7 Things You Need to Know About Crowdfunding

It wasn’t that long ago that if you had an idea for a business or a product and you didn’t have the capital to make it happen, you went to the bank for a loan. Or you went to private investors. Essentially, you traveled around, hat in hand (as they say), and pitched yourself and your idea to whoever would listen.

Today, inventors and creators are still pitching their ideas to investors, but those investors aren’t established financial institutions or wealthy individuals – they’re regular, everyday folks. Thanks to the connectivity offered by crowdfunding platforms like Kickstarter and Indiegogo, anyone anywhere can potentially be an investor in your project.

It’s fundraising for a hyper-connected, digital-everything age and it offers an almost unlimited amount of choice and control over what ideas you want to support. That open accessibility is something of a double-edged sword. On the one hand, it creates a marketplace where you can support projects as diverse as a flying car or a personal memoir or a stranger’s honeymoon. On the other hand, that openness also leaves plenty of room for scammers and other, less legitimate entrepreneurs.

If you’re ever so inclined to support someone’s online fundraising campaign, here are some important things you need to know about crowdfunding before you take out your credit card.

A donation really is a donation – it entitles you to nothing (not even a tax write-off)

Generally speaking, most crowdfunding is a request for donations. It’s money you give away with no expectation of a return. It’s not really charitable giving either – in most cases, crowdfunding donations are not eligible for tax deductions. (As a rule of thumb, you can usually only claim a tax deduction on donations to qualified nonprofits. Speak with a certified tax professional if you have more in-depths questions about tax deductible giving.)

Crowdfunding campaigns can be a little confusing (and sometimes outright deceitful) on this front. Many campaigns promise you perks in exchange for your donation. If the goal is met and the campaign is funded, then, according to the Federal Trade Commission, you are entitled to the perks that were promised.

It’s important to remember, however, that most of the time, when you support a crowdfunding campaign, you aren’t buying something. You’re providing funds to the producer to help support their ability to create the final product. If that product is never actually made, then there’s a good chance you’ve given your money and gotten nothing in return. Again, this is why the money collected is called a donation.

Don’t expect crowdfunding platforms to protect you

There are tons and tons of different crowdfunding platforms available. Kickstarter is probably the most famous, but there are many smaller platforms that support slightly more specialized campaigns. What’s important to remember about these platforms is that they are designed to be as hands off as possible when it comes to the relationship between the product creator and the donor.

Many platforms have certain standards that a campaign needs to meet, but by and large, the platforms themselves exist to connect people who need money with people who have money, and then pass those funds along. If you are a donor and you have a complaint about a project you helped fund, you’re not likely to get much help from the platform.

In other words, be sure you understand the terms and conditions before you offer financial support to any campaign.

If the campaign goal isn’t met, you may or may not get your money back

One of the better known Kickstarter policies is that if a campaign goal isn’t met, all the donors get their money back. That’s Kickstarter. Other platforms have other rules. On Indiegogo, for example, it doesn’t matter if the goal is met. The donated money is still collected either way. Again, make sure you read the terms before making a donation.

Campaigns fail – a lot

Kickstarter seems to have the highest standards for campaigns – at least 20 percent of submitted campaigns are rejected – and even so, less than half of the projects on Kickstarter ever meet their funding goal. The percentage is usually much lower on other crowdfunding sites.

In reality, crowdfunding is an extremely crowded marketplace, full of inventive, energetic people with no idea how to raise funds. If you’re looking at your donation as anything other than philanthropy, it isn’t enough to simply be excited by the project – you need to vet the people behind the project. Have they done this before? Do they have a good business model? They’ve got you – what are they doing to get other people excited about their project?

It can be incredibly difficult to back out of a donation

If the platform holds donations until the campaign goal is met, you might be able to cancel your donation directly with the platform. If, on the other hand, the funds are immediately passed through to the producer, you’re probably going to have a hard time getting your money back.

Another issue – if you made a donation by credit card and the company ultimately failed to deliver, you may consider having the charges reversed. Unfortunately, you usually have to make that sort of request within 60 days and it will likely take much longer for the company to complete production (or fail to complete production, as the case may be). Once again, donate at your own risk.

Crowdfunding is a high risk, low reward form of investing

Crowdfunding comes in three varieties: the first is where you donate to a company or individual (this is the most popular form); the second is where individual investors act as a bank, supplying money for personal loans (The Lending Club and Prosper are two examples of this); and the third is equity crowdfunding, where you buy equity/stock in a new, still-developing company.

Peer-to-peer funding and equity crowdfunding are forms of investment – your expectation is to make money back. Both are risky, but equity crowdfunding in particular can be dangerous if you don’t know enough about the company you’re supporting. Even if you do the research, there’s still a very good chance that the company will not succeed and you’ll be out of luck.

If you decide to use crowdfunding as a form of investing, trend lightly and make sure you understand all of the risks.

Scams are everywhere

This can’t be said enough. The openness of crowdfunding platforms makes it easy for scammers to abuse the system. If something seems too good to be true, it probably is.

And it isn’t just the intentionally unlawful you have to worry about. Many people start crowdfunding campaigns with good intentions, only to be immediately overwhelmed by the realization that they simply aren’t equipped to deliver on their promises.

Always do your research and be cautious. Just because someone is using an established crowdfunding platform doesn’t mean they’re legitimate. If they made the same pitch to you in person, what more would you want to know?

You don’t need to be scared of crowdfunding. When used correctly, it’s a great way for consumers to directly impact the creation of products or pieces of art that they believe in. Just make sure you understand what you’re getting yourself into before you press that big donate button.