Crowd funding is a form of capital raising that uses the internet to connect many individual investors with a company, project or person. Originally, crowd funding issuers could only give token gifts to donors, and crowd funding was mainly used by internet content providers to create work paid for by their patrons. Legislation, however, has paved the way for startups to sell equity stakes through crowd funding. Some investors are attracted to this investment vehicle that allows individuals to invest in high risk start-up companies, but it is important that those investors understand the substantial risks inherent in crowd funding ventures.
Investments in startups are illiquid and carry a high risk of failure or bankruptcy. In addition, investors should realize that investing through crowd funding exposes them to an increased risk of fraud. The Jumpstart Our Business Startups Act (JOBS) signed into law on April 5, 2012 gives crowd funding issuers alarming freedom from the oversight of federal regulators. This dangerous law allows start-ups to raise as much as $50 million without even registering with the SEC. “Emerging Growth”companies can even go public without SEC oversight if they earn less than $1 billion in revenue a year. Investors need to understand that this lack of oversight increases the risk of securities fraud and manipulation. Regulators and securities experts claim that crowd funding “is tailor-made for Internet fraud.”Startups reportedly can get a “seal of approval”placing them on crowd funding portals with only a cursory background. This “seal of approval”could lull investors into a false sense of security. Moreover investors should question how thorough and accurate such background due diligence is, and whether all material risks about the investment are communicated to investors.
Experts expect that investors will be bombarded with thousands of purported “can’t lose”crowd funding opportunities from predatory scammers. The SEC charged an Illinois-based advisor and CPA of offering over $500 billion in phony securities using social media sites like LinkedIn. This highlights the opportunity that any fraudster with an internet connection has; he or she can make up descriptions of a great company, take in tons of investor dollars and then wire out every penny to foreign accounts. Crowd funding may be the equivalent of sweepstakes scams that prey on the elderly.
Valuation of these securities is challenging even without fraudulent intent. Startups in general are significantly harder to value than established companies with proven track records. It is difficult to predict market demand for new products and services. Also, many internet companies rely on user growth or other metrics that are less understood than cash flows and earnings. These companies often lack professional accounting departments and the experience to understand their true growth prospects. Finally, the lack of audited financial statements and government oversight permits crooked promoters to fraudulently overstate their value.
The North American Securities Administrators Association (NASAA) believes that the lack of transparency and regulation in the crowd funding market poses a great risk to investors. As more companies rely on crowd funding to generate capital it is inevitable that fraud will occur. If you invest in crowd funding startups, be prepared to lose your investment.
If you have investment losses or problems involving crowd funding, call the lawyers at Page Perry for experienced representation at (404) 567-4400 or (877) 673-0047 (toll free).