By Bryan Sullivan and Stephen Ma, attorneys with Early Sullivan Wright Gizer & McRae, an entertainment and business law firm in Los Angeles.
With the success of the Veronica Mars and Garden State-sequel Kickstarter campaigns, it appears that the crowdfunding business model has made its way to mainstream Hollywood. While crowdfunding certainly has advantages, including giving filmmakers more creative control over their projects, this business model is open to potential claims of fraud, misappropriation, conversion and embezzlement, which lead to the risk of financial exposure in the form of adverse judgments and the cost of litigation, and can potentially stop the project. In
order to minimize risk, people using the crowdfunding business model should first consult an attorney, and follow what Sullivan & Ma have coined as the “Ten Commandments of Crowdfunding.”1) Thou shalt make truthful, clear, and accurate disclosures: Be clear about what you are offering in exchange for the donation and you should be able to deliver on those offers. For example if, like the Veronica Mars campaign, you are offering a speaking part in a movie, then make sure you don’t end up having too many people qualifying for that role because you may then be unable to deliver to many of them. Also, do not offer something that one may consider a joke. For example, if you are raising money for a film about Abraham Lincoln, don’t offer a copper engraving of Lincoln in exchange for a $50 donation and then the send the donor a penny. While accurate and funny, it is arguably actionable fraud.
2) Thou shalt be careful not to mislead unsophisticated or unaccredited investors: People often interpret offers differently, especially the more complicated offers. This concern is even greater when film-making and other entertainment matters are involved. Many people may have only limited knowledge or interest in private equity companies or hedge funds. But a much wider group of people will be interested in becoming involved in entertainment projects. (Just ask the unsuspecting people who lost money investing in allegedly fake film productions by individuals claiming to work with a company called Cinamour Entertainment, who were arrested by the FBI in 2011). Unsophisticated investors may not fully understand an offer, and will bring a lawsuit to enforce their unrealistic or misinterpreted expectations. Be explicit!
3) Thou shalt be able to make the project: Presumably, Rob Thomas, the creator of Veronica Mars, had the rights from Warner Brothers to make the movie. However, people may be raising money to convince a studio to make a movie based on other intellectual property that are owned by the studio or, whose rights may be already tied up. You could face liability if you solicit money for a project that you don’t have the rights to make.
4) Thou shalt be aware of what it means to offer equity through crowdfunding. It may create fiduciary and other legal duties between you and the investor. Although the Securities and Exchange Commission has not yet released its much-anticipated rules for crowdfunding, a filmmaker’s efforts to raise funding are already governed by applicable common law and statutes such as California’s Unfair Competition Law (Section 17200 of the Business and Professions Code). Know your legal duties and comply with them!
5) Thou shalt deliver on your promise: If you say that you’re going to make the project, then you have to use your best efforts to make the project. If you fail to put forth sufficient effort to make the project, then you could face liability.
6) If thou cannot make the project, thou shalt consider having a “back up” alternative: If you cannot make the project, then you need to explain to people why you are not making it and what you are doing, such as development, with unspent money. One suggestion is to say that you will donate the money to a charity (preferably, a 501(c)(3)).
7) Thou shalt account for every dollar: If you do not keep track of how you spend the money you raise, then you could face liability for misappropriation or embezzlement. Make sure the funds are kept in a separate account, and all receipts properly support payments and withdrawals from that account.
8) Thou shalt not use the money raised for oneself: Many people who use Kickstarter to raise money often think that such money can be used for their own living expenses or salary while the company gets started. While it may not be illegal to do this, it may be problematic, especially if the project does not go forward. People who donate through Kickstarter do so because they are passionate about the project and would not appreciate you spending the money on your own personal expenses. Plus, this opens you up to claims of misappropriation, or embezzlement.
9) Thou shalt pay taxes: Unless you are an approved charitable organization, which is unlikely if you are looking to make a movie, then all “donations” likely have federal and state tax consequences. If you do not determine what these consequences are ahead of time, then you may be hit with a surprisingly large tax bill that will affect your ability to complete your project.
10) Thou shalt be thankful to your donors: Ultimately, donors to a Kickstarter campaign are doing it because they are passionate about the project and believe in you. As a result, you should treat them with respect and thank them in some way for their loyalty and passion. After all, these are the people that are hopefully going to pay $15 to see your movie and attract several of their friends to do the same thing. Moreover, angry donors can become aggressive litigants when their expectations are not met.
Retaining legal counsel to oversee your Kickstarter or Crowdfunding campaign could be the most important thing you do to avoid a potential nightmare. While most entrepreneurs seek to avoid hiring a lawyer when starting a business to avoid the upfront cost, especially in cases when it appears that money is easy to raise, such a strategy is penny-wise and pound foolish. You could end up jeopardizing your project, your reputation and your career.
Posted from: http://www.forbes.com/sites/ciocentral/2013/05/15/the-ten-commandments-of-crowdfunding/