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Crowd funding's dark side

Glenn Stark couldnt wait to get his hands on a pair of Eyez, high-tech glasses that promised to record live video. The problem was, they didnt exist yet. No problem. Stark last year joined more than 2,000 others dazzled by the glasses design to collectively contribute more than $ 300,000 to the entrepreneurs developing them. The two-man team behind the company, called Zeyez, developing the glasses told these financial backers they would receive the glasses ahead of the fall 2011 goal. Tech press gushed over the idea. Yet even today, Eyez glasses still arent being produced and individual backers including Stark havent received a pair. Meanwhile, the entrepreneurs have curtailed providing online updates on the project and wont answer questions from backers, Stark says. Stark figures he is out his money: $150 plus $15 for shipping to Switzerland. Its hard to find a real address and even harder to find a legit phone number, Stark wrote in an e-mail to USA TODAY. Carlos Becerra, who is listed as the companys CEO, declined to comment. Seeing such a small unproven project lure $300,000 in a short period of time highlights the potential power, but also the risks, of so-called crowd funding. Crowd

funding harnesses the power of the Internet to funnel money from interested individuals to entrepreneurs building products considered too risky or too small for big companies, banks or venture capitalists to back. Hopes are high that crowd funding could be one answer to help fix the USAs economic rut, where job and business growth has been anemic in part because of tighter lending. Crowd funding is supposed to give entrepreneurs a direct line to individuals willing to bankroll relatively unproven companies. Some think crowd funding could be an alternative to a stock market that has turned hostile to new companies as investors demand higher returns and companies face higher costs to comply with securities regulations. Such optimism over this new way of raising money is giving crowd funding political power that will make it available on a much grander scale. Currently, crowd funding is very limited and is really just a twist on a traditional donation. Many crowd-funding
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efforts support art projects or humanitarian causes. Consumers may also help business projects by contributing money in exchange for T-shirts or by prepaying for products before theyre released. More than $290 million has been pledged for more than 26,000 funded projects on Kickstarter, the largest U.S.-based crowd-funding site. But crowd funding will soon reach a much broader level. As soon as next year, due to the Jobs Act, which was signed into law in April, individuals may invest a limited amount of money in companies using crowd funding. The Securities and Exchange Commission, despite its public concerns about crowd funding, has 270 days from the enactment date to set rules, putting it around January 2013, though delays are possible. Suddenly, crowd funding will become not just a way to contribute to a cause, but to take stock in a company without having to go through the U.S. stock market. Companies are rushing to be major players in stock-based crowd funding, even before the rules are put in place by the SEC. While Kickstarter hasnt expressed interest in the stock-based crowd-funding area, there are others at various stages of pursuing it, including Crowdfunder, EarlyShares, Crowdcube, Symbid, RelayFund, Grow VC, PeoplesVC, Indiegogo and more. SoMoLend is setting up to allow crowd funding of a companys debt. Some brokers may also choose to participate.

Despite the theoretical allure of allowing consumers to fund such early-stage companies, though, lessons from crowd fundings very early days shows the risks, including: Large chance of delays. Just a quarter of Kickstarter projects have been completed on time and another 33 percent had yet to deliver, according to an analysis of 471 projects in the design and technology categories by Ethan Mollick, professor at the Wharton School at the University of Pennsylvania. Larger projects and those that pooled more money than the entrepreneurs originally asked for are the most likely to be delayed. Just 75 percent of projects delivered any product even eight months after their promised delivery date, Mollick says. Some examples of delayed projects include Levitatr, a keyboard for mobile devices that raised nearly $70,000 in contributions. The product, which was expected to be
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But there are risks

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released late last year, is still not available. The company could not be reached. And the High Roller adult-size tricycle, designed to be a Big Wheel for grownups, raised nearly $90,000 in October 2011 a nd was originally to be released by December 2011. But after starting the p roject, the entrepreneur behind it, Matt Armbruster, learned that the estimates he was given for manufacturing costs and scheduling were way off. Armbruster, trained in aerospace engineering, found a new production facility in Taiwan and then learned the product wouldnt be available until late this summer. He says the original run of 300 High Roller cycles will be done by September and will be mailed to backers. The learning curve is up a wall, he says. But, its happening. Higher hazards than IPOs. Facebooks initial public offering provided a highprofile lesson in how risky a traditional IPO can be. Investors have lost 90 percent or m ore of their money on 16 percent of the companies that went public that were less than a year old, says Jay Ritter of the University of Florida. The odds of losing 90percent was even higher, 21 percent, for companies that went public when they were 2 years old. And this high failure rate is among companies that have the financial resources to go public. Crowd funding means taking an even bigger chance than a traditional IPO because of how small and unproven the companies and their products are. Risk of misrepresentation. The chances

of outright busts in crowd funding have been rare on Kickstarter. Only about 5 percent of the Kickstarter projects studied were complete failures, Whartons Mollick says. But sometimes people who provide crowd funding walk away feeling they didn t get what they bargained for or worse. Complaints by consumers who didnt get what they feel they were promised are on the rise at Ripoff Report, an online registry for consumer complaints, says Ed Magedson, who founded the website. The difficulty in researching the companies and people behind the companies is problematic, he says. Consumers have little recourse if crowd-funded companies dont deliver on their promises. One example was Mythic, a video game project, which last year raised nearly $5,000 based on attractive artwork and plans for the game. The project was canceled this year before any money, pledged by backers, was taken. Alfonzo Burton of the Burton Design Group says
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that the pitch for the Mythic game used photos and images from Burtons games. No one at the company behind Mythic could be reached for comment. Even so, Burton says rare misrepresentations like that shouldnt condemn the practice. Crowd funding has become a top way for independent makers of video games to raise money, he says. Video game Double Fine Adventure has raised more than $3.3 million on Kickstarter. The game is due to be released next year. People should not seek financial gain when contributing to projects, Burton says, but should do it to help entrepreneurs produce new and interesting products. These websites allow us to do something with our passion, he says. Most of the contributions, too, are fairly small, says Francis Gaskins of IPOdesktop. com. He says that crowd funding is fine as long as investors understand theyre doing it for fun, not in a way to try to make money. Whether investors will continue to understand that once crowd funding goes beyond donations and becomes actual investing in companies is yet to be known, he says.

financial statements certified by an officer of the company, she says. Companies raising $100,000 to $500,000 will need to have financial statements reviewed by a certified public accountant, and those raising more than $500,000 will need to be audited, Hanks says, based on her current interpretation of the Jobs Act. Additionally, safeguards will be put in place to limit losses. Most regular investors will be allowed to invest only up to $2,000 a year in crowd funding, she says. Despite these safeguards and fanfare, though, Ritter thinks crowd funding will never amount to more than a sideshow. Just a small number of these companies will be winners, leaving most investors discouraged and holding stakes in worthless investments, he says. Theres not a shortage of money to be invested, but instead, a dearth of good ideas worth investing in, Ritter says. Venture-capital returns have been lackluster since 2000 largely due to the
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Vetting the companies

Meanwhile, efforts are already made to add order to the chaos, says Sara Hanks, CEO of Crowd Check, a service that will review young companies and vet the ones that seem legit. Companies raising less than $100,000 will likely need to have

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scarcity of winning ideas, not a lack of investment money, he says. The problems may intensify as crowd funding evolves from being a place to donate for altruistic reasons to one to invest for profit, says Whartons Mollick. You will have many disappointed people. Youll have people backing things, most of which will go bad.

The Levitatr keyboard features elevating keys and LED backlighting. This image shows the keys hidden and elevated. Levitatr is powered by a Liion rechargeable battery and features a built-in kickstand.
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