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Crowdfunding Isn’t Like Shopping Retail

In our last blog post on crowdfunding, Charles Landes, CPA took a deep look at equity crowdfunding, specifically how the Securities and Exchange Commission rules are shaping up as required by the Jumpstart Our Business Startups Act of 2012. However, equity crowdfunding is not typically one’s first introduction to this new funding approach. Many are first introduced to crowdfunding through one of the various crowdfunding platforms that exist, such as Kickstarter. If you are not familiar with crowdfunding through a platform like Kickstarter, the concept is relatively simple. A person or company comes up with an idea, determines the cost to create this idea and sets a funding due date. Projects also feature rewards based on the contribution, for instance, backers may receive a T-shirt or the actual product they are supporting. If the project fails to meet its finance goal by the set date, then the project is not funded.

Backers have funded all types of projects, from virtual reality systems, like Oculus Rift (which was recently acquired by Facebook), to dream cars, like a DeLorean Hovercraft. Other projects have gone on to win an Oscar and be featured at the Cannes Film Festival. However, not every project makes it. What happens when a funded project fails to deliver on its promise?

There are cautionary tales as well. There have been instances where funded projects have not been completed or others that have failed to meet their delivery date. One such example is Instacube. The project was to create a digital photo frame that wirelessly streamed Instagram photos from user accounts. It was a massive hit, raising $621,049 from 3,434 backers, enough to produce 5,500 units. The company had only set out to raise $250,000. In the first 24 hours, they had already raised $125,000. By all accounts an incredibly successful crowdfunding campaign, the company even started adding other design concepts to the project, varying colors and style.

The product, which was expected to ship March 2013, was never delivered. Backers flooded social media with demands for an update, but the company behind the product stayed silent. Update demands quickly morphed into refund demands and then lawsuit threats. Some backers went as far as attacking employees personally on social media and even tracking down their private contact information and posting it online. So, why did Instacube fail to deliver?

Ultimately, the project suffered from unrealistic manufacturing expectations and hardware setbacks, according to Savannah Peterson, Instacube’s former marketer. Savannah relayed her experience with the project during a SXSW session earlier this year, “I Ran an Extremely Successful Crowdfunding Scam.” While it turned out not to be a scam and just poor planning and communication with backers, there is an important lesson for potential backers to learn from this experience. The good news is that Instacubes finally started shipping earlier this year.

Backers should understand: crowdfunding is not a supermarket. When you participate in a crowdfunding campaign, you are investing in that company or person. The products you see do not exist yet. You are contributing to their potential creation, just as if you invest in a company directly, so think like an investor. Ask yourself the right questions and do your research: Is the project timeline realistic? Do they have a prototype? How much experience do they have? Do they have other successful crowdfunding campaigns?

Crowdfunding is still quite new and potential investors should approach it cautiously, just like any other investment. In 2013, three million people (worldwide) participated in crowdfunding, pledging a total of $480 million. In a recent Harris Poll conducted for the AICPA, just 4 percent of U.S. adults reported contributing to a crowdfunding campaign in the past year. Respondents cited the top reasons for committing money included: opportunity to be an early investor; belief in the project mission; involvement of a family member or friend in the company or project; and interest in the rewards offered for contributing.

What has been your experience with crowdfunding?

, Communications Manager, American Institute of CPAs.

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