Crowdfunding Policies: Risk or Reward?

Crowdfunding has gone from obscurity to a globally trending topic in just a few short years. It has provided hundreds of millions of dollars of funding for many entrepreneurial, creative and philanthropic projects that might otherwise never have been possible. In short, it has had an amazing infancy.

But as crowdfunding matures beyond the early adopters, it is running into issues. Specifically, contributors’ participation is shifting from eyes-wide-open active financial support in helping launch projects, to expectations of simply pre-ordering the product or service described by the project creators. The more contributors “shop” for hot new products, the more they expect that the product will be delivered without fail. This ignores the risks inherent in launching any new product and the fundamental risk-sharing basis for crowdfunding the project.

Sometimes projects fail to achieve their goals, and when this happens, some contributors who think they are “buying” the product demand a refund. In a normal ecommerce scenario, such as buying something on eBay, this would be a natural response and can be easily accomplished. In essence, the company selling the product loses a sale, the money is refunded, and things are settled.

However, in a crowdfunding scenario, the money collected from the contributors is spent to try to build the product. In some cases the project fails. When that happens, there is no money left to refund and yet no product to show for the effort. Still, the contributor is demanding a refund and the rules of the credit card processing industry require they get one. Who will have to pay it?

The answer is that the payment processors, such as PayPal, end up on the hook for the refunds. Even though they are only an intermediary in the payment process between the contributor and the campaign owner, they bear the full financial responsibility for the failed transaction. This hardly seems fair or right. Many payment companies simply refuse to let their service be used for crowdfunding initiatives or charge a premium to cover their risk that takes more money away from the people raising capital for their new innovation.

PayPal’s approach is different. They want to support innovation without charging a premium to sites like FundRazr. Over the last few months, they have consulted with major players in the crowdfunding industry, including FundRazr, in efforts to craft a policy that would allow crowdfunding platforms to continue to enable successful funding of projects, but would limit the potential for unnecessary failures and losses. Tomer Barel, the chief risk officer at PayPal has published a blog about this. You can read it here.

At FundRazr we believe the new PayPal policies help clarify to contributors the risks associated with giving to these types of campaigns.  It tackles the fundamental problem that contributors need to understand that a project may not be successful and that, if that happens contributors won’t receive their product. By ensuring that the contributor is required to acknowledge this risk as part of the payment process, there is a higher probability that they will make a better decision about their participation in the project and will have better expectations of what may happen. And by requiring that all crowdfunding platforms follow this process, it will help the many new, inexperienced platforms follow industry best practices.

The policies also address a second crowdfunding industry problem of transparency and accountability. When it is possible to accumulate large amounts of money quickly, criminals are inevitably drawn in like moths to a flame. PayPal’s policy of requiring increased transparency and disclosure of who is running the crowdfunding campaign, who is getting the money, and how it will be spent puts up additional barriers against bad actors without unnecessarily burdening campaign creators who have good intentions.

FundRazr has raised tens of millions of dollars for crowdfunding projects so far. We believe these fundamental changes in the industry are a natural and necessary part of its maturation. Without them, there is the potential that the crowdfunding industry will experience a meltdown in both campaign owner and contributor trust in the process. By adhering to this new policy, campaign owners can be assured they will not have their projects unnecessarily restricted and contributors will have better visibility into whom they are supporting.

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