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The Downsides of Crowdfunding

In early posts we’ve discussed the potential “Wisdom of The Crowd” has for businesses, especially when combined with micro-financing and micro-credit for small businesses. Nevertheless, one must ask: Can CrowdFunding be an effective way for raising money for a small business?

President Barack Obama signed the JOBS (Jumpstart Our Business Startups) Act, which will help startup companies raise funds from-non accredited investors. This means that funding rounds will now be easier through online CrowdFunding.

The problem, as Daniel Isenberg described in the Harvard Business Review, starts when investors’ decisions are based on mouth to ear recommendations. If so many people decide to risk so much money, they cannot be wrong, can they? Well, not quit, or as Isenberg puts it: “Crowds are frequently stupid”.

As always there are exceptions. CrowdFunding for donations can work and has worked. Nevertheless, it does not indicate that the crowd knows how to do it wisely. In a research made by Susan Moeller who analyzed how the media “sell” disease and death to the crowd, focusing on CrowdFunding for curing diseases in Africa, she found that Anti-Ebola virus drugs raised more money than Anti-Meningitis virus drugs or any other disease. These results are surprising as the Ebola virus killes significantly less people than the Meningitis virus. The explanation was simple: the crowd does not have the time or will to try and understand the complexity of the problem in Africa.

Investing in a startup company or even in a small business requires the investor to thoroughly understand the risks he is bearing, so he can make informed and educated decisions that are endangering large amount of money of his own pocket. If this is the case with traditional investor then what is that saying about CrowdFunding and “ordinary” people who are investing online? It’s only reasonable to think that they will tend to risk less due to the complexity of the venture. Nevertheless, their expectations for success in the short run are high, so they might follow the herd and invest money based on “fashion” and trendiness. This is one of the reasons why you won’t hear about failures. In this clash between the entrepreneur, who is seeking for CrowdFunding, and the crowd, who is looking for investment, both sides might lose.

Related Posts

Kickstarting on Kickstarter
Crowdsourcing: A “How To” Guide for SMBs
Kickstart an Idea
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