Risks in Crowdfunding

The phrase “buyer beware” is typically uttered when a backer talks about supporting a crowdfunded campaign. The phrase “buyer beware” comes from contract law that controls sale of property. It refers specifically to information asymmetry, because the seller of the product has more knowledge than the buyer.

The caution of “buyer beware” is appropriate in rewards-based crowdfunding, because, in most cases, the product may still be at the idea stage:

Depicting the early stage of crowdfunding compared to other commercial transactions, using product development

Depicting the early stage of crowdfunding compared to other commercial transactions, using product development

A backer faces a balancing act: because the product is still at the idea phase, supporting the project creator to fulfill his dream is part of the journey and an emotional investment. But the actual product may vary from the vision, and the backer may not get the reward he was expecting.

A backer mainly uses the project description and any communication from the project creator as an indication of the product and its quality. But, the project creator may not be telling the whole truth about the project or product, thereby hiding the actual status of the product from backers and not influence the funding campaign.

Apart from the information asymmetry in the crowdfunding process, there are multiple other risks that a backer needs to be aware of. Predominantly, these risks relate to manufacturing and shipping of the reward. Because the backer may not get his rewards, I analyse the opportunity cost a backer incurs from taking part in crowdfunding as well as the maximum monetary loss under various scenarios.

The type of project creator also influences the riskiness of a project, specifically the manufacturing and shipping of goods. The risk is higher with start-ups and lower with experienced project creators.

Lastly, because a backer is an innovator and early adopter of products and ideas, there is an emotional investment that is also made when taking part in crowdfunding. A backer supports a project creator via the pledge, support and encouragement for the project, and by completing small tasks, such as sharing content. Accordingly, there is also an emotional risk for backers when pledging.

The key articles in this section are: