Consumer Protection Laws Reach Crowdfunding Projects

Crowdfunding is a federal affair

Donation based crowdfunding is the practice of capitalizing a passion project or a commercial venture by raising funds from numerous people (the “crowd”). This is often done through dedicated websites or applications such as Kickstarter, Indiegogo, GoFundMe, and hundreds more. The Federal Trade Commission (FTC) has extended its regulatory power to non-equity based crowdfunding projects and the contracts and promises made on these popular online fundraising platforms.

Crowdfunding is serious business

One billion dollars have exchanged hands on Kickstarter alone and all platforms combined reached approximately $5.1 billion in 2013. Virtual reality startup Oculus raised $2.4 million on Kickstarter and was acquired by Facebook for $2 billion 18 months later, famously stiffing backers on substantial returns because their financial contribution was a “donation” and not an investment for equity in the company. A Kickstarter project seeking $10 “to make potato salad” raised over $50,000 in 2014.  Donation based crowdfunding has disrupted film financing, philanthropy, and startup capitalization, and the practice is now under the jurisdiction of all consumer protection laws enforced by the FTC.

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The FTC filed its first complaint against a Kickstarter campaign in June 2015. According to documents filed in the United States District Court in Portland, Oregon, Kickstarter.com user Erik Chevalier, DBA The Forking Path Co. started a crowdfunding project to raise the funds to create a new board game. Mr. Chevalier stated that if he raised $35,000, backers would get certain rewards (a copy of the game or specially designed game figurines).  He raised more than $122,000 from 1,246 backers, most of whom pledged around $100.  He represented in updates that he was making progress, but after one year of raising the funds through crowdfunding he announced he was canceling the project and refunding his backers’ money. He then failed to provide refunds. The FTC alleged Chevalier spent most of the money on unrelated personal expenses such as rent, relocation, personal equipment, and licenses for a different project, and violated Section 5(a) of the FTC Act, 15 U.S.C. § 45(a). (Read the complaint here)

 

The FTC’s Settlement Order (link to pdf) against Chevalier includes a monetary judgment of over $110,000. The FTC’s settlement also prohibits Chevalier from misrepresentation in future crowdfunding campaigns including:

  • Whether customers will receive a deliverable in exchange for a contribution
  • The purpose for which funds raised from a crowdfunding campaign will be used
  • Any facts material to a consumer’s decision about whether to contribute to a crowdfunding campaign.

Crowdfunding is unpredictable

With the potential for millions of dollars on the line and now federal oversight, entrepreneurs must be prepared for the elements of volatility and herd mentality when transacting with the crowd. Crowdfunding demands commonsensical best practices and legal due diligence similar to any other funding or marketing event, including matters such as corporate structuring, trademark search, intellectual property clearance, and the contracts formed with backers. Startups, technology inventors, and small businesses should use funds raised on crowdfunding platforms on that specific project, and keep promises regarding rewards or refunds.

Screen Shot 2014-09-21 at 11.16.38 PMAuthor: David N. Sharifi, Esq. is a Los Angeles based intellectual property attorney and technology startup consultant with focuses in entertainment law, emerging technologies, trademark protection, and “the internet of things”. David was recognized as one of the Top 30 Most Influential Attorneys in Digital Media and E-Commerce Law by the Los Angeles Business Journal in 2014. Office: Ph: 310-751-0181; david@latml.com.

Disclaimer: The content above is a discussion of legal issues and general information; it does not constitute legal advice and should not be used as such without seeking professional legal counsel. Reading the content above does not create an attorney-client relationship. All trademarks are the property of L.A. Tech & Media Law Firm or their respective owners. Copyright 2015. All rights reserved. 

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