Three Reasons I Don’t Like “Crowdfunding” Individuals

There is a growing emphasis on the idea of crowdfunding for both startup and established companies. Two new online companies, Pave and Upstart, are making crowdfunding personal.

These sites allow backers to invest in the income stream of other people. The idea is that prospects, generally young people at the front end of their career, can get some upfront money in exchange for future personal earnings. The usual deal exchanges 7-10% of the prospect’s income over the next ten years.

For a young person that needs money now, this exchange seems like a good idea. Throw in the fact that the investors are also going to become mentors (both because it is at the center of both the websites’ models, and because it makes good business sense), and some of these relationships can pay off for everyone involved.

But for at least three reasons, I think that this idea poses a real downside to everyone – backer, prospect and society at large. And in the long run it poses a threat to the success of crowdfunding.

The first reason has directly to do with prospect. When you are young (and most of these prospects are in their 20s), money “feels” so much more valuable. Generally speaking, the income of this group is very low, at the same time they are trying to make their way. Credit card companies target this age group, because quite frankly, young people make terrible credit decisions, making the credit card companies millions of dollars in interest and fees.

Of course, everyone makes terrible buying, investing, love and other decisions in their 20s. But that’s just because young people don’t have the experience to know better. Contrast that with someone who may be a backer (investor). These people are generally older, wiser, richer, more successful – and while they are not necessarily smarter – they are more experienced. And they are more savvy than the average prospect.

The penalty for being younger, more desperate for money, and less experienced is that the average prospect is going to get a bum deal. I don’t like the idea of generational theft, burdening young people who should be buying houses and starting families for the benefit of successful, experienced investors.

The second reason that I am not a fan of crowdfunding people is that it places a premium on betting on young business people, further diminishing the value of lower-income people to the society. It further devalues the contributions of musicians, writers and other cultural contributors. Sometimes these people aren’t financially recognized in their lifetime. The price of art often dramatically increases after the artist’s death.

The third reason is that Pavers will be a lot less likely to get mentorship and guidance that is really in their best interest. For example, if the prospect (and the world) is better off because they decide to backpack Europe, go back to school, or just take a lower paying job for the experience it offers, why shouldn’t they? Well, the backer is not going to suggest that they do things that will pay off for the prospect in 20 or 30 years. The backers want to get a return on their short-term investment. So mentorship will be skewed in favor of the backer’s own personal financial interest.

I strongly applaud Pave and Upstart for being very creative in the crowdfunding space. I also think that it’s valuable to reward mentors with financial benefits. However, if we set up a system where young people are “rented ” for a while, we will all be worse off for it. And if people start thinking that crowdfunding is synonymous with modern-day sharecropping, then the political support for a critical new funding mechanism will completely erode.

Jonathan Frutkin is an attorney at The Frutkin Law Firm, PLC in Phoenix, AZ. He’s written a new book called “Equity Crowdfunding: Transforming Customers into Loyal Owners” which will be published in May, 2013.