The Internet has become the new Wild West of investing through a mechanism known as “crowdfunding,” a money-raising scheme that allows people to pledge amounts as small as $5 to a new or expanding business. Better Business Bureau of Southern Arizona is alerting businesses as well as investors to the potential perils of this new form of funding a business.
“Obtaining funds by asking strangers to buy into your bright idea may sound good,” said Kim States, BBB president. “But as in most forms of investment, there are no guarantees that a business will carry out its plan or return money to its investors. People need to understand that once they send in their money, there may be little chance of getting anything back.”
Securities administrators have found nearly 8,800 Internet domains with crowdfunding in their name, and a Google search of the word returned 10.3 million results. Not all of the sites were active or had been developed. Some were simply placeholders set up in anticipation of new investment rules authorized under the “Jumpstart Our Business Startups” (JOBS) Act. The Securities and Exchange Commission has not yet finalized those rules.
Some crowdfunding sites are used to promote artistic ventures through social networking sites or offer merchandise for a small ‘investment.’ But businesses cannot legally raise money that conveys an ownership stake in the business until the SEC rules are in force.
The North American Securities Administrators Association (NASAA) has set up a task force on Internet fraud in anticipation of potential scams involving these sites. Some sites were set up by established businesses while others appear to be operating out of someone’s basement, the association said.
Many crowdfunding services require that a company obtain a certain amount of pledged funding by a specified date before they can begin projects. Some require a business to return the money if it doesn’t meet the deadline. Meeting the funding requirement is only one of many steps. Companies may still need to obtain licenses, find commercial space, line up suppliers, hire employees and fulfill other obligations.
BBB advises investors to be very careful before committing money to any crowdfunding scheme. The securities administrator group NASAA has issued the following warnings:
- Crowdfunding investments cannot be offered legally until the SEC adopts rules to permit them. Beware of offerings that seek investments immediately.
- All investments have risk, but small business investments have even greater risk than normal. About 50 percent of all small businesses fail within the first five years.
- Issuers using funding portals to raise money may be inexperienced. Their track records may be unproven, unsubstantiated or outright fraudulent.
- The information about the investment is limited to what is provided through the funding portal. Investors may need to rely on their own research to determine the issuer’s track record.
- Because state regulators are not allowed to review crowdfunding issuers or their offerings, full and complete disclosure may not be available to investors.
- Investors may have limited legal ability to take action against the issuer should the investment not perform as represented. Due to limited regulatory oversight over these offerings, investors may be left on their own to pursue costly private lawsuits when things go wrong.
- Crowdfunding investments are mostly illiquid and investors must be prepared to hold their investments indefinitely. It also may be difficult or impossible to resell these securities due to the lack of a secondary market.
- Funding portals must be registered with the Securities and Exchange Commission (SEC), belong to a self-regulating organization (SRO), and comply with other rules the SEC may issue.
- Crowdfunding portals claiming an accreditation or “seal of approval” from a standards program or board may not be legitimate.