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Why crowdfunding can be a terrible investment

Posting in Design

Has crowdfunding's lustre already worn off?

There's no doubt that crowdfunding has blown up. In 2009, crowdfunded projects raised $530 million worldwide; in 2012, research firm Massolution projects that they will raise $2.8 billion.

But as more people get in on this trend both on the project creation side and on the investing side, more problems are cropping up, demonstrating the pitfalls of crowdfunding both as a way to seek investment and as a way to invest.

Victims of their own success

Last winter, a Kickstarter project busted through their goal of $75,000 to raise almost $1.5 million to create the sleek aluminum Elevation Dock for the iPhone. The creators promised they'd start shipping the device in April.

But now, five months later, the comments page of the project is full of people complaining that they still haven't received the dock, or that they have now bought the iPhone 5 and so their dock (whether or not it has arrived) is obsolete and that they haven't heard from the company at all about the whereabouts of their dock.

And then, there are commenters chiding these backers saying things like:

"Go read the Kickstarter is not a Store article on their blog. Quite whining that your 4/4S dock doesn't work with your iPhone 5. No 4/4S dock does. And yes it took longer than they ESTIMATED before they had any idea how many orders they would have and before they had a chance to get the first units through a production line. That is part of the RISK YOU signed up for when you agreed to provide VENTURE FUNDING to a new startup idea."

The crux of the issue is that funders of Kickstarter projects think of themselves as customers while the project creators consider them investors who don't get equity, but technically they are philanthropists (that generally don't get tax deductions for their donations).

Projects can also cause problems for the project creators, especially when projects become more successful than anticipated. As The New York Times points out:

A study by Ethan Mollick, a professor of management at the Wharton School of the University of Pennsylvania, found that 75 percent of design- and technology-related projects on Kickstarter, most of which involve physical products, failed to meet their promised deadlines.

Tips for crowdfunding projects and supporters

Learning how to handle the feelings on both sides of crowdfunding projects is going to become even more important next year. That's when the JOBS Act will make it possible for certain startups to raise up to $1 million through crowdfunding.

For potential backers

As the Kickstarter commenter noted, crowdfunding websites like Kickstarter are not traditional stores where you fork over money to pay for a piece of merchandise. While that is what appears to happen (or is at least promised), what you're actually doing is making a donation in exchange for a promise that you'll receive a gift in return. And remember that in most cases, you won't receive a tax deduction for your donation.

And next year, when the JOBS Act kicks in and there are sites where you can actually invest and receive equity in a company, learn all the ins and outs of regulation, which some critics say will not be enough to protect people from losing their money.

For project creators

If your project becomes more successful than you anticipated, you could receive an avalanche of emails that takes 10 hours to handle every week, according to Jason Best and Sherwood Neiss, the founders of Crowdfund Capital Advisors. So, plan ahead for communicating with your investors, and also let them know how often you plan to reach out to them.

via: New York Times, TechCrunch

photo: Images_of_Money/Flickr

— By on September 23, 2012, 8:00 PM PST

Laura Shin

Features Editor

Laura Shin has been published in The New York Times, The Wall Street Journal and The Los Angeles Times, and is currently a contributor at Forbes. Previously, she worked at Newsweek, the New York Times, Wall Street Journal and LearnVest. She holds degrees from Stanford University and Columbia University's Graduate School of Journalism. Follow her on Twitter. Disclosure