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Understanding Your Disclosure Obligations to Your Investors

October 19, 2020

A company and its management have an obligation to disclose all material information that a reasonable investor would want to know prior to making an investment in the company. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in determining whether or not to make an investment. Failure to disclose material information, or disclosing incorrect or inaccurate information, can result in liability for the company and management. To avoid such liability, management should take seriously its disclosure obligations to its investors by carefully vetting and disclosing material information about the company. The following article describes steps management can take to meet such obligations.

Start from the Beginning

Your disclosure obligations begin from your first encounter with your potential investor. Often, an initial encounter means sharing a pitch deck, executive summary, or similar document providing a summary of the company, including, its product or service, value proposition, team, business model, and competition. While such documents are meant, in part, to sell or market your company, they are also the first disclosure of material information about your company. While no summary can be complete, it should nevertheless be accurate. Carefully review pitch decks, executive summaries, business plans, term sheets, and other sales and marketing documents to make sure all information included is up-to-date, accurate, and not misleading.

Beware of “Forward-Looking” Statements

A “forward-looking” statement proposes a future event as a possibility or expectation. Common forward-looking statements include statements about possible economic performance of the company or plans for future operations, product features, or markets. Entrepreneurs are, by their nature, very confident in their product or service. But, while such optimism is important for success, these statements can sometimes be misleading, as they can be mistaken for factual statements, as opposed to informed and positive speculation. Federal law provides a “safe harbor” for certain forward-looking statements if you include a disclaimer noting, among other things, that such statements are based on management’s current information and expectations, while reminding investors of the speculative nature of the statements. If you include forward-looking statements in your sales and marketing documents, be sure to include a carefully worded “safe harbor” disclaimer.

Do Not Count on Your Investors to “Fend for Themselves”

Investors come in all types. Some investors may engage in rigorous due diligence which might include an extensive written request for responsive documents and information. Do not assume that merely responding to such a request is sufficient. Such due diligence requests are likely to be generic in scope and, therefore, may fail to request information that is material given the circumstances. The fact that an investor has provided you with her own due diligence checklist is not a substitute for the company disclosing material information (regardless if such information was not requested by the investor).

Of course, other investors may forego a due diligence process entirely and may rely instead on the company’s representations and warranties contained in an investment agreement. Again, do not assume that the representations and warranties are sufficient, as they too may be generic in scope and fail to disclose information that is material given the circumstances. Likewise, the fact that an investor may forego due diligence does not relieve you of your disclosure obligations.

Set Up a Virtual Data Room to Disclose Documents and Information

Virtual data rooms have been replacing traditional paper “document dumps” as the most common method of providing investors with access to material information. This is because, among other things, they provide company management and service providers a central location for uploading and updating materials, while allowing investors to access such materials simultaneously and at times that are convenient for them.

To set up your virtual data room, create separate folders, and as appropriate subfolders, by major topic (e.g., Corporate Documents, Employment Matters, Intellectual Property, etc.), and populate them with material documents and information relevant to the topic. If a lead investor has provided a due diligence checklist, the folders should match the topics in the checklist. Once the folders are organized and you are satisfied that all material and responsive documents have been uploaded to the data room, the data room should be made available to all investors by sending an email invite.

While not all investors may choose to access the data room, it is nevertheless important that all investors are invited and have such access. Regardless of a particular investor’s interest in due diligence, the company nevertheless has a duty to provide all investors will equal access to the same information. Likewise, if additional documents and information are later uploaded to the data room, all investors should be notified of the additions and re-invited to the data room.

Give Investors a Point Person for Follow-up Questions

In addition to your data room, also make sure that your investors know that they have access to management to ask questions and request additional information. Questions and requests should be submitted in writing to a single point person, typically someone in senior management. If needed, this point person can always refer the questions or requests to others, such as legal or tax counsel, but it is important to have a single contact for receiving and responding to investor communications to ensure the consistency and quality of the information coming from the company.

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