Sure way to lose money- crowdfunding a firm


Crowdfunding is often perceived as a way to democratize finance. Everyone can commit a small amount of money to fund small companies. Crowdfunding is also known as P2P lending.
Unlike VC funding or debt, crowdfunding requires potentially less paperwork. You can do it on Kickstarter, you can borrow from friend and friends. But crowdfunding can be dangerous. Better startups would have received attention from formal sources such as angel investors, venture capital firms, banks and laboratories. Crowdfunding firms bypassed these sources to ask the public for money. Is there a potential for adverse selection?
Can we conclude that there are more “thrashy” projects on crowdfunding platforms? People who invest little amount of money invest when they feel inspired by ideas. They probably do less due diligence than VCs. This is why crowdfunding can be dangerous for the investor.
There are intermediaries like Lending Club who tries to include some credit risk analysis into startups. But anyone will be able to attest that business stability leading to proper cash flow evaluation is always almost impossible. When the investor losses their investments in the case of crowdfunding, there is little recourse. Pursuing legal actions is costly and difficult. Here are some examples of start-ups which, even though they raised money, didn’t manage to complete their project successfully:
Pirate3D Inc raised nearly $1.5M on Kickstarter in 2013, planning to make a 3D printer available for use by anybody. A total of 3,520 backers invested money to the project including 3,389 who gave more than $300 to eventually get a printer.
Another example is that of Neil Singh’s lawsuit against Seth Quest. The latter launched a Kickstarter campaign in March 2011 for Hanfree, a standing iPad mount he’d devised. The crowdfunding campaign was initially a success, and he raised $35,000. However the production was a disaster and Quest couldn’t fulfill his backers’ pre-orders, one of whom was Neil Singh.
The fact is crowdfunding companies probably need more than capital. They need professional advice. Money is one of the many things they will need.
Summarily, if you are an individual, do not invest in startups in your retirement plans. Instead, keep them in an index fund, ensure low cost investments. There are plenty of evidences of how active management does not outperform passive management. Here are some links:
[UPDATE] A very recent and vivid example of crowdfunding risk, is that of FND Film, a filmmakers’ start up, which raised about $78,000 in 2014 through Indiegogo crowdfunding platform, regardless of the fact that they didn’t provide any other detail about their project, but the name of the film “It’s All Good”.
After raising all that money the filmmakers disappered and started posting photos in social media showing that they were enjoying themselves with champagne and limos in Italy. As it was expected, the people who funded the project got furious, for what eventually turned out to be a troll, as the filmmakers made the movie two years after. It came as a very pleasant surprise to their supporters that the project they funded, was actually a metamovie of not making a movie, illustrating vividly the risks that crowdfunding entails.