Proving Crowdfunding Good Faith | Transparency

Crowdfunded projects are wise to keep detailed records.  Records help insulate project owners from legal liability.

Failure is an Option

Fully-funded, rewards-based crowdfunded projects can fail.  For example, a game project called “Haunts: The Manse Macabre” exceeded its funding goal on Kickstarter.  It raised $29,000 to make an online game.  It told backers (people who contributed money) that they would be rewarded with certain levels of access to the game when it launched.

But the project is unlikely to launch.  It encountered problems and roadblocks.  Although it paid developers to create parts of the game, the developers have left, the game is not finished and the project is about out of money.

Legal Liability for Fraud

Did the project owner commit fraud?  Could backers sue the project owner, or could a consumer watchdog like a state attorney general take action against the owner?

Although I don’t know the answer to those questions for  “Haunts: The Manse Macabre,” the answer for some projects could be yes.

Address Risk

From the outset, a project owner must prepare for risk.  The owner is wise to warn potential backers of the risk of failure.

Kickstarter says projects funded through it are expected to make a good faith effort to complete their projects.

Good faith is a subjective standard.  Like beauty, good faith is in the eyes of the beholder.

Evidence of Compliance

To establish that the owner did make a good faith effort, detailed records of the project’s activities can be invaluable.  Detailed records can include accounting ledgers, emails, instant message logs, and even a daily diary of activities.

Opening to Outside Review

Another step an owner can take is to be utterly transparent as work on the project unfolds.   To achieve transparency, an owner could post the records it is making, for public viewing as soon as they are made (or soon afterward).

When the owner makes a payment or makes a draft of a deliverable, they can post it on the web for public scrutiny.  They should invite comments.  Example: “As we execute the steps of the project, if anyone thinks we can do better, then please say so publicly or in a private message to the project owner.”

Such transparency helps to invest third parties – both backers and critics – in the actual execution of the project.  It contributes to an eventual defense like this from the project owner: “I was showing you every step as we did it.  If you thought I was not making a good faith effort, then why didn’t you say so months ago?”

–Benjamin Wright

Dispel Allegations of Fraud

The most common forms of crowdfunding today are based on donations and rewards.  Many folks are raising funds over the Internet by just asking for charity donations or by promising some kind of reward, including priority shipment of a new product, in exchange for money.

Compared to equity crowdfunding (which typically involves the sale of securities), donation/rewards crowdfunding is relatively unregulated.  [Donation/rewards crowdfunding is also known as "project" crowdfunding.]

Remedies for Fraud

Nevertheless, people raising money through donations/rewards crowdfunding can still be subject to review by government regulators.  Example regulators are the Federal Trade Commission and state attorneys general, who investigate and punish fraudsters, particularly people who prey on the general public.*

Also, the people who contribute money to a crowdfunding project can sue to get their money back (plus maybe attorneys fees) if the project is fraudulent.  The injured people might unite into a class action lawsuit against the people running the project.

Full Disclosure

Thus, people leading crowdfunding projects want to give themselves margin for error.  They want to go to pains to ensure there can be no claim that the money contributors were tricked or cheated.

A key to avoiding any allegation of fraud is full disclosure of the facts, including facts that might turn off contributors.

Being Upfront about Negative Facts

Naturally, project leaders want to create compelling pitches – with videos or slideshows – that explain why a contributor should support the project.

But they should also be candid about negative facts, such as administrative fees that will be charged or risks that technical or logistical problems may delay or prevent delivery of a promised product.

Video Makes Good Evidence

On the Internet, video can be a very effective medium for making key points clear to common people.  This video is an example of what could appear on a web page promoting a crowdfunding project:

I am not saying that crowdfund project leaders should put all disclosures in video.  Text and FAQs are often adequate.

But select disclosures in video can be strong evidence that the project leaders were candid and honest.

–Benjamin Wright

*The Texas Attorney General essentially shut down the Texas Highway Patrol Museum because it misspent donated funds on liquor, cigars and fancy trips.  Nathan Koppel, "Texas Museum Reaches the End of the Road," Wall Street Journal, Aug. 30, 2012.

Update:  Inexperienced entrepreneur who raised $35K, but could not deliver, meets legal disaster.