Generally speaking, I’m a huge fan of crowdfunding. I’m an investor in one of the major platforms, Indiegogo. Crowdfunding sites like Kickstarter and Indiegogo are helping fill the financing void for startups that struggle to find traditional financing. For example, I recently wrote about crowdfunding being a viable option for hardware startups who notoriously have a tough time attracting funding from VCs. But there is a bit too much hype around crowdfunding right now. And as we know from history, too much hype doesn’t always end well.

The Good: When crowdfunding works…

In particular, I’m bullish on crowdfunding when it’s about passionate consumers rallying around an idea, cause, or product concept they believe in. In this case, the funders have modest expectations…either a small perk (like a t-shirt) or just the simple satisfaction of supporting a company or cause they care about and watching it grow.

Take JamStik as an example. It’s a prototype mini-guitar that interacts with an iPad or iPhone. The project has currently raised $129,000 with an initial goal of $100,000 on Indiegogo. Its funding packages range from an exclusive backers t-shirt, your name on the Founder’s wall, to discounts on a JamStik or one of the earliest prototypes.

Crowdfunding can also be a way for startups to finance parts purchasing and manufacturing by taking customer pre-orders. For example, Tindie fundraisers can give startups working capital to buy parts for the final assembly of their products (full disclosure: I am an investor in Tindie).

The Bad: Disappointing expectations

While Tindie fundraisers usually work very well in terms of meeting customer expectations, turning crowdfunding into a wide-spread platform for taking pre-orders can be risky business. The Pebble smart watch may have had one of the most publicized delivery delays, but they’re hardly alone. Statistical analysis by Professor Mollick of Wharton uncovered that 75% of all funded projects on Kickstarter shipped late.

When consumers start to look at a crowdfunding site as the equivalent of an online store where they can buy new toys, there will be trouble (hence the Kickstarter blog post: “Kickstarter is not a store”).  Delays in production/delivery are usually expected among investors, but even a few weeks delay can frustrate and anger this new class of ‘investor customers’ who are expecting the same smooth process as when they order something from Amazon. Their frustration ripples throughout the web, souring the entire industry.

The Ugly: Crowdfunding for equity

Recently, there has been a lot of talk about crowdfunding for equity. The idea here is to make it very easy for anybody to invest small amounts of money in startups through crowdfunding platforms. I personally think this is a recipe for disaster. Here is the problem: the fact is that few angel investors make good investment returns…and that’s true even for those who are lucky enough to have a huge winner in their portfolio. On average, VCs had pretty dismal returns over the past decade. And those are sophisticated investors who look at hundreds of deals and then work for years to help their portfolio companies build the best teams and execute.

In short, early stage investing is hard and typically only the top tier investor with a proprietary deal flow can make great returns. It’s not the place for the average consumer to put his or her money.

If the driving force behind crowdfunding platforms is to make it easier for anybody to become an angel investor and have fun tracking the progress of their project (without much expectation for a return), then crowdfunding is a welcome addition to the financing landscape. However, if we start to see people putting up large swaths of their retirement savings in the hopes of funding the next Google or Facebook, this will end in a disaster. Time will tell what happens. But unfortunately, if the future is anything like past history, the latter scenario is more likely.

Related articles

• CircleUp raises $7.5m to expand its crowdfunding platform to more consumer companies (banklesstimes.com)
• Donald Trump gets into crowdfunding (finance.fortune.cnn.com)