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When it comes to investing, should you go with the crowd? Add to ...

Crowds are funny things. Usually disorganized and disparate, they can sometimes come together to do something big. While laying waste to Vancouver streets is a recent negative example, crowds can also do positive things. Like launch a business. Or fund an artist.

Crowdfunding sites are online venues where artists, do-gooders and small business owners congregate, create a campaign page and make a pitch as to why people should invest in their idea. The goal is to build a crowd to fund their aspirations through microdonations.

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In return for their money, investors tend to get little back. Maybe a signed piece of art here. A keychain there. Crowdfunding does not seem to be about earning large dividends. It is more like the social media's spin on fundraising; a new kind of altruism where investors get to know that their contribution (no matter the size) helped launch a person's idea. And that power is appealing to investors.

Ruth Stuart, a 47-year-old insurance analyst from Kitchener. Ont., found out about crowdfunding through Twitter after an author she follows tweeted about a sci-fi-themed cookbook that was trying to get off the ground. "My little donation, which could be $20, is not a lot of money for some people," she said. "But if you add that to everybody else's $20, you suddenly have enabled something to happen that is so much bigger than you could have personally done on your own."

Trust is a fundamental part of any economic transaction. And generally, trust is earned through a prior relationship. But the fascinating element of crowdfunding is that many of the donors are complete strangers to the people launching the campaigns.

Another Twitter recommendation led Ms. Stuart to the campaign of a Portland, Ore., designer who invented a reusable, bamboo-covered notebook. Later, she helped fund a photo project that featured portraits of people suffering from Parkinson's disease. In total, Stuart has funded eight projects without knowing any of the solicitors but she invested anyway because they all sparked her interest. On average, she gives between $25 and $30 a project, but for some - like the Parkinson's exhibit - she will contribute as much as $50 if the cause strikes a personal chord. Her friend's mother had recently been diagnosed with the disease.

Leonard Kung, an IT manager for HMV Canada, is much more cautious when it comes to crowdfunding. He has only invested in one online campaign - a project run by his long-time friend Claudia Hung to fund a poverty-fighting mission in a Ugandan village. But like Ms. Stuart, Mr. Kung gave to Ms. Hung's Raising the Village campaign because he believed in the cause. And he gave generously, investing $1,000.

"Not only is the project - what they are doing - worthwhile, the fact that you know who is doing it does make a big difference," he said.

While Mr. Kung feels more comfortable investing when he knows the people behind the campaign, he acknowledges that crowdfunding, by virtue of being a purely online tool, makes it much more difficult to sift through fraud.

"It's hard to know. I'm sure there are lots of people that are like 'Hey I've got this project that I'd like to finish off and would you like to give me some money?,'" said Mr. Kung. "It could be my home renovation project, maybe I just need to finish off my deck … how would the people out there know?"

Josh Tetrick knows that investor trust is one of crowdfunding's biggest stumbling blocks. In February, the 31-year-old started 33needs.com, a crowdfunding site for small businesses that aim to solve social issues. To prevent possible fraud cases, Mr. Tetrick instituted a rigorous vetting process that judges the integrity of each project.

"What is the integrity factor here? Are these people that we are potentially going to work with - are they coming from a good place?," said Mr. Tetrick. "We don't want them using the money on Vegas hotels, we want them to use the money to start businesses that matters."

He admits this is hard to assess. So far, Mr. Tetrick's site hasn't had a fraud problem and he thinks this could be how crowdfunding maintains its legitimacy.

"I would be really disappointed [if a project turned out to be fraudulent]" said Ms. Stuart. "You kind of want to take it at face value."

Trust in humanity is not enough for Lang Evans, the director of the enforcement division for the British Columbia Securities Commission.

"If I was thinking about investing through crowdfunding solicitation … I'd get financial advice," said Mr. Lang. "I'd go to them and say 'What do you think of this as an investment?'"

He added that the size of the investment did not ease his concern about fraud, he believes people should always do their due diligence. Even with microinvestments, the opportunity for fraud is still very real.

"If you defraud 100,000 people of $100, that is quite lucrative," Mr. Lang said.

Securities legislation, he says, was designed to protect investors by keeping companies that solicit money accountable. Because the majority of the crowdfunding campaigns skirt under the securities law - if all you get is a T-shirt in return for your investment, it likely won't be considered a security - investors have little recourse if they are burned.

Mr. Kung is just as wary as Mr. Lang. He sees the potential for fraud, but he also sees solutions. He suggests that crowdfunding projects ought to be clear and specific in communicating their costs and then post receipts to prove that the money is used properly. But even receipts can be doctored. Mr. Kung points out, however, that even with registered charities, you can never really know how your well-intentioned dollars are being used.

Ultimately, as with any investment, crowdfunding only works if the crowd is smart.

Follow on Twitter: @_mjwhite

 

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