I agree with my colleague's response.
So many things are wrong with what your acquaintance is doing it is difficult to know where to begin. No one should invest under these circumstances. Those who have already invested have the right to sue to recover, at the least, the amount they invested. Your acquaintance could find himself subject to state civil and / or criminal actions for securities law violations, and possibly federal actions, as well.
Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.
What he is doing is illegal and violates securities laws based on your facts. There are written disclosures that have to be made and registrations that also are needed.
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Huge problems with Securities law. Based upon your facts, the investors should sue in hopes of a rescission or return of their investments. The members can also contact the Attorney General Securities division for additional assistance.
DISCLAIMER—This answer is for informational purposes only and discusses general legal principles, trends, and considerations and is not intended as specific legal advice regarding your question. This answer does not establish an attorney client relationship.
Business people often overlook the fact that when they sell "shares," "units," or some other interest in their company they are walking right into Securities-Ville. When you sell an interest in your company that doesn't allow the purchaser to meaningfully participate in the management of the company (i.e., the purchaser is generally regarded as a "passive" investor) that is a "security." And Securities-Ville can be a very harsh place, if you don't comply with the law of the land (moreover, the "law" as it were is often a pastiche of federal and state law depending on the residence of the parties purchasing the shares.)
Many business people figure that since they are not Google, they do not need to go through a cumbersome IPO process. They are only part right. There is still a process (e.g., comply with SCOR, or an applicable Private Offering under SEC Rule 504-506). And the hallmark of complying with this processes is: 1) disclosing the parameters of the “offering” of shares, units, etc., by registering with the various states and the SEC; and 2) providing adequate disclosure documents to the prospective purchasers that detail all the risks of the investment, as well as detailed information about the management, the business model, etc. (There are exceptions to this process, given the financial wealth of the prospective purchasers, but as a general rule you should always disclose risks.) Failure to do so could afflict the offering company and its principals with the dreaded “fraud” label and expose all to personal liability.
In this case, it would appear that at the very least the inventor would have to disclose risks associated with creating and marketing the prototype. Moreover, barring the investors from even talking to each, while providing drastically deal terms to each one, screams fraudulent dealing.