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You may have heard of crowdfunding and wondered if it is a worthwhile investment. Crowdfunding can uniquely diversify investments and support startups and entrepreneurs without you needing the millions typically associated with venture capitalists or angel investors. However, it isn’t without risks, including the potential for fraud and scams. Learn more about determining if crowdfunding makes sense to add to your portfolio and, if so, how to do it safely.
What Is Crowdfunding?
Statista reports that the global crowdfunding market will reach a total transaction value of $1.2 billion in 2024. This increasingly popular fundraising method allows startup companies and growing businesses to raise capital from a large pool of investors through online platforms. For investors, it is a way to support business ventures for a smaller amount of money than traditional business investments.
The 2012 Jumpstart Our Business Startups Act, or JOBS Act, opened up legal opportunities for crowdfunding. The act allows non-accredited investors to invest in startups and reduces regulatory and reporting requirements for entrepreneurs. Startups now have more access to potential investors, and investors have more options. However, the decreased regulation creates more potential for fraud.
Types of Crowdfunding
There are three main types of crowdfunding investments. Equity crowdfunding means investors receive a share in the company, similar to investing in a company through the stock market. With rewards-based crowdfunding, investors receive rewards such as products, discounts, exclusivity like pre-market products, or privileges like naming rights. Peer-to-peer (P2P) funding allows you to loan money to businesses generally at a higher interest rate than you would receive from a savings account.
What Are Popular Crowdfunding Websites?
- Kickstarter “exists to help bring creative projects to life.” It bills itself a “home for film, music, art, theater, games, comics, design, photography, and more.” It does not allow companies to offer equity or revenue sharing and only releases funds when companies reach their goals.
- Indiegogo, which started as a site for independent film fundraising, has now expanded to all product categories, specializing in technology and hardware products. It offers both fixed and flexible funding options.
- StartEngine provides equity crowdfunding, allowing investors to buy shares of companies. Kevin O’Leary, businessman and investor known for his role on “Shark Tank,” is the company’s strategic advisor.
- CrowdStreet allows individual investors access to real estate investment, the 3rd-largest asset class in the U.S. Unlike some of the other websites, investors must be accredited with requirements such as having a pre-tax income exceeding $200,000 annually for the past two years and a net worth of more than $1 million, excluding the value of your primary residence.
What Are the Benefits?
Like any investment, the primary benefit is the possibility of generating financial returns. When companies are successful, investors can earn crowdfunding money through equity, rewards, or interest.
Crowdfunding also allows investors to support small businesses or fields where you have a social interest. If you want to contribute to green energy or advances in healthcare technology, you can find companies to support at the forefront of these ventures. It can also be a way to support the entrepreneurial efforts of friends and family without a significant stake. 
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What Are the Risks?
According to the Chamber of Commerce, 595,000 businesses fail or close each year, 18% within their first year, 50% after five years, and approximately 65% by their 10th year in business. This makes most crowdfunding, which is generally for startups, a risky investment. There is also low liquidity or the ability to take your money out quickly and easily. Additionally, fees for many crowdfunding sites can be high, making it more difficult to see gains.
One of the biggest risks with crowdfunding is scams, which occur when campaigns ask for contributions under false pretenses. For example, a Federal Trade Commission (FTC) suit against iBackPack of Texas, LLC claims they “raised more than $800,000 from consumers through four crowdfunding campaigns, falsely claiming the funds would be used to develop a handful of products.”
How to Protect Yourself from Scams
Unfortunately, due to the nature of crowdfunding, it can be challenging to avoid scams, but you can take steps to lessen your risk.
- Select reputable crowdfunding platforms and look into how they handle cases of fraud.
- Research the background of company leaders and past projects.
- Understand the terms and conditions of the crowdfunding platform and the specific campaign.
- Monitor campaigns for transparency and updates.
- Look for warning signs of fraudulent schemes, such as lack of transparency, unrealistic expectations, pressure tactics, overuse of emotional appeal, and unverifiable claims or credentials.
- Report any suspicion of fraud to the FTC.
So, should crowdfunding be part of your investment strategy? Investors with a high-risk tolerance and a diverse portfolio may benefit from adding crowdfunding to their portfolios, especially if supporting entrepreneurs or specific ventures aligns with overall goals. Always do your homework to avoid scams and be aware of the potential risks.
