To Disclose or Not To Disclose, That Is The Question

DisclosureIn connection with a private offering of securities the issuer will provide potential investors with some form of disclosure document. Regardless of what type of offering it is (e.g. Rule 506, Title III, Intrastate, or other private offering), the intent of this disclosure document is to give potential investors all material information about the company and the deal before they invest. Unfortunately many issuers see this exercise as more of a burden and typically opt for providing only the minimum amount of information possible. This type of approach can often lead to trouble later and with all of the new private offering options available to issuers I thought I would share some my thoughts on the subject.


There really is no bright line standard for what should be disclosed to investors (except as statutorily required in certain instances which I will touch on later) and the form and breadth of disclosure documents will often vary significantly; even within the same types of offerings. There isn’t even a standard name for the disclosure document; often being called a “Private Placement Memorandum,” “Offering Prospectus,” “Offering Circular,” etc. (for purposes of this post, I will refer to the primary disclosure document as the “Memorandum”). However you put it, the Memorandum (together with whatever supplementary materials are attached) is supposed to provide potential investors with enough information about the company and the offering to allow them to make an “informed decision” about investing. Now the term “informed decision” is a legal term of art with its own history and adjudicated meaning which is well beyond the scope of this article. For our purposes, let’s just say that potential investors should be given enough information to be able to weigh the benefits and risks of investing. But exactly how much information is enough to do this? Unfortunately, in most instances, the answer to this question is entirely subjective.

What, and how much, to disclose is often one of the biggest points of contention between issuers and their attorneys. Issuers simply want to provide the basics and get to raising money as soon as possible. Their attorneys on the other hand, knowing the perils of improper disclosure, are trying, for lack of a better expression, to help their clients cover their a**. Admittedly, some attorneys go too far which is why you see 80-100 page memorandums costing issuers $30k plus. On the other hand, I have seen 3-5 page Memorandums that barely describe the offering let alone the inherent risks. So how long should a Memorandum be you ask? I will answer that with a modified version of Winston Churhill’s famous quote: ”A good [Memorandum] should be like a woman’s skirt; long enough to cover the subject and short enough to create interest.” (FYI, please direct any comments and criticisms regarding this quote to Winston Churchill’s estate).

The Highlights:

With the explosion of new types of private offerings available to issuers, I thought a discussion of the main points to be covered in a memorandum was in order. Now before I get into this discussion, I should note that the drafting of a Memorandum has become more of an art form than a science and each attorney will have their own opinion as to the structure of the Memorandum, what should and should not be included, etc. The following are simply my opinions on the subject and are not ordained mandate. With that out of the way, here are some of the main points I stress with my clients:

  • Identifying information about the Issuer.

Of course every memorandum will have the basic information about the issuer. What I am talking about is specifics about the Issuer and their operations; in particular, who Organization Presentationis running the company. In some instances an issuer will be statutorily required to disclose both officers and equity holders with more than an X% voting interest in the company. Even if such information is not specifically required (e.g. in connection with a Title II/Rule 506(c) offering), this is a good practice in general. The intent here is to let potential investors know who they are getting into bed with. For example, if say Bernie Madoff was on the board of directors of your company and you failed to let investors know that, you would have a hard time saying that you gave investors enough information to make an “informed decision.”

  • Intended use of proceeds.

This is a biggie and I get into fights with my clients on this all the time. Issuers should provide a reasonably detailed project budget/breakdown of the use of the offering proceeds. It doesn’t have to be overly granular (e.g. $5 on paper clips) but it should give investors a reasonable description of what the issuer intends to do with their Budgetmoney. Why issuers tend to get upset about making this disclosure is that they don’t want to be hamstringed if they need to change direction after the offering. That really isn’t an issue. The intent is to give investors a reasonably detailed glimpse into the issuer’s business plan but it would be entirely unreasonable for a potential investor to assume that such budget numbers are written in stone. Moreover, the attorney putting the Memorandum together (if he/she is good) should always build in language to the effect that the presented budget is “subject to change without notice” or something to that effect. If nothing else, issuers should at least be disclosing how much they intended to pay in salaries to officers/employees of the company. Investors like to know whether their money is going to further the business or going out the door into someone’s pocket. For example, if you are raising a million dollars and intend to pay $999k of it out as salaries to employees, potential investors would want to know that and if you fail to disclose it to them you could be in serious trouble.

  • Restrictions on transfer.

Most, if not all, Memorandums will include the basic disclaimers concerning the “highly illiquid” nature of private investments, the “lack of a secondary market” for these securities, etc. These are all well and good but what I am referring to are the restrictions (if any) specific to the issuer. These can include anything from “first AdobeStock_88850373option” rights of other equity holders/persons, to “drag-along” rights, to “call options,” to mandatory “redemption” provisions, etc. This would also include any requirement of an investor to get the consent of the company before transferring their securities. Basically the Memorandum should outline all of the instances where an investor would be required (whether or not they want to) to sell/redeem their securities, to offer their securities to another person before being able to transfer it freely, and/or to get the consent of the company or any other person before transferring their securities to a third-party.

  • Proprietary Information.

When it comes to an issuer who is relying on a proprietary product/idea, disclosures with respect to the same need to be well thought through. On one hand an issuer should be giving potential investors enough information to evidence they can/sell what they intend to. For example, if you are telling investors that you are trying to sell jet-packs there should be some evidence in the Memorandum that you actually can make a jet-pack (so as not to be seen as materially misleading investors as to your ability to make the product). On the other hand you don’t have to give the secret sauce away either.

It is understandable that the giving of any information related to a proprietary product/idea is often a big concern for issuers as they fear a competitor stealing it. That being said, I often tell my clients that if their product/idea is easy enough to steal from a general description in a Memorandum then it’s probably not all that protectable to begin with. Moreover, you can’t really expect investors to shell over their money without giving them a little peak behind the curtain. The good news for issuers is that idea stealing from crowdfunding campaigns has yet to be a problem at all (at least as far as I have seen).

  • Investor Specific Risks.

This is another hot button issue between issuers and their attorneys. Most issuers (particularly younger entrepreneurs) see the world in terms of opportunity not risk so when they are describing their investment opportunity its almost always sun and roses. Now enter us attorneys who, unfortunately for us, are trained to see the world from the risk side of things. Like Eeyore trying to warn Winnie the Pooh about the risk of getting his face stuck in a honey pot (look it up people!), I often find myself in the unfortunate position of explaining to my issuer clients all of the things that might go wrong with their idea and why those risks should be disclosed to investors. A properly drafted Memorandum should include a discussion of the material risks that could Riskaffect the issuer’s business and/or an investor’s investment in the business. These can include anything from risks related to key personnel (is the company overly dependent on the ideas/employment of one person; e.g. Steve Jobs), to the ability to secure future approvals for the company’s products/services (e.g. FDA approvals etc.), to simply being able to secure/maintain a particular retail location (location, location, location).

The fundamental issue at odds here is access to information. The issuer is in the best position to know their respective businesses and to adequately identify and assess the risks. Investors on the other hand will not have access to such information unless it’s included in the Memorandum. This is easier seen in an example. Take a typical entrepreneur who dreams of opening his own coffee shop. He knows there is a Starbucks down the street from where he wants to open his shop but he thinks Starbucks sucks (me too) and his coffee is better so he doesn’t see them as a risk. As such he raises money from investors without ever disclosing the location of the Starbucks to investors. His business fails because it cannot compete with Starbucks and his investors are pissed, probably hopped up on caffeine, and screaming that they never would have invested had they known about the Starbucks. Needless to say, our little coffee shop owner is in hot water (see what I did there).

Issuers need to take the time to adequately, and impartially, assess and identify the risks involved with their business/proposed business plan. Often issuers rush through this exercise believing many of the risks are immaterial or obvious. This is a mistake, I can assure you. What might seem an obvious or immaterial risk to the issuer is often hotcoffeematerial to an investor. Just look at McDonalds who took for granted that its customers should know that coffee is hot only to later get sued for not alerting them. Obviously that was not a securities case but it illustrates the point that people sue for all types of reasons and I can tell you for certain that if investors lose money, they will look for whatever reasons they can to sue the issuer.

Generally speaking investors will not win a suit against an issuer for a lost investment if they were given enough information to make an informed decision and took the risk anyway (sidenote, same rules apply at Vegas blackjack tables, take it from someone who tried to argue a bad hand once, wasn’t pretty). Problems arise for issuers when they do not give enough information to the investors before they invest. As a result, issuers need to take the risk identification process seriously and think of this as the important CYA exercise that it is. Trust me, if investors come suing an issuer will want to be able to point to as much disclosure information as possible.

Going Above and Beyond

As noted above, depending on the type of offering the issuer is doing (e.g. Rule 506, Title III, Intrastate, etc.) the applicable state and/or federal rules may mandate the disclosure of certain specific information.  For example, under the Illinois intrastate laws the issuer is statutorily required to disclose most, if not all, of the information I highlighted above. If the issuer is conducting a Title III/Reg CF offering on the other hand, the SEC requires issuers to complete Form C which also includes references to the majority of the information I highlighted above.

Statutorily required disclosures are great but it can often lull issuers into a false sense of security. What I mean is that issuers often see these requirements and feel that meeting the bare minimum should suffice. Not necessarily. One size does not fit all and statutory requirements are generally intended to be the bare minimum of required information, not Office Space 2an exclusive list. As I said above, the intent of the Memorandum is to provide potential investors with all material information regarding the company and the offering. If this means going above and beyond the minimum amount of statutorily required information then issuers need to do so to help protect themselves as much as possible.

I think it is important to take a minute to specifically touch on some concerns I have about the use of the Form C in lieu of a traditional Memorandum. It is true that the Title III rules expressly state that a Title III issuer can use the completed Form C as its disclosure Memorandum. However, I personally have a couple caveats to Title III issuers.

First, the Form C is written to be a very succinct disclosure document. As such, issuers may be tempted to provide only the most basic of information. For example, the “Risk Factors” section of the Form C includes 11 blank, single spaced, lines for the issuer to use to describe their risks. Of course it says “add additional lines and number as appropriate” but just looking at this section, I can see how an issuer might be tempted to write 1 line descriptions of material risks. Whether or not 1 line is enough to adequately describe the risks, who knows, but I would be highly skeptical that it could. In any instance, I would highly discourage any issuer from completing a Form C without some type of professional guidance. Yes the Form C can be used as the Memorandum but the information in it must still be complete and provide investors with all material information.

Second, and this is a bit more tenuous of a concern, there are a ton of past SEC cases and actions that hinge on how certain disclosures were actually made to investors. Without going into detail, the main points of these cases relate to whether material risks were prominently made known to potential investors (like the disclosures in bold and caps at the beginning of many Memorandums) and/or whether they were presented in a manner that potential investors could actually understand. Title III offerings and the use of Form C are brand new so these types of issues have not yet come up. However, I can easily see a situation where a Title III investor might sue an issuer stating that a material piece of information (e.g. like the Starbucks being down the street in the above example) was buried in the Form C and not made clear, and/or the information presented in the form C was confusing. Whether such claims would ultimately be successful I cannot say but the potential for actions is certainly there.

The takeaway here is that, regardless of what type of offering you are doing, an issuer should put themselves in the shoes of potential investors and impartially ask themselves “what information would I need to see if I was the one making an investment in this company?” If this means giving potential investors more information than what is required by law (if any), and/or putting such information in a more presentable format, then that is exactly what the issuer should do. Issuers should not be afraid to go above and beyond the minimums as it will only help them in the long run if something goes wrong and their investors are unhappy.

What’s The Worst That Could Happen?

If you are an issuer reading this post you might be thinking to yourself, “what’s the worst that could happen if I fail to disclose something? So I might have to give an investor their money back, big deal!” Failure to make proper disclosures is actually a VERY big deal and the potential liabilities go way beyond giving money back. Issuers can actually face a
leo-dicaprio-fbi2myriad of civil and criminal charges under both federal and state laws.

Without going into the various state laws which vary from state to state, under the Securities Act (15 U.S. Code § 77l) an issuer can be civilly liable to investors for making an “untrue statement of a material fact or [omitting] to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading.” In any such civil case, the liability of the issuer would go well beyond returning investor funds and most often includes substantial punitive damages. Moreover, the Securities Act provides for certain criminal liabilities for issuers who intentionally or unintentionally mislead investors. Such penalties can range from fines of up to $10,000 and/or up to 5 years in jail (15 U.S. Code § 77x) all the way up to fines of $20,000,000 and/or up to 20 years in jail (15 U.S. Code § 78ff).

Needless to say, you are going to want to do everything possible to avoid having the guys in blue jackets with yellow letters show up at your door…..

Where To Begin?

Now after reading the above you might be thinking to yourself, “Ok well I definitely want to give investors all material information but how do I know exactly I should be disclosing?” The bad news is that the answer may differ dramatically for each issuer as their respective business, and the inherent risks and rewards of such business, will be different. Don’t despair however because the good news is that there are a ton of resources to help guide you along the path to disclosure nirvana.

First, as noted above, in connection with certain types of offering the laws will spell out a certain amount of required information. This information is freely accessible online (though can be sometimes hard to find if you don’t know where to look). The Form C for example is set up in a question and answer format to make it easier for issuers to think through what information should be included. Also, if a particular internet portal is being used to conduct the subject offering, it will often have materials and/or people on staff which can help issuers understand what should be disclosed.

Second, newer companies like are working toward making the disclosure process easier for issuers. With a website set up in a “turbo tax” type format, idisclose-robotissuers using iDisclose are walked through various questions intended to isolate key facts to be disclosed. At the end of the processes the issuer is given a compiled Memorandum that they can then take to their attorney to finalize. They even have a newer service which helps walk issuers through completing, and even submitting, a Form C. As Georgia Quinn from iDisclose put it “we are trying to relieve a significant pain point and help issuers prepare the first draft of their documents themselves. This cuts down on both time and cost for companies trying to raise money.”

Final Word.

Whichever way you choose to go, I highly recommend that you work with an attorney or other offering professional. The laws regarding issuing securities are tricky, to say the least, and are filled with landmines for the unwary. A seasoned attorney will be able to guide you through the disclosure process and the preparation of the Memorandum. Such services will range in cost however depending on how hands on you will need the attorney to be (e.g. are they drafting the Memorandum for you or are they reviewing and commenting, etc.). Just remember what your mother said, “an ounce of prevention is worth a pound of cure” so the upfront costs of using a good attorney will always be justified in the long run.

About Anthony Zeoli

Anthony Zeoli is an experienced transactional attorney with a national practice. Specializing in the areas of securities, commercial finance, real estate and general corporate law, his clients range from individuals and small privately held businesses to multi-million dollar entities. Mr. Zeoli is also an industry-recognized crowdfunding, peer-to-peer (P2P) lending and JOBS Act expert and is currently an active board member and Secretary of the CfPA (Crowdfunding Professional Association) and an active member of CFIRA (Crowdfund Intermediary Regulatory Advocates). Most recently he drafted Illinois House Bill 3420, a bill which provides for an intrastate crowdfunding exemption in Illinois and which was unanimously approved by the Illinois’ house and Senate. Anthony is also currently actively involved with the entrepreneurship program at the University of Illinois at Chicago as both a mentor and a student advisor and is an active advisory board member of the New York Distance Learning Association (NYDLA).
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1 Response to To Disclose or Not To Disclose, That Is The Question

  1. Jor Law says:

    Good write-up. Good rule of thumb is that if they have to ask whether or not they should disclose it, they probably should! Another area where there’s often pushback is disclosure of intermediary fees.

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