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This Startup Wants to Protect Your Startup From 'Bad Actors'

This Startup Wants to Protect Your Startup From 'Bad Actors'
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Raising money to launch or grow your business is often a go-big or go-home moment. You get the money you need to move forward, or you don’t. It’s not a time when you can afford to mess up.

While recent law changes could make the fundraising process easier, if you violate certain regulations, you could end up having to give all the money you raised back to your investors.

CrowdCheck wants you to avoid that. The Alexandria, Va.-based team of securities lawyers set up shop approximately two years ago, just before the JOBS Act -- or Jumpstart Our Business Startups Act -- was officially inked by President Obama. Their goal is to help you identify any 'bad actors' involved closely in your company's fundraise. This includes your company's officers, directors, stakeholders who hold more than 20 percent of your company's stock and anyone promoting your fundraise or acting as an intermediary.  

Related: In Crowdfunding, Who is Responsible for Preventing Fraud?

The need for this kind of service has become all the more important as the fundraising rules have loosened. Where before it was illegal for entrepreneurs to publicize their efforts to raise money, the JOBS Act made it so that they can shout it from the rooftops, tweet it, blog about it, post about it on Facebook, or write it in the sand on the beach. The new laws also made it legal for entrepreneurs to sell pieces of their company to non-professional investors -- a practice called equity crowdfunding.

The Securities and Exchange Commission has said that entrepreneurs must take “reasonable care” to ensure that there are no “bad actors” involved in fundraising efforts. This is very vague. But the stakes are very high.

If there are any “bad actors” involved in your raise, as an entrepreneur, it means you have violated Section 5 of the Securities Act and potentially other provisions, said Sara Hanks, the CEO of CrowdCheck. “The end result is that you have to undo the entire deal and give everyone their money back with interest.”

The new CrowdCheck service will also likely be useful to crowdfunding platforms that are hosting campaigns. Miami-based crowdfunding-platform EarlyShares has used the service to check up on entrepreneurs using its platform. "We have a reputation to protect, we don't want to host any offerings by Bad Actors," said Heather Lopes, the co-founder and Chief Strategy Officer of EarlyShares, in a statement

Determining who is a bad actor in the eyes of the SEC is pretty daunting. The SEC has outlined eight categories of disqualifying events, including everything from a criminal conviction to court injunctions and restraining orders to a United States Postal Service false representation order. The problem is that there is no single database where you can go, type in someone’s name, and determine whether a person is a so-called bad actor.

Related: As Comment Period Closes, Debate Over Equity Crowdfunding Rules Rages On

CrowdCheck sought out guidance from the SEC and from FINRA, the Financial Industry Regulatory Authority, a self-regulating body deeply involved in the rule-writing. “So we went to the SEC and said, ‘Ok, what are best practices here. You know. What should we be looking for? What databases should we be pinging?’ And they said, ‘Ergh, there is no central database.’ And we went to FINRA and said, ‘What’s best practices?’ and they said, ‘We don’t know. Maybe an industry standard will develop and maybe you will develop it!’ So we did,” says Hanks.   

CrowdCheck’s proprietary process, which was unveiled and promoted this week, checks around 30 different databases and sources of information. As an entrepreneur, a one-off bad actor report will run you $499 with CrowdCheck. If you have a package of other services from CrowdCheck, then the price is can be negotiated lower. Almost $500 may seem expensive, but when your only viable alternatives are uncertainty or hiring a lawyer from a law firm (which will run you way more), a few hundred bucks becomes way more reasonable.

“I can’t ever promise that you will make the SEC happy,” says Hanks with a laugh. “But the SEC knows about this and we absolutely believe that this meets the SEC’s ‘reasonable care’ standards.”

It’s all rather circular, in a way: entrepreneurs helping find solutions to other entrepreneur’s problems. “This is super complex and what we are trying to do is make it easy. The JOBS Act has made, it has brought a whole level of regulatory complexity into an entrepreneur’s life much earlier than in the normal process, so we are trying to make it easier for the entrepreneurs.” 

Related: States Charge Ahead With Their Own Crowdfunding Laws

Catherine Clifford is a senior writer at Entrepreneur.com.

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