Crowdfunding and Network Marketing: Part II

    Thomas Ritter is an associate attorney at Thompson Burton PLLC. His practice area focuses primarily on cybersecurity law, which includes an assortment of data protection and privacy-related matters, and a wide-variety of business transactions. He assists diverse businesses from well-established companies to early stage start-ups.

    monopolyIn Part 1 of the crowdfunding series, I discussed the rise of the crowdfunding phenomenon and Title III’s recent enactment under the JOBS Act. While Title III may appear to be an attractive avenue  of capital fundraising for entrepreneurs and startups, founders of a network marketing company may find it a boardwalk littered with more stops than gos. As for crowdfunding as a MLM product service or offering, in my opinion, its a chance to go directly to jail. 

    TITLE III CROWDFUNDING AS WAY FOR MLMs TO RAISE CAPITAL

    If you remember, the benefits of a Company looking to use Title III appear numerous. Title III provides the ability to raise up to $1 million without having to deal with burdensome SEC requirements. For an MLM looking for startup funding, what’s not to like?  Well . . . er, money for one. The logic goes something like this: you have to have money if you want to raise money.

    For Title III securities crowdfunding, a company’s campaign must take place through a funding portal registered with the SEC. Don’t expect these funding portals’ fees to come cheap. According to people like Daryl Bryant, a co-chair in the Crowdfunding Intermediary Regulatory Association (CFIRA) trade group, the fees charged by funding portals could be somewhere between seven and twelve percent. Therefore, a fairly substantial portion of what a company raises may go towards the platform that hosted its campaign.

    Furthermore, Title III requires companies to comply with certain disclosures, specifically in regards to its financial statements. Before a company can begin their campaign, disclosures like financial statements have to be filed with the SEC and made available on the funding portal. By the SEC’s own estimation (see the chart comprised of footnotes 918-924 in the preceding link), this could be expensive. The SEC predicts the cost of paying a CPA to annually review or audit the necessary financial statements could range from $0, to $14,350, and all the way up to $28,700 depending on the amount a company wishes to raise. This required but nonetheless preemptive action represents a bit of a gamble for companies looking to raise capital through Title III. After paying money in order to have all your i’s dotted and t’s crossed, you better hope the return on such an investment was worth it. One possible solution to this quandary of spending before earning is proposed legislation by Congressman Patrick McHenry, which would make significant changes to the JOBS Act so as to allow companies to solicit interest before jumping through the required hoops.

    For MLMs interested in using Title III to raise capital, the brain trust behind the company better be prepared to hire the necessary attorneys and accountants needed to comply with disclosure requirements. Just because this new method exists doesn’t mean one will be able to take the fly-by-the-seat-of-your-pants approach. For the majority of MLM companies, I predict few will want to so quickly cede some ownership control AND expend the resources to meet all appropriate requirements.

    CROWDFUNDING AS A PRODUCT OR SERVICE OFFERING

    In the world of multi-level marketing, almost any conceivable notion is fair game when it comes to a product or service offering. However, any run-of-the-mill idea rarely equates to a good idea. The last two years have produced a fair share of MLM companies offering crowdfunding as the main course. What do you get when you mix crowdfunding with MLM? A Molotov cocktail.

    For most MLM crowdfunding companies, the payment of a monthly or one time subscription fee gives a participant access to a “unique” platform with a “customizable” page in which to create one’s project. After the creation of a project page, a participant is then given the right to earn money off of successful referrals of others to the company. For some MLM crowdfunding companies, it doesn’t even matter if you use the platform or raise money for your specific project, successful referrals still result in remuneration.

    There’s an abundance of inherent problems with crowdfunding MLMs. For one, offering to pay money for a crowdfunding platform seems ignorant in lieu of free options like Kickstarter and Indiegogo (however, these crowdfunding platforms do take a percentage of fees raised). And any crowdfunding MLM that downplays or outright states the platform need not be used in order to make money is a serious red flag. Lack of legitimate usage is an indicator that the “product” is simply incidental to the right to participate in a money-making venture.”¹ Like any questionable MLM, a crowdfunding-based business should be evaluated based upon some of the questions asked by the court in the BurnLounge case.

    • Does the product/service lack value: Meaning are the prices competitive with similarly situated products/services in the general marketplace?

    Considering that most crowdfunding platforms are completely free, the answer is it depends.

    • Where’s the emphasis lie in the company’s marketing materials: Meaning is the emphasis on recruiting more than it is product value?

    A company that dismisses the need for people to use the platform for fundraising while simultaneously encouraging the recruitment of new participants is indicative of a big problem. The marketing emphasis is undeniably recruitment-centric.

    • Purchase patterns: meaning do you know of any customers that use this service? Are the distributors using it?

    If customers aren’t using the crowdfunding platform, or worse yet, there isn’t even an option for customers to use the platform without joining the business, then there’s a small likelihood the business is anything other than a money transfer.

    For most MLMs wrapped around the crowdfunding model,  it takes more than just selling an alleged product or service to be considered a legitimate company. If the product or service doesn’t have legitimate value, then it’s not a product or service at all; and when commissions aren’t based upon any legitimate product or service, the business is a pyramid scheme, period.

    CONCLUSION

    Crowdfunding has a lot to offer businesses in general, but right now appears to be a buyer-beware proposition.

    Do you see any way crowdfunding may positively affect network marketing in the future? 

    ¹ This language is taken from the 2004 FTC Staff Advisory Opinion to the DSA.

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      Thomas Ritter is an associate attorney at Thompson Burton PLLC. His practice area focuses primarily on cybersecurity law, which includes an assortment of data protection and privacy-related matters, and a wide-variety of business transactions. He assists diverse businesses from well-established companies to early stage start-ups.