Crowdfunding platforms like Kickstarter have exploded in popularity over the past few years. As the number of funded projects has grown so have the number of projects that never deliver on their stated goals. The Federal Trade Commission (FTC) recently filed its first ever complaint with a Kickstarter project that did not provide its stated rewards to backers.
Launched in 2009, Kickstarter offers artists and entrepreneurs a platform to solicit funding from a wide audience for anything from potato salad to multifunction drink coolers. Project creators pitch their ideas to prospective backers and set fundraising goals. If a project meets its goal, its backers receive a reward based on the amount of money they pledged. If a project fails to meets its fundraising goals, then the backers receive a refund from Kickstarter. Likewise, if a project is funded but cannot deliver its promised rewards, the creator typically refunds their backers. The website earns money by taking a percentage of the money raised from projects that reach their fundraising goals.
Soliciting donations from backers online allows an entrepreneur to bypass traditional financing, which benefits small projects that would not otherwise qualify for a loan or venture capital investment. Additionally, crowdfunding benefits projects in research and development intensive industries such as virtual reality that will not turn a profit for some time to come. Unlike traditional financing methods, crowdfund backers receive neither an equity stake nor a monetary return on their investment. The most that backers will ever see is the reward promised to them on a crowdfunding website, even if that company is later sold to Facebook for $2 billion.
Since Kickstarter does not guarantee the receipt of rewards, there are no real protections for Kickstarter pledgers. The FTC complaint hinges on failed entrepreneur Erik Chevalier’s misrepresentation of how he intended to use the funds. While he promised to hire artists to design the board game, the money was instead used “on unrelated personal expenses such as rent, moving himself to Oregon, personal equipment, and licenses for a different project.” The fine that Chevalier agreed to in the settlement is less than the total raised on Kickstarter, and the projects backers will not receive a refund. Fortunately, another company called Cryptozoic Entertainment stepped in to publish The Doom That Came to Atlantic City, so backers did not leave empty handed.
Crowdfunding is still relatively new, and the FTC complaint could be seen as growing pains. In combining elements of finance and fundraising, crowdfunding offers very little transparency to backers. It relies upon backers trusting creators, which has worked well so far based on the growth of Kickstarter. However, if too many projects abuse the trust of their backers, crowdfunding will quickly lose its appeal. The FTC complaint made an example out of one bad project, but enforcement will become more complicated as more money changes hands. In cases of malfeasance, consumers should get their money back from offenders. Websites like Kickstarter must take additional measures to weed out scammers so that project backers do not lose their faith in crowdfunding.
Vice President and Director, Governance Studies
Founding Director, Center for Technology Innovation
Darrell M. West is vice president and director of Governance Studies and holds the Douglas Dillon Chair. He is founding director of the Center for Technology Innovation at Brookings and Editor-in-Chief of TechTank. His current research focuses on educational technology, health information technology, and mobile technology. This post first appeared on Brookings Tech Topics.