs. a situation where you went far off the business plan and invested in something not on the Use of Proceeds list.  Founders have multiple roles with investors, they are fiduciaries of the shareholders, and managers of the business.  They have an obligation to the shareholders to maximize their value.  As an executive of the business, their job is to ensure that they execute the business plan to the best of their ability.

Get an Umbrella insurance policy

If you have a house, a ranch, or other family assets, you should probably get an Umbrella insurance policy which covers those assets if you get sued.  The umbrella insurance is not specifically for people raising funds, it’s for general situations like if a stranger trespasses on your property and breaks their leg and sues.  The insurance agent can explain the benefits of it, but the idea is to provide some protection to your core assets in the case of lawsuits.

The LLC or Corp provides basic protection

Incorporation when starting a company is key, it means that any lawsuit would be against the entity, not the individuals.  Having said that, a founder is in a unique position because they typically are the main shareholder, the executive, and the person responsible for the entity.  However, this is the most basic protection and the reason that entities are formed, the group of shareholders are stakeholders who share in the profits or the losses of the business together.

Setup a Trust

If you have children, having a Trust is a great idea to pass assets however modest without dealing with Probate.  A Trust can provide other advantages of asset protection, but it does cost money to set it up.  This varies from state to state, but you should talk to a local attorney near where your primary residence is located.  A Trust should be local, it shouldn’t be in Delaware where most Corporations are registered.

Keep in touch with investors

There’s a reason why publicly traded companies have quarterly investor calls.  Imagine the following scenario-  you have an investor who gave you a decent amount of money to start your company and you don’t hear from him for years.  Time goes by and your business grows, and then you face a huge problem from a competitor, and there is a loss.  You call to tell him that, he’s not going to be happy to listen to this.  But it’s always about the lack of info and attention, if you were calling them or if you write an investor letter at least quarterly, you probably wouldn’t be in such an awkward position.  Regular updates are a great way to keep investors informed, and if they are displeased with anything they’ll tell you that then.

Under promise and over deliver

Getting caught in litigation is usually because an investor feels they were abused, lied to, tricked, or that they got an unfair deal.  If you under promise, and then over deliver – this vastly reduces the chance of someone feeling bad about the investment.  Investors don’t expect miracles and founders are not magicians, things happen, everyone knows that.  But if you provide great results, defined as better than what you originally told them, how could anyone have a problem with that?

This goes to the core of writing great terms, be conservative, be reasonable, explain the risks.  Many will say, that it will be ‘harder’ to raise money if your projections are conservative – exactly!  It’s a filtering process, you don’t want someone to EXPECT a huge return because then if you don’t do it, it will be a problem.  There was a FINRA case where a REIT promised 8%, delivered 5%, and got sued (we’re paraphrasing the terms for the sake of the example).  Or in other words, the 5% return was actually very good, but they hard sold and promised 8%, so it left some to feel that it was misleading.

11. When Speaking, Speak Honestly

According to one lawyer, what can prevent lawsuits is simple honesty.  Don’t exaggerate claims or speculate about the future, and certainly don’t speak about future potential as if it’s fact.  Avoid superlatives such as “Will” and instead use language like “May” because you really don’t know what will happen in the future.


This is not an exhaustive list, but it should provide the idea of how to risk mitigate the potential for getting sued, which is a real liability for founders, issuers, and reps.  There isn’t any language you can add to an investment contract that prevents an investor from suing (which is logical, if you think about it, because real scammers could use that language to shield themselves).

So consider taking the high ground, the ethical approach, disclose more than necessary, be above regulatory standards, don’t just meet the minimum requirements.

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