Crowdfunding sites have revolutionised the way people invest and how international companies seek out capital, with the World Bank estimating that the industry is set to bring in more than $93bn worth of investment by 2025. Most people who have taken part in the practice get involved in what is known as reward-based crowdfunding, where start-ups and entrepreneurs use websites like Kickstarter and IndieGoGo to pre-sell a product or service.

There is usually a tiered system of donation, with the highest entry point allowing backers to obtain a copy of the product if the campaign can raise the necessary capital. But if backers cannot stretch to the top tier of investment, they can still help to get the project off the ground in exchange for incrementally smaller perks, depending on how much money they are willing to part with.

Then there is equity crowdfunding, with the key distinction being that, unlike the reward-based model, investors receive shares in a company in exchange for the capital they put in. With both types there are massive risks involved. Start-ups are notorious for failing fast, and failing often. But that does little to deter the millions of investors from logging on and paying out, all in the hope of getting involved in the next big thing. But while both backers and investors share an eagerness to support fledgling companies to take flight, there is a clear distinction in the decision-making behaviour of the two – one where emotion and objectivity are exercised in unequal measure.

Falling short
When the right product comes along it can send people into a bit of a frenzy, with happy backers showering crowdfunding campaigns with money in an attempt to see their dream device or service made a reality. This is exactly what is happening to the Sondors Electric Bike that launched its quest for capital on IndieGoGo. It is priced well under its competitors at just $649, and the bike boasts some impressive stats for such a small price, helping it to raise nearly $4m – far exceeding its modest goal of $75,000. But when something sounds too good to be true, it usually is. This is why, despite attracting a lot of funding, it has also caught the attention of others in the e-bike industry that question whether it can really deliver on all of its pre-sale promises.

In an interview with Yahoo! Tech, Robert Provost, CEO of Prodeco Technologies, a company that sells its own line of electric bikes, accused the makers of the Sondors Electric Bike of making hugely inaccurate and false claims in their IndieGoGo campaign. “What they are claiming is highly suspect”, says Provost. “We’re afraid a lot of people who think they got a great deal will be disappointed with the bike.”

Apart from its very low price tag, the e-bike claims some impressive stats: a powerful 350-Watt motor capable of generating a top speed of 20mph and a lithium ion battery that can be charged in just 90 minutes, with enough juice to keep it moving for 50 miles – all adding up to make it an attractive offering to the market. But industry insiders are not convinced.

“I do question some of the [bike’s] specs”, says Court Rye, owner of the Electric Bike Review website and YouTube channel. “The lightest fat-tire electric bike I’ve ever reviewed and weighed myself is the Felt Lebowski, a $5,800 performance model built with 6061 aluminium alloy — it weighs just 48 pounds. Steel is much heavier, in my experience.”

To answer some of their doubters the team behind the Sondors Electric Bike have planned a number of demonstration days in order to prove naysayers wrong and display to consumers that their bike can do what they claim: “There has been a lot of speculation about the bike over the past few days and we want to assure you that it is real, it exists and it is quality”, reads an update on their IndieGoGo page. “We feel the best way to address this is to invite our backers, potential future backers and those naysayers out there to test the bike for themselves.”

The bike will need to perform well if it is to lower many a raised eyebrow over claims made about the bike’s range and top speed. Critics contend that with a rider in tow the direct drive motor is simply not powerful enough to reach such speeds and that 10 to 15 miles is a much more realistic range for a battery of that size. Electric-FatBike.com even went as far to imply that the people behind it are “overselling their bike to the point of fraud” and highlighting the inconsistencies in the company’s marketing campaign.

“In the photos and video they show people riding bikes that are prototypes with foot-pegs instead of pedals and using much larger motors than a 380-Watt system”, writes the reviewer. “They also advertise it as Direct Drive, but in the pictures the motor is clearly a geared hub. They talk about hydraulic brakes, but then show pictures of cable brakes. There is little to no consistency in the description and the pictures and videos.”

Great expectations
But even with his expertise, this reviewer still hopes that the Sondors Electric Bike will deliver, even admitting at the end of the piece that he would “rather give [his] money to a beach bum surfer with big promises than a CEO of a big company any day”. Many people seem to get so blinded by the possibility of getting their hands on the product of their dreams that they are no longer capable of exercising any kind of objectivity.

This proclivity of people to allow themselves to get caught up in all the excitement, means that entrepreneurs may inadvertently over stretch or make promises that will fall short in an attempt to acquire the necessary attention and capital they require. This vicious cycle becomes even more disconcerting because these sites do not offer refunds if it all goes south. Nor are the creators contractually obligated to refund funders, so long as they supply them with something. Whether it lives up to its initial billing, however, is irrelevant.

The world of videogames is a clear example of this vicious cycle in action. Peter Molyneux, a developer who once carried a lot of weight in the industry, has seen his reputation take a nosedive. After he successfully got his most recent offering, Project Godus, off the ground through Kickstarter back in 2012, the game is still yet to reach players’ PCs. This has naturally angered fans and led to him coming under huge criticism from the gaming community, as well as those who supported his campaign.

Adding to the irritation felt by supporters of the project, Molyneux recently announced that he will be shifting his attention onto a different project, leaving backers wondering if he has just decided to shelve the game for good. Molyneux is not the only developer to pull this type thing. Many consumers have had their excitement snuffed out by broken pre-release promises.

But to put all the blame on these entrepreneurs and would-be start-ups is simply not fair. The backers of these campaigns are just as much at fault for backing them in the first place. Both campaigns received well over their target amount. The sensible choice would be to wait and see, but the fact that people are unwilling to show restraint is indicative of their inclination to act on impulse. The criticisms aimed at developers like Molyneux taking too long and the likely complaints that will be levelled at the Sondors Electric Bike should it fall short, also provide evidence of the fact that many simply fail to comprehend the huge undertaking that is game development or the potential risks and manufacturing road humps that arise when bringing a prototype to the mass market.

Bigger stakes
Equity crowdfunding is a different story entirely. Users of sites like Crowdcube are not looking at the product or service in isolation – they are looking at the business as a whole. “Investors are looking for a strong idea that offers the opportunity to scale up, so there needs to be a really clearly defined market opportunity – a real problem that your business is solving”, says Luke Lang, Co-Founder of Crowdcube. “No matter who is investing, whether it is a crowd investor, an angel investor, or a VC. They’re all looking for the same thing: a strong team with decent levels of experience and a proven ability to exercise a successful business plan.”

Looking at companies from this perspective alters the types of businesses that equity crowd funders are interested in. Enterprises that are already up and running and operating with a decent degree of success – which are looking for the next round of investment to really accelerate growth – are particularly popular. “It is not to say that we do not fund startup businesses, but it is slightly more challenging for the entrepreneur”, says Lang. “But they need to be even more convincing that their business or idea is highly transformational or that they have spotted a niche in the market that they believe they can plug.”

“It just makes the investment pitch that little bit harder. I guess that is why our investors tend to edge towards the early stage businesses, as it lowers the amount of risk that they expose themselves to.” Christine Lomax is a London-based business advisor who has invested in four companies through Crowdcube and recommends that before investing in any business or start-up to do some thorough research behind the scenes.

“It’s better to be cautious if you feel sales projections seem sky high or you just feel they’re getting a bit too crazy; make sure people aren’t pulling figures out of the air”, says Lomax. “They should have a very transparent business plan and cash flow, with a good attention to detail – the figures have got to stack up.” Backers on IndieGoGo, however, tend to look strictly at the product or service and usually from the perspective of a consumer, not an investor.

Although understandable, backers of campaigns on reward-based crowdfunding sites might be better off exercising a little more caution, especially if the project has already reached its goal. There is always the opportunity to buy the product once the business is fully operational, and at that point any kinks or manufacturing potholes are likely to be smoothed out.

Over-funding could also inadvertently put the start-up in bit of a bind, as manufacturing is notoriously hazardous, with delays and mistakes a plenty. Excessive orders, therefore, can be more trouble than the are worth for an inexperienced entrepreneur.

Even tech behemoths like Apple struggle to get products out in time, so assuming a small start-up with little or no experience to hit all its targets and live up to the huge expectations that are placed on it by backers is demanding a lot.

Agency loss can occur if the principal and the agent do not share common interests. So as long as both parties desire the same outcome then everyone is happy. In equity crowdfunding this parameter is adequately met, as both investors (principal) and management (agent) seek to maximise personal economic wealth and, therefore, agency loss is minimised.

But in reward-based crowdfunding there is a problem: the principal is not concerned with maximising economic wealth, but instead, the principal simply wants a good or service in return for their investment. The agent on the other hand is seeking to maximise economic wealth. This reduction in common ground leads to agency loss and negatively impacts the relationship between both parties.

As equity crowdfunding rewards investors for choosing companies that can achieve long-term success, there is a tendency for people to gravitate towards companies that offer more than an impressive-looking product. Investors are looking to be involved over the long haul, and investors and management bond over a desire to make money. But just because backers on sites like Kickstarter do not have equity in the company, it shouldn’t lead to short-term thinking.