What is Crowd Funding? Why It Stinks Bad….

What is crowd funding? This is a question you might ask if you own a small business and need cash or are an investor. Is it a great investment opportunity or just another internet investment scam? Let’s find out.

What is Crowd Funding?

Crowd funding is similar to social lending. Companies put people with money together with people who need money through their websites. The big difference is that crowd funding is used to fund small businesses and social lending is used to fund individuals for the most part.

Advantages

I’m a born skeptic and we’ll get to the problems with this in just a minute – but even I’ll admit there are some benefits to crowd funding.

First if you need money to fund your entrepreneurial idea, this could be an important life source of capital. And if you are an investor, this could be an attractive alternative investment to the low interest rates banks offer.

Disadvantages and Dangers of Crowd Funding

Business owners who want to tap in to crowd funding have to use an intermediary. These sites will complete the necessary paperwork and will market your offering to potential suckers…ooops….I mean investors. That’s going to cost these business owners money and there will likely be no guarantees that any money will be raised. A better alternative might be to revert to social lending companies like Lending Club. As you’ll see in a moment, you might have a better chance to raise the money there and you won’t pay much to start the process.

And for investors, crowd funding looks like a disaster waiting to happen. Remember, the people who are trying to raise money online have unproven business ideas that nobody else is willing to capitalize. Most small businesses are funded by the owners and the owners’ friends and family. If even they are unwilling to take a chance on the company, why should you?

Also, the regulatory oversight is paper-thin. Under a crowd funding law passed in April of 2012 a company can raise up to $1 million online every year. The registration process to do this is minimal. They only have to provide a few financial statements and a list of the officers of the company.

The ease of SEC registration for crowd funding scares me. To make matters worse, companies using the crowd funding apparatus don’t even need to go through a broker/dealer. That means even less scrutiny and no oversight with respect to suitability. Yikers!

And you should get ready for these “once in a lifetime, too good to be true” offers to deluge your email inbox. That’s because it’s so easy for scam artists to use crowd funding to separate you from your money.

As a result, it’s going to be hard for you to separate the very few deals that have merit from those which do not. If you do get tempted to get involved with crowd funding just assume that the offer is “dreck” and make the promoter prove otherwise. Guilty until proven innocent is my motto. This is especially true when it comes to online money ventures.

Remember, these deal makers can promise you the moon and the stars. And if things don’t work out and you lose your money, you have no recourse. They might have you sign disclaimers or they might bury the risk factors deep inside the prospectus. Either way, you likely won’t get your money back if you decide to sue them.

Overly Harsh Analysis?

I am not against this business just because the government doesn’t regulate it. After all, regulatory agencies weren’t able to stop the biggest investor rip-off artists like Bernie Madoff. I don’t like this investment alternative because most small businesses fail and because most investors don’t have the training to spot the few diamonds in the rough. As a result, I believe most people who invest in these ideas will lose money.

Proponents of crowd funding argue that the internet is a great tool that protects investors. They argue that it’s easy to investigate the reputation of crowd fund organizers and that social media is the great equalized. I’m not convinced.

As I mentioned earlier, social lending is better organized and offers better protection for investors. People who want to get loans must go through more underwriting scrutiny including a history review and full credit check. Also, investors can spread their money over hundreds of deals by putting in as little as $25 in any one loan. That spreads the risk and seems to make more sense for unsecured loans.

And even with all those added safeguards, I’m not a huge fan of investing in social lending (although I love the idea for people need to borrow money.) Maybe I’m a girly-man and afraid of my own shadow.

How do you feel about crowd funding? Would you invest this way? Why or why not? Are you a girly-man like me?