Crowdfunding plays an important role in democratizing access to capital for small entrepreneurs, but as we’ve written before, entrepreneurs of every ilk need to remember that their representations to consumers need to be truthful, accurate and not misleading. Last month, the FTC filed a complaint against Douglas Monahan and his company iBackPack of Texas, LLC, alleging that Monahan and his company had violated Section 5 of the FTC Act by scamming consumers on crowdfunding sites Indiegogo and Kickstarter with four crowdfunding campaigns that together raised over $800,000, including a campaign to develop a bulletproof backpack that could recharge personal electronic devices and act as a mobile hot spot.

iBackPack ad

Like most crowdfunding campaigns, Monahan promised contributors that they would receive certain perks depending on the amount of their contribution, including a backpack that featured batteries, cables and speakers for $169, an upgraded backpack with Wi-Fi for $299, or other products. Throughout the campaigns, Monahan publicly posted updates on manufacturing and production of the backpacks, and told Indiegogo staff that “hundreds if not thousands” of backpacks had already been shipped to contributors.

Consumers, alas, were not left holding the bag—and complained to regulators that was the case. Monahan (allegedly) spent most of the funds he raised on personal expenses, failing to deliver even a single product to any contributor. Indeed, after the success of his first crowdfunding campaign, which raised over $720,000, Monahan launched three more campaigns to fund next generation versions of the backpack—even though the first generation had never materialized.

When customers began complaining about the missing backpacks, Monahan allegedly threatened them with lawsuits and physical harm. Ultimately, he took down the website and social media profiles for the company, emptied the corporate bank account, and cut off contact with contributors. Very few contributors ever received refunds, and those that did mostly received them from the crowdfunding platforms, although when Monahan and his company were notified of the FTC’s investigation and provided with a copy of the draft complaint, they began refunding contributors to the later campaigns.

The FTC’s complaint contains a single claim: Monahan’s representations that the crowdsourced funds would be used to develop, produce and distribute the backpacks were deceptive in violation of Section 5(a) of the FTC Act, 15 U.S.C. § 45(a), given Monahan’s utter failure to use the funds for those purposes. The takeaway for entrepreneurs thinking about using crowdfunding as part of their product development strategy is equally simple:

  1. Keep your promises when crowdfunding. If you promise rewards, give them. If you promise refunds, provide them.
  2. Use the money raised from crowdfunding only for the purpose represented. If you collect money for a specified project—say, a Wi-Fi enabled, multi-device charging backpack—use the money only for that purpose. Don’t use it for personal purposes or to start another project.
  3. Adhere to the terms of the crowdfunding platform. This one’s new (at least since we last wrote about crowdfunding enforcement here on the blog). In its complaint against Monahan, the FTC examined the terms of use for the Indiegogo and Kickstarter platforms, noting they, too, required campaign owners to deliver on their promises to contributors. Although the FTC did not seek to enforce these terms against Monahan, we can envision a scenario in which the FTC argues that a campaign owner’s failure to adhere to published terms provides an independent basis to allege deception, under a theory that by launching a campaign, the campaign owner is implicitly representing to consumers that it complies with the platform’s terms of use—including, for example, a requirement like the one in Indiegogo’s Terms of Use that the seller deliver the promised product or provide a refund. The FTC has done this in the privacy context, arguing that a business’s failure to adhere to its privacy policy constitutes a deceptive act.

Crowdfunding will no doubt continue to be a popular way of funding product development “by the people, for the people” in the future, but the Monahan action is a reminder that the FTC is still watching—and, of course, state Attorneys General are, too. According to the FTC, then, the crowdfunding world is not just “buyer beware,” it’s “seller beware,” too.