23 Jun Nine Risks Associated with Crowdfunding
Crowdfunding has been around for a while, but in the world of finance, fundraising using online platforms is fairly new. For this reason, rules and regulations to govern it have not been clearly defined and therefore, a lot of the campaigns happen with barely enough supervision to minimize the following risks associated with Crowdfunding:
- Risk of fraud e.g. funds may be used for different purpose than what was initially disclosed, the creator may also portray an idea he/she doesn’t own. The creator, who has been deemed malicious, may also use the campaign to go on a Phishing trip, where he/she gains access to a backer’s personal and financial records e.g. banking and credit card information and use it to defraud the sponsor. It is expected that the backer perform due diligence before giving their money, but a lot of times they don’t. A survey showed that backers fail to perform due diligence because:
o A lot of donors are just average people. They are not subject matter experts and might be ignorant on the processes that go into various projects
o Since the companies are small and private, or probably not even registered, then audited company accounts as well as business plans may not be available to allow them to find out more about the company.
o Crowd funders give small dollar amounts and thus are not particularly bothered by the returns, they write it off as soon as they give the money
o There is a free-rider problem where everyone thinks that others have carried out due diligence whilst in essence no one has.
- Experts are particularly concerned that the Crowdfunding revolution may be crowding out other forms of financing e.g. angel, venture capital financing and traditional financial institutions. This is because a lot of people are turning online for financial help and completely ignoring the other means of financing.
- A lot of project creators and backer do not realize that crowds do not know everything. See, human interest, curiosity and excitement is always easily piqued by novelty. Ideas may be great and well received but they may be not easily commercialized. Unfortunately, according to well researched reports, 3 out of 4 startups fail. What this means is that 75% of all successfully funded ideas FAIL. This is very unfortunate.
- For Crowdfunding, transactions are one time, and not continuous. Business owners and project creators must learn how to balance the short term influx of cash raised through Crowdfunding efforts with the daily cash flow expense requirements of their business.
- There is no protection of intellectual property on Crowdfunding platforms. If one put up information on a Crowdfunding platform or online that has not been patented, then they have up to one year from the date they posted it to patent the idea, after which they lose the chance to patent it. This is recorded in the U.S. Patent act. A lot of the creators seeking funding do not have this knowledge and end up losing the rights to their proprietary information.
- There are limited follow up mechanisms. There is no way for the sponsors to follow up on how their money was used, and neither can they follow up on promised rewards if the project owners choose to dishonor their promises.
- There is a grey area on ownership of ideas where a project owner, would use an idea submitted by someone commenting on their product or service without giving the commenter credit for it. This could cause a PR meltdown and probably even present legal issues.
- A lot of the creators posting their projects online have good ideas and no business expertise. They have no idea how to set up a business or how to fulfill the legal requirements of owning a business and do not have experts to guide them on this. This is a recipe for disaster.
- Finally, tax laws governing the ecommerce environment are not clearly defined. For instance, since the funding happens across borders, do international tax laws apply? If rewards can be looked at as sources of income or material possessions, should these be taxed as well?
The Crowdfunding industry will need a lot of regulation to minimize the above mentioned risks. However, many governments are town between regulating the industry, by leaving it as it is, or over regulation that will end up killing the innovation that has been borne by this wild finance market that it is. One thing is for sure, whether the governments choose to regulate it or not, we must be aware of the risks before embarking on Crowdfunding either as a backer or as a creator. Now that you know the risks, consider yourself saved.
- Steinberg, Scott. 2012. “The Crowdfunding Bible.”
- Ries, Eric. 2011. The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses. New York: Crown Publishing.
- Resources for Entrepreneurs www.gaebler.com
- Gage, Deborah. 2012. “The Venture Capital Secret: 3 Out of 4 Start-Ups Fail.” The Wall street Journal, September 19.http://online.wsj.com/article/SB10000872396390443720204578004980476429190.html