Today’s letter has a quick and dirty guide on how to avoid getting burned with “crowdfunding.”
Before we get to that, here’s a little background on “crowdfunding.”
The good news is that is now easier to raise money for small to medium sized projects than it was in the past.
Why is it easier?
Two recent developments: Kickstarter and the JOBS Act.
- Kickstarter is a Web site that makes it easier for people and companies to get funding for their projects. Recently, the site gained critical mass and some projects, from a computer game to an iPhone accessory, raised millions of dollars in funding.
- The JOBS Act is a new US law that makes it legal for small companies to “go public” without all of the pesky SEC and accounting paperwork that makes going public so tough and expensive. So, it’s now possible for companies to sell shares of stock (equity) directly to the public in small amounts.
These developments are great news for those of us building resilient communities. Why? It opens up new options for getting resilient infrastructure built and resilient businesses launched. Unfortunately, this new freedom will come at a cost.
The bad news is that this funding method is going to be terribly abused by the same broken financial system that gave us the financial meltdown of 2008. Here’s what I mean.
You can see the problem already in the term the press is using to describe this new funding activity. They are calling it “crowdfunding.” This name conjures up an image of a nameless faceless mob of people, ready to throw money at any project that makes enough noise, regardless of its merits.
In short, crowdfunding is a recipe for pump and dump. Boiler rooms and Internet hype selling investments in the next “Facebook” or “Twitter.” Boom and bust with most people ending up less well off than they were before they invested. Yuk.
Embrace Community Funding!
The way to avoid getting burned is to avoid crowdfunding completely. You should only engage in community funding. Here are the rules successful community funding:
- COMMUNITY. If you aren’t part of the community that uses the project or product you are funding, don’t invest in it. That applies to investments you make online or locally. Also, make sure the people or company requesting funding is actively engaged with the community in a positive and mutually rewarding way. If they aren’t, there’s a problem.
- PRODUCT. The best reward for an investment in a project or company isn’t stock. It’s product. In most of the successful projects on Kickstarter, the investors were customers pre-buying a product they wanted to see made. The same is true for investments in local farms or aquaponics businesses. The best way to get a positive and rewarding return from community funding is to get the product you funded the development of.
- TRUST. IF you do want to buy equity, don’t invest with any team you don’t know and trust 100%. In fact, I’d recommend that you limit your community funding investments to only those companies managed by trusted incubators or to local businesses where you know the parties involved. Why? It’s very, very tough to get a financial return on a small equity investment in a start-up, since the system is rigged. Simply, if you can get squeezed out, you will be (take it from an entrepreneur that has raised tens of millions of venture capital).
Hope these rules help you in the future. You are going to hear and read a lot about crowd-funding in the next couple of years. If people like these rules, I can expand them into a small report.
Your hoping RC readers can avoid needless lessons in the school of hard knocks guide,
PS: If you didn’t know already, I’m not a certified financial analyst. I’m just a successful entrepreneur that’s been through the school of hard knocks in start-up funding many times before.