THE BLOG

Backers Beware: Crowdfunding Risks and Rewards

06/12/2015 02:57 pm ET | Updated Jun 11, 2016

Let's say that you want to open a restaurant, make a documentary, publish a book, or bring a technological gadget you've invented to market. If you don't have the money you need for such a project, where can you turn? You could try to get a bank loan or find some investors who will give you financing. But increasingly, people are also turning to crowdfunding platforms - where funding comes in small chunks from a large number of people - as a way to raise money for such ventures.

The internet has made it easy to participate in crowdfunding, either as someone seeking money, or as someone who is willing to provide financial backing to a particular project or cause. Numerous crowdfunding websites provide platforms to help connect those seeking funding and individuals who might want to give money to support a project - but potential backers should note that investing is not without risk.

People can use crowdfunding to raise money for everything from a political campaign, to getting help with medical bills, to paying for a wedding, or even supporting scientific research. In some cases, backers who give money to a crowdfunding campaign receive nothing tangible in return, which is often the case where the cause is a charitable one. In other cases, if backers are helping finance a tangible item or goal - like opening a cupcake bakery, putting on a play, or manufacturing a gadget - funders will be promised tangible rewards in return for their support, such as free cupcakes, tickets to the play, or a free gadget.

You might be moved to contribute money after reading a story about someone in need or watching a video demonstrating a really neat device - but not every project may be what it seems. If you are interested in supporting a crowdfunding project, you should do some research first. Read all of the information about the project or cause carefully. Try to determine whether the individuals looking to raise funds have the experience and knowledge needed to accomplish the goal or project they are promoting. If the project involves the manufacture of a product or gadget, do the claims about the product and the technology involved seem plausible? And you can always ask questions directly of the people raising funds - crowdfunding websites should have a way for you to contact the people behind the project or cause.

While crowdfunding fraud appears to be rare, it has been known to happen. Also, even if someone raising funds has the best intentions to complete a project, nothing can be guaranteed. Any number of unforeseen obstacles or delays could happen with opening that bakery or publishing that book. Because of this, you should keep in mind that even if you have been promised an item as a reward, crowdfunding websites are not stores. They are not selling products that are sitting on a shelf or in a storeroom somewhere. They are offering you the opportunity to invest in a project or cause - and there is a certain degree of risk involved. There is no guarantee that the project will be successful. If you have been promised an item as a reward, it could be delayed, not exactly what you were expecting, or it might never arrive at all.

To the extent that outright fraud is occurring on crowdfunding sites, such behavior can violate the Federal Trade Commission Act. The FTC recently announced a case involving a crowdfunding project on the website Kickstarter.com, where a project creator raised funds to develop a board game called The Doom That Came to Atlantic City. The creator had a fundraising goal of $35,000, and succeeded in raising almost $123,000 from more than 1,200 individual backers.

Although the money was supposed to go to the development, manufacture, and distribution of the board game, the FTC alleged that the creator used the funds for other purposes, including an unrelated project, and personal rent and equipment expenses. The creator ending up cancelling the Kickstarter project and did not provide refunds or promised rewards to individuals who had contributed funds.

The FTC charged in this case that the project creator promised to use the funds for a particular purpose and did not do so; this was deceptive and violated federal law. But the FTC does not -- and cannot -- guarantee that every crowdfunding project will be successful. Like any business venture, the success of a crowdfunding project can depend on many different factors, including experience, planning, expertise, market conditions, and luck.

Crowdfunding can provide tremendous benefits, helping bring innovative products and creative projects to fruition without the need to obtain traditional financing. And consumers who contribute to crowdfunding projects can sometimes directly engage with project creators to provide input, and get the satisfaction of supporting a cause or project that they deem worthy. But crowdfunding is not a sure thing, and investors should understand the risks involved before deciding to contribute.