The pros and cons of crowd funding

Appealing to crowds of like-minded invidividuals over the internet or through social media can be a great way to raise money for that indie project or a good cause. But there are things to watch out for.

The idea of crowd funding shot to the top of the public consciousness this week with the story of Karen Klein, the 68-year-old bus monitor in upstate New York who had been bullied to tears by a group of teenagers.

When a video of the incident went viral, a Good Samaritan opened an account for her on Indiegogo, inviting people to contribute and hoping to raise $5,000 to give Klein a vacation. 

The crowd-funded account has now surpassed $550,000 and may continue to rise.

But what exactly is crowd funding and how does it work?

What is crowd funding?

The core idea behind these crowd-driven campaigns is to generate funds for worthy projects. Creative works like journalism, music and films can be supported in this way, as well as entrepreneurial business ventures.

Indiegogo, one of the more popular crowd-funding sites. (CBC)

Even public works can be developed, like additions to hospitals or the purchase of expensive machinery, through online crowd-funding engines. Or political campaigns, like Barack Obama's notable online contributions during his 2008 presidential run.

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Advocates see crowd funding as a way to cut out the middleman, i.e. record labels, distributors or film studios, and to deliver money right to those who create the product.

While not a necessity, the hallmark of crowd funding is the use of micro-transactions, where a person contributes a small amount to a cause. The small donations can make a big pile by the end, as was the case with Karen Klein.

The crowd-funding facilitator usually holds the money until a certain money target or date requirement has been met;

Is crowd funding a good idea?

Proponents of crowd funding say it allows good ideas that might not be able to get bank loans or conventional funding to be set out directly to members of the public with like-minded interests wherever they may be.

Crowd-funding websites allow for donors and causes to make a connection, rather than relying on conventional fundraising that might target, say, a particular geographic region.   Because of their limited resources, many small charities, for example, tend to be overlooked in favour of more established ones. Crowd funding allows these causes to find supporters via the internet and social media.

Crowd funding can help causes all over the world. Indiegogo, for example, is the largest global crowd-funding platform available, says Rose Levy of Goldin Solutions, public representative of Indiegogo.

Small businesses, film, music, dance, theatre, all sorts of causes have used it, she says. So did "a couple couldn't get pregnant and couldn't afford IVF treatment; they raised money on Indiegogo to get a treatment and have a baby. People who don't have health insurance have used it."

What are the dangers of crowd funding?

Critics say there are several dangers associated with crowd funding, both for the project owner and the public.

Ideas that are set out on Indiegogo, for example, are not protected in any way, and their exposure may inspire someone else to run with the concept. (Experts recommend early patent filing and use of copyright protection to head off these concerns.)

Rose Levy says that her company is not responsible for any money contributed to Indiegogo once the donor requirements have been met.

In other words, once a cause has reached its specific cash target and had its month of fundraising expire, the money becomes entirely the property of the project lead and donors having second thoughts are out of luck.

Also, while donating to charitable causes can bring instant gratification, it is different when the money is being invested in the more multi-year requirements of new business ventures.

In addition, crowds can often over-invest in a newly popular industry, some caution, leading to bubbles that pop once the true revenue power of an industry is revealed

What are the current models of crowd funding in Canada?

Currently, there are two broad forms of crowd funding in Canada.

The first is the straightforward Indiegogo model of a hands-off, donation-based system where project owners directly receive money from willing donors, based on the sales pitch.

Some, like Indiegogo, offer a broad range of genres to suit almost every taste, while others, such as Kickstarter, have gatekeeper filters in place to keep out certain types of projects.

Another type of platform is SoKap, which has the unique feature of also incorporating revenue distribution into the model. According to David Geertz, its founder, SoKap "is the first crowd-funding platform that allows people to fund a project and make a financial return without the sale of a security."

"We're not selling equities; we're actually selling micro licenses or small promotional opportunities," says Geertz. The SoKap model allows a person to buy the rights to small geographic areas and realize small revenue when a creative product is purchased in that area.

Money raised from these rights sales goes towards supporting the particular project. Project owners also see revenues from digital sales on SoKap's website.

What lies ahead for global crowd funding?

The U.S. recently legalized the concept of equity-based crowd funding in its so-called JOBS Act, which stands for jumpstart our business startups.

Although trades will not be permitted until 2013, equity crowd funding allows members of the public to invest directly in a company's stock without having to go through or have the protections of a stock exchange.