Crowfunding is as old as any other type of capital fundraising but the regulations were codified officially in the 2012 JOBS ACT. Some 40 billion dollars have flowed into the various types of projects since then, increasing each year. Reg CF of Title III allows a startup to raise up to $1.07mn from the public without restrictions as to investor type. There are limits on contributions which depend on salary, such as a percentage of one’s annual wages or a flat amount of $2200, whichever is greater.
The public non-crowdfunding markets are rife with shenanigans but at least they have a company, products, and revenues, even if no profits. They’re vetted by the SEC, third party audits, and major institutional underwriters. When an IPO is made the early investor insiders are selling, they already made their money and they’re not about to get on the “dumb money” roller-coaster. It’s possible to make money on IPOs if the public rushes in and pushes the price up but many times that is also manipulated with institutional buying which is later dumped. It’s a form of legalized scammery.
Crowdfunding is far less regulated than the IPO markets, and requires an intermediary licensed broker-dealer to effectuate the fund raising from the public. There are a few types of crowdfunding options such as donation based where the money is basically given away with no expectations, rewards based where the investor is promised something like a product at the end (could be anything), and equity crowdfunding which is sale of securities that is regulated by the SEC and the investor will get an ownership interest in the project and potential resulting profits.
The crowdfunding intermediary platform is more or less responsible for vetting the project, though this is barely the case. Only US entities are permitted to fund raise under Reg CF though many of the rewards-based platforms such as Kickstarter, Indiegogo etc., do not even verify the existence of a US entity. All they generally want is a US social security number; they don’t verify the project founders or development team or even the existence of a product.
So, the platform more or less does zero project vetting, or founder verification. In fact, they totally disclaim any liability to the investor, meaning investors fund projects at the risk of losing their entire investment. Further, there a conflict of interest between the offering platform and the investor in that the more projects get fully funded the more commissions the intermediary makes. If a project doesn’t meet its goal then all funds are returned to investors and the intermediary makes nothing.
This situation should be changed to having the start-up pay a flat fee to be listed on the platform which would include a due diligence process by the intermediary which would verify the existence of the project and who the founders are. If the funding goal is met the start-up gets everything, if not then the funds are refunded and perhaps a portion of the fee may be refunded as well, or if the funding goal is met then an additional flat fee charge would be paid by the start-up.
At a minimum the intermediary should require that all the founders and their bios are prominently displayed on the offering page. The existence and status of the project as described by the start-up on its funding page should be verified. Meaning, if the project team states they have a working product that needs to be alpha or beta tested, or is ready for production, that needs to be confirmed and verified by the intermediary.
Many of the projects listed make numerous unverified claims that cannot be confirmed by the investors. At a minimum CF regs should require the start-up to retain a CPA firm and legal counsel. Professional advisors have ethical obligations that require honesty and fair dealing, and would properly vet the wording of any marketing or funding materials and investor risk disclosures. A CPA would properly calculate financial statements which should be disclosed if the start-up has any history, even if just bootstrap funding or solely founder/family investments; it should all be disclosed. 3rd party paid endorsements should be prohibited, which is something commonly done in crypto-coin offerings as well, and has gotten some endorsers into trouble.
Basically, the majority of crowding projects fail, either they deliver nothing or deliver a substandard product that will not be ready for retail until numerous additional funding rounds are conducted. Some CF projects, about 10% or so are outright scams where the funds disappear never to be seen again. Prosecution and fund recovery is difficult for foreign projects, and the FTC/SEC/FBI don’t have the resources to pursue any but the largest fraud occurrences.
Raised funds should be required to be held by independent 3rd parties, such as legal counsel or a CPA or a bonded escrow company, same as my recommendation for crypto-coin offerings, and disbursed as needed for specific purposes which propel the project forward. Audited statements should be provided at least semi-annually. A private bond should be purchased by the start-up as a form of partial insurance to at least provide a portion of investor funds back in case of project failure.
In summary, crowdfunding has potential to create substantial and profitable disruptors to various industries but to date there have only been a few companies which received their seed capital this way, so crowdfunding’s use case remains debatable, but popular. It has certainly been profitable for the intermediaries and to some start-ups who got away with providing inadequate products or no products at all. Investors should be aware of the total risk to their investment and be able to fully vet the project and founding team, which is currently not easy to do, if possible at all. Donation based funding is clearly the safest type, since all funds are gifted.
