This story highlights the danger posed by the three “F’s” of crowdfunding: Frauds, Failures, and Flakes.
Frauds are easily understandable. They lie to you to get your money for their benefit, without any intent to make good on their promises. Sometimes the lie is total: They say they build widgets and they don’t, never have and never will. That money you invested for a new widget machine? Plane tickets to Belize. Sometimes the lie is partial: They build widgets, but that machine they “need” $200,000 for? Really costs $100,000, the rest is for their pocket. Either way they know they are lying to you, they know they won’t make good on their promise, and they just hope they don’t get caught.
Failures are also easily understandable. They really want to make good on their promises, try, and just can’t quite make it. They say they make widgets, make the widgets, and unfortunately the widgets aren’t good enough, or marketed well enough, or just lucky enough to succeed in the market. These folks put their blood, sweat, and tears into vindicating your investment, and just fail. It happens, and while it isn’t a good thing by any stretch, for you or for them, it is an honest thing.
Flakes on the other hand, are an interesting case. They don’t have the malicious intent of a fraud, but don’t pursue the activity enough to actual “fail” (at least in the sense we are using it). Maybe they truly believe they can do something and are simply clueless how out of their league they are. Maybe they get the money and develop a vapor lock on how to pursue the next step. Whatever the reason, the investment isn’t used productively but probably isn’t used maliciously either. It just sits there, or gets frittered away on false starts and tire spinning.
Adding to the trouble, the three are not even mutually exclusive. One could imagine a flake who, frustrated by a lack of progress, gets tempted to pocket the rest of the money; or a person whose company is failing losing steam and flaking out.
How can an investor protect themselves from these dangers? While there is no surefire protection besides not investing, since failure is always a possibility, being informed is the best defense. The more an investor knows about the company and the people behind it before they invest, the more they can screen out bad actors, assess the prospects for success, and evaluate whether the company has a plan to effectively convert on a successful crowdfunding round. Of course, information is not just useful before an investment decision. If investors can demand access to progress reports and information from the company after the raise it will help them understand what is happening with their investment and whether there are any red flags they should be aware of.
Likewise, companies can benefit from investors demanding information. The accountability this provides helps potential flakes keep on task and moderate their ambitions, knowing they will be held to account sooner rather than later, and gives potential failures even more reason to refine their assumptions and product so it has a better chance of success. The only people who don’t benefit from an informed investor are the frauds that will face more intense scrutiny and more chances to be caught.
We at CrowdCheck are firm believers in giving investors the access and tools they need to become informed, which is why we force companies to be transparent, including submitting to checks at regular intervals after they raise the money. The companies that have gone through CrowdCheck care enough about attracting potential investors that they are willing to be extra open, and accept the discipline the enhanced openness provides. Does this mean they will all become wild successes? Unfortunately no, but it does show that they welcome investors who want to be informed…and that is a good thing.