Linda Worton Jackson Byline: Crowd-funding: Investing At Your Own Risk—Or Reward

December 6, 2013 Posted in Firm News

Crowd-funding: Investing At Your Own Risk—Or Reward

By Linda Worton Jackson

What do a Pebble and Kobe beef jerky have in common? Both were crowd-funded projects that opened people's eyes as to the real risks of crowd-funding. These cases and the explosion of crowd-sourcing today have regulators taking a second look at the trend.

For the Pebble smart watch, the issue was a delayed ship date that left thousands of kickstarter.com investors concerned about their orders and wondering about their investments. The watches eventually shipped, the company righted its ways, and it has become a darling of the crowd-funding marketplace, yielding impressive returns for investors.

The same cannot be said for "Kobe Red—100% Japanese Beer Fed Kobe Beef Jerky." After enticing kickstarter.com to potentially hand over $120,000 in investor money, on the eve of delivery of the funds, the crowd-funding source realized the product was fake, withheld funding and cancelled the project.

For the uninitiated, crowd-funding is a process where thousands—even tens of thousands—of investors can back a project via a website. The project's creators list the project on a funding site like kickstarter.com, and then investments are made with relatively small amounts of money, often for as little as $100.

For investors looking to back legitimate opportunities, crowd-funding can be a good option. Pebble ultimately became a success. And other products—from movies and films to software and applications—have found similar success.

But if ever the phrase caveat emptor applied, this would be the time. The government has become involved in regulating the crowd-funding industry. But buyers must protect themselves. Just as Ponzi schemes often fall beneath the federal radar, so, too, may crowd-funding projects.

How can you protect yourself and your investment dollars from fraud and scams? There's no magic formula, just a few basic principles:

--If it seems too good to be true, it probably is. Consider Bernard Madoff's Ponzi promises: 45 percent growth, year after year. The line on the chart was unwavering, but investor confidence should have been. If a crowd-funding opportunity promises tremendous gains, step back and take a more thorough look.

--I hate to say it, but you should probably avoid charitable organizations and causes unless you can verify them. The risk can be too great and the ability to verify too small. Best to avoid them altogether.

--Check to see if the business is registered as part of Jumpstart Our Business Start-Ups (JOBS). Companies seeking crowd-funding must register with financial portals—special websites developed for seeking financing through crowd-funding. Similarly, prospective investors also must register. These portals, in turn, must be registered with the Securities and Exchange Commission.

--Ask for detailed information about the offer. If it's legitimate, they'll have a professionally produced presentation or solicitation. Truth be told, even scams may have such sales documents, but if they have no such documents at all, walk away.

--Perform due diligence on the offer. Has the offer or company filed as a business in its local market, state or with the federal government? Increasing regulations are requiring crowd-funded opportunities register.

--Investigate the individuals behind the offer. This can be as simple as a Google search. Search their names (including commonly used diminutives or abbreviations, like Jim for James or Chuck for Charles, as well as middle names or initials, if you know them). Remember, as with any online scam, people are not always what they seem, so be diligent.

--Search by geography. Include their cities or any past companies or affiliations. With any search, use commonly-used words associated with such shams, like scam, fraud, lawsuit, breach of contract, claims, etc.

--Do a social media, press search and corporate search. Search social media, newspaper articles, the local or state Better Business Bureau, and the state's department of state or business regulation (in Florida, that can be MyFlorida.com or SunBiz.org).

--Hire an investigative company. Not surprisingly, where there are scams, there are investigators to sniff them out. Companies are now emerging whose sole purpose is to identify Internet and crowd-funding scams. Additionally, an industry has arisen where crowd-funding opportunities voluntarily submit to background checks by third parties in hopes of convincing prospective investors as to the company's or executives' legitimacy. What's yet to be determined is where any liability may reside if a company determined to be clean turns out to be a fraud.

What also remains uncharted territory – part of what one writer once characterized as "the Wild West" – is where investors turn should they get burned. No central organization exists for filing grievances, and there's no centralized reporting mechanism on the Web. You might have a cause of action against the individual who posted the offer. But if you're like most investors, your investment was small. This leaves investors to weigh the merits of chasing small claims.

Crowd-funding is a wonderful vehicle for entering the world of investments with whatever amount of cash you have available for investing. But, like the Wild West itself, you need to be careful and you need to be prepared for the ride.

Reprinted with permission from the November 26, 2013 edition of the Daily Business Review© 2013 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almeprints.com.