The Double-D (as in Due Diligence)
Get your mind out of the gutter! Now, when you first saw the title, you asked yourself what business has to do with anything relating to double-Ds — of any kind.
We’re talking about Due Diligence. Sexy, isn’t it? Due diligence is a topic that gets a lot of people talking and writing, but they don’t make it interesting. It loses its sex appeal. The problem is that when these articles appear, most entrepreneurs turn their head and pay no attention or often comment back saying my lawyer does it all. The future of their company depends on following due diligence best practices, and yet they’ve washed their hands of it. They lose sight of the need to get naked for money.
This all changed on 28 October 2015 for companies, investors, and equity portals around the globe whether they know it or not. The SEC caught one American company committing fraud through equity crowdfunding, costing their shareholders almost $2 million in misspent funds, and it isn’t about to let them off easy.
We had our first fallout because no due diligence was done. So what does this mean for companies, investors, portals, and anyone else that’s part of the ecosystem? For one, it means that the level of scrutiny has to increase, for the good of the industry. The fraud could have been detected had Ascenergy gone to an equity crowdfunding portal that was operated by a FINRA broker-dealer. Instead, the fraud occurred through bulletin board style portals such as EquityNet and Crowdfunder. These boards do no due diligence of their own, and all of the risk around picking a legitimate company with a real opportunity is shifted to the investor, and the responsibility to ensure that they’re staying compliant and transparent.
Equity portals will need to emphasize to investors the high level of rigorous due diligence they perform on companies before they’re listed on their platform regardless if you are doing Title II, Title III and Title IV. They’ll need to reassure their investors that their companies can, to the best of anyone’s knowledge, be trusted, and educate them on the steps they take to vet opportunities. Building trust will be critical for equity portals. An investor that buys into a fraudulent deal on an equity crowdfunding portal isn’t very likely to do so again.
Each equity portal will employ different levels of due diligence, and may utilize third party companies to provide them with a FINRA compliant due diligence report which they can then combine with their own due diligence. Portals such as Republic.co, Venture.co, BreakAway Funding, StartEngine, BankRoll.Ventures, MicroVentures, and CircleUP pride themselves on the rigorous due diligence they perform in companies.
For companies that thought that simply having a Power Point presentation and term sheet was going to be enough, all I can say is that you’re not going to be successful in having your company listed on equity portals. Companies will need to make sure they fully understand all the due diligence requirements they need to meet. Today, there are tools that help companies prepare their documents so they can share with equity portals to conduct due diligence. It helps them stay transparent with their shareholders, and effectively get naked in front of the crowd for money.
Title III in now live, and many entrepreneurs are wondering how rigorous due diligence will be on their companies. They wonder if the process will be simplified, or if the requirements will change in any way. The answer is simple: due diligence isn’t going away and the market will be crowded. Portals will only take companies that meet and go beyond the basic due diligence requirements of Title III.
The due diligence requirements for Title II and Title III are very different. Now, I caution all entrepreneurs, yes certain due diligence requirements are reduced under Title III, but equity crowdfunding portals operating under Title III can, at their discretion, decide not to accept you if they don’t feel you met their requirements. My recommendation is to plan your due diligence as if you were doing a high-quality Title II raise, as you will need to stand out in the crowd.
It takes a pretty big leap of faith to hand over so much money to a company you’ve only just heard of, with a team you’ve never met, so portals and companies need to work in concert to create investor confidence. Due diligence is in place to protect the interests of the investor, and make no mistake that doing so is essential to ensuring the sector succeeds. It’s an inextricable part of the marketing efforts of everyone involved.
I’ve written on this in the past, advising a paradigm shift in investor relations. Now we’re doing the same for due diligence. This is your chance to lay it all out there, to make your best argument for your company, your portal, and your future success, and create advocates out of strangers.