Budding investors have been warned to be on their guard against Dragon’s Den-style ‘crowdfunding’ ventures.
Experts fear that thousands of people could be left “high and dry” unless tighter controls on the practice are put in place.
Crowdfunding appeals to amateur investors because it gives them the chance to own a stake in a new business without a significant outlay.
Investment opportunities are usually marketed over the internet by companies unable to secure funding through traditional lending channels.
But the system remains largely unregulated and an increasing number of questionable ventures are appearing online.
It means novice investors could be at risk of losing their life savings or being financially exploited by unscrupulous scammers.
The warnings come just weeks after Crowdcube became the first equity crowdfunding platform to come under regulation by the Financial Services Authority (FAS).
The move will give investors the means to claim compensation of a backed project fails to deliver on its promises.
Jasmine Birtles, the founder of consumer finance site MoneyMagpie.com, is now calling on the FSA to widen its net and cover all other crowdfunding platforms.
“Crowdfunding is an exciting new way for start-up businesses, entrepreneurs and good causes to raise the money they need to get going through the support of ordinary people,” she said.
“It has grown rapidly in the last few years and has had a number of high-profile success stories, but worryingly – unlike traditional routes of investing – it remains largely unregulated and unmonitored with little in the way of consumer protection if a project fails to materialize.”
Birtles, who is currently researching a book about crowdfunding and the collaborative economy, added: “It has become something of a Wild West free for all: lawless and a high risk to novice investors who might not recognise a money pit so easily. The FSA needs to step in and act before it is too late.”
Crowdfunding first emerged in the late 1990s and was used by musicians, game developers and technology start-ups, who would offer rewards such as a free CD or name-check in return for contributions.
Since then over 400 crowdfunding platforms have sprung up online and the model has been adopted by more mainstream businesses offering traditional equity shares in a company.
But for all its popularity, crowdfunding remains a high-risk pursuit.
According to statistics released by American-based Kickstarter, one of the most popular crowdfunding platforms with pledges totalling over £227million to date, less than half of projects on the platform succeed.
And when a project fails – either because they it does not reach their required funding level or cannot meet goal deadlines – crowdfunding platforms are usually under no obligation to refund backers’ money.
“Though the average crowdfunding investment is relatively small, around £45 on Kickstarter for example, it’s still money down the drain if the backed project doesn’t succeed,” Birtles warns.
“There needs to be tougher regulation in place to cover crowdfunding sites, and the types of ventures that can use them. Until then consumers should approach only with extreme caution.”