Bullish on the Crowdfunding Economy Despite The Serious Pitfalls

Time magazine recently posted an article on the growth of the ‘crowdfunding economy’ enabled by the 2012 Jumpstart Our Business Startups (JOBS) Act, which passed through the federal government with bipartisan support and was signed into law by President Obama. Under JOBS, companies can sell ownership shares to investors via websites and social media channels – this includes through crowdfunding and peer to peer lending platforms like Indiegogo.com, wefunder.com, startupvalley.com, microventures.com, and many more.

wefunder.com crowdfunding

Wefunder.com and other crowdfunding sites allow you to buy shares in startup companies

The kick-to-the-head ‘a-ha!’ moment comes when you realize the implications. Now, any entrepreneur from any country in any industry with only an internet connection and an idea can find people willing and able to invest in their businesses. This is going to accelerate the rate at which new startups form – but a key question is will this make startups more successful? Spoiler alert: the answer is most certainly NO.

This Act effectively relaxes constrains and lowers hurdles for businesses to gain access to capital, which is especially important in a post-recessionary economy still facing uncertainty. Businesses need funding to get off the ground, but VCs, banks, and other institutional lenders are only willing to make bets on the best of them. Crowdfunding democratizes lending, giving anyone with some extra cash the opportunity to become an investor in a new idea. No question about it, many great ideas will come to fruition thanks to crowdfunding in this regard.

At the same time, many investors will lose their shirts. The relaxed lending constrains of the JOBs act along with the inherent dangers of investing in a startup company are worry enough. But when these risks are combined with the fact that businesses crowdfunding online can easily withhold or overlook key information that investors should know before they opt in, you start to see the downside; it’s much riskier, especially if you don’t know what you’re doing or the right questions to ask. While yes, the opportunities for impressive returns are there, so is the significant chance that the company will go belly up and you’ll never hear from them again. Fraud is also a major concern. This is simply the inherent nature of crowdfunding as it exists today.

I myself was a $25 pledger to the Kobe Beef Jerky scam on Kickstarter.com, which currently stands as the largest and most blatant attempted crowdfunding fraud in history. This diabolical team faked a Jerky company specializing in Kobe Beef, asked for a few thousand dollars on Kickstarter, made up fake testimonials and taste-tests, and raised $120,000  from 3,200 backers. The more people that funded it, the higher they were listed on Kickstarter’s trending campaign pages which drove more pledges; they grew bigger by the hour. Everyone, including me, was very excited for the delicious treats to come. If 3,000 other people believed their pitch, why shouldn’t I?

Kobe Beef: the largest attempted fraud in crowdfunding history

Largest attempted fraud in crowdfunding history

Then, just a few minutes before the campaign deadline was reached and cash changed hands, Kickstarter shut it down. Thankfully, the fraudsters were found out. This story became an anecdotal lesson and not national news, and the sanctity of crowdfunding was upheld. However, it was a bit too close for comfort; just a few more minutes with a slightly less engaged crowd and this would have been a catastrophe. A few individual community members who did their homework found out this fraud, it wasn’t an elaborate sting operation – we got lucky! The bottom line is that when crowdfunding ANYTHING you need to do you homework, regardless of how idiot-proof the investment seems or how many others have backed it. Crowdfunding may allow for the harnessing of collective buying power, but the responsibility still rests squarly on the shoulders of the individual giving their money; don’t forget that.

These risks considered, I’m still bullish on crowdfunding and excited to see what happens in the next 5-10 years. No question about it – the challenges are great. Bad ideas will be funded and fraud will happen, but my belief is that the ‘crowd’ will become better and better at spotting those negative outliers before they’re funded.

My advice to you is to remember my mistake in the coming years when a crowdfunding opportunity presents itself. Get all the facts, do your homework, and invest with care. Do these things to minimize the chance that you’ll be waiting patiently at home for your box of finger-licking-good jerky to arrive, only to realize that you’re a sucker.

-Chris Kluesener, Open Innovation Central

The Crowdfunding Economy Is About to Pop | TIME.com.

One comment

  1. Reuters just posted a followup explaining how equity crowdfunding is completely separate from rewards-based crowdfunding – the 2012 JOBS act isn’t changing much on the rewards side.

    http://www.reuters.com/article/2014/01/29/idUS231237475920140129

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