Raising Capital - Risk Disclosure

When raising capital, the law requires that you disclose to a prospective investor all material information regarding your business.   Without this disclosure, the prospective investor is not prepared to evaluate your offering and make a decision to invest or to walk away.

From an investor perspective, although you are required to disclose everything that may cause your business to succeed or fail, most investors are only concerned about failure.

Failure, in this context, has many meanings and many levels.

Obviously, you should disclose anything that may cause your business to fail:

  • You or a key member of your team die, are permanently disabled, or are temporarily disabled for long enough

  • You fail to complete development of your technology

  • You fail to make a product or service

  • No one buys your product or service

Aside from these majors, you should also include that you fail to raise your capital goal.  This is just a starting list, don’t stop here.

If, you have made any projections with regard to sales, revenues or profits, failure is not measured just in terms of your business, but also in failure to achieve your projections.  This lowers the level of threats that you need to disclose.

In addition, failure to disclose something can also get you in trouble.  You are accountable not just for what you say, but anything you should have said.  Fraud by omission.  Be complete.  Be thorough.

Simply listing the risk is not enough.  You have to explain how it may negatively impact your business and the extent of that impact.

By this time, you may be thinking that you are going to scare away all of your investor candidates.  You may be right.  The less sophisticated the investor candidate, the more likely that they will walk away.  More experienced investors will listen to what you say and draw their own conclusions.  In any event, it is better to have an investor candidate say no than to try to explain later why you left something out.

Failure to disclose a risk is important.  It constitutes securities fraud.  This makes you, as a principal in your business, personally liable for any harm that occurs.  You cannot shield yourself behind the structure of your business.  An investor may sue you personally in addition to your business.  Depending upon which securities laws have been violated, you may be liable for treble damages and attorneys’ fees after returning the investor’s money.

To avoid this problem, be objective in assessing the challenges that your business will face.  This is where having a management team is helpful.  Create a competition for the person who creates the most complete list of possible risks.  In the event that all your team has ‘drunk the Kool-Aid’ and is giddy with the prospects of your business, go to someone outside your business.  Hire one or more advisors or put together a group of experienced entrepreneurs.  Ask them to tell you everything that can go wrong.  This may take a while.  You may be surprised and entertained.  Write it down. Compare it against your list.  Upgrade your disclosures and put them in writing.  Include them in your offering memorandum or your investment contract.