As a small business owner, you are always on the lookout for new funding opportunities to grow your company. Crowdfunding platforms have exploded in popularity, offering the tantalizing prospect of raising significant capital from enthusiastic everyday investors. However, this relatively new funding model comes with significant risks that every entrepreneur must understand.

Unscrupulous startups with more hype than substance are exploiting regulatory loopholes to attract millions from unsuspecting backers. In this article, I am going to arm you with the knowledge you need to protect your business from falling victim to risky crowdfunding scams.

The Dynamics of Crowdfunding

To understand just how tricky crowdfunding can be, you must first comprehend its key players, regulations, and dynamics.

The Allure of Regulation A

In 2012, the SEC introduced Regulation A, allowing smaller companies to raise up to $75 million annually while facing less oversight than a traditional IPO. On the surface, this sounds like an attractive proposition for cash-strapped startups and small businesses. However, this looser regulatory environment has opened the door for bad actors to mislead investors.

Many ventures taking advantage of Regulation A have little to no proven track record, which makes it difficult for investors to assess their true potential and risks. If you are considering crowdfunding, it’s essential to understand the implications of Regulation A and the due diligence challenges it presents.

Hype-Driven Campaigns

Many crowdfunding ventures rely heavily on slick social media marketing to generate excitement and investments. Flashy videos, influencer promotions, and bold claims about “game-changing” products are common tactics.

You must look beyond the hype and carefully evaluate the substance behind these campaigns. Don’t let FOMO (fear of missing out) cloud your judgment. Remember, if a company’s marketing focuses more on generating buzz than showcasing a viable business plan, that’s a red flag. Take the time to thoroughly research the venture’s fundamentals before getting swept up in the excitement.

In fact, Ramon has gone into great valuable details about this particular issue in his podcast, you watch it here.

Novice Investor Risks

Crowdfunding platforms are magnets for first-time investors who may lack the financial savvy to properly vet investment opportunities. Swept up in the excitement, these novice backers can behave more like fans than shrewd investors. This dynamic creates fertile ground for scams and allows shaky startups to raise far more money than their fundamentals warrant.

As an entrepreneur, it is crucial to recognize that the crowdfunding space is filled with investors who may not have the experience to spot red flags. Don’t assume that a venture is solid just because it has raised a lot of money from the crowd. Do your own thorough due diligence.

Red Flags to Watch Out For

Now that you have a better grasp of crowdfunding, let’s turn our attention to the warning signs that can help you spot risky ventures. Keep a sharp eye out for these three red flags.

Missed Deadlines and Shifting Goalposts

If a crowdfunded company consistently pushes back production or delivery dates, that is a major warning sign. Delays do happen, but repeated missed deadlines suggest deeper issues with the business. Be wary of ventures that constantly shift their goalposts or timelines.

If a company can’t stick to its commitments, that’s a strong indicator that it may lack the operational capabilities to deliver on its promises. Don’t be fooled by endless excuses or vague reassurances. A pattern of missed deadlines is a serious red flag that should not be ignored.

Lack of Transparency

Crowdfunding investors often receive far less transparency than traditional startup backers. If a company is vague about its finances, progress, or challenges, that is a red flag. Reputable ventures will provide clear, regular updates to their investors. They will be forthcoming about their cash burn rate, revenue, partnerships, and any obstacles they are facing.

If a crowdfunded company is refusing to share key information or seems to be hiding something, that’s a major cause for concern. Don’t invest in or partner with a venture that isn’t willing to be an open book.

Unproven Track Records

The vast majority of Regulation A crowdfunding campaigns involve companies with little to no proven track record of success. While every startup has to start somewhere, be extremely cautious about investing in or partnering with ventures that have never brought a product to market before.

Look for evidence that the company’s leadership team has relevant experience and a history of delivering results. If the team seems green or has a checkered past, proceed with great caution. An unproven track record doesn’t necessarily mean a venture will fail, but it does significantly increase the risk factor.

Protecting Your Business

Spotting red flags is just the first step. As a small business owner, you must also take proactive measures to insulate your company from crowdfunding risks. Here are four key strategies to protect your venture.

• Look beyond the hype: You know the importance of marketing. However, when evaluating crowdfunding opportunities, you must look past slick campaigns to assess the company’s real fundamentals. Don’t get caught up in the fear of missing out on the “next big thing.” If something seems too good to be true, it probably is.
• Demand transparency: Before investing in or partnering with a crowdfunded venture, insist on detailed information about their financials, leadership team, production progress, and challenges. If a company is unwilling to be fully transparent, consider that a major warning sign. Do not let excitement override your need for critical data.
• Diversify your funding and partnerships: Crowdfunding can be a valuable funding source, but it should not be your only option. Diversify your financing by also pursuing traditional loans, grants, angel investments, and VC funding. The same goes for business partnerships – don’t go all-in on an unproven crowdfunded company.
• Consult experts: Crowdfunding is very complicated. Consult with experienced financial advisors, lawyers, and mentors to help evaluate opportunities and protect your interests. Their expertise can help you spot risks that you may overlook on your own.

Conclusion

Crowdfunding offers enticing opportunities, but the space is rife with risks that every small business owner must take seriously. Approach crowdfunded investments and partnerships with caution and thorough due diligence. Your business is too important to gamble on unproven startups, no matter how flashy their promises may be.