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Can a Crowdfunding Platform Really Protect You From Fraud?

Posted in Crowdfunding by Nathan

You may have come across media reports highlighting one Encik Farhan, a Kickstarter donor who appears to have been pledging large amounts of funds to back projects, only to withdraw the cash once the rewards had been offered.

To execute this heist, Farhan gamed a system known as the credit card chargeback, scamming more than 100 Kickstarter project owners in the process.

About the ChargeBack

The credit card chargeback itself is nothing new. It was created to protect buyers from fraud and merchant negligence, and in most cases, achieves its desired result.

When a buyer purchases an item that does not arrive, receives an item that was misrepresented, or discovers their card was used fraudulently, they file a dispute with the credit card company of record.

At that point, the credit card company investigates, and after a period of time, renders a decision. In most cases, this is a process that favors the credit card owner, as it can be difficult for a merchant to prove nefarious intent on the part of the buyer.

How Chargebacks Affect Crowdfunding

When a chargeback is rendered, the bank immediately refunds the proceeds to the winning party. Should the decision favor the buyer, the merchant is rendered chargeback fees on top.

Generally speaking, chargeback fees range between $10-$15 and are charged on top of the refund, converting your sale into a negative transaction. While unpleasant, these charges are minuscule when compared to the overall raise, and unfortunately, are a part of doing business in the Internet age.

But what happens when you’re using a crowdfunding platform like Kickstarter and a chargeback occurs? One would think that the hefty commissions paid to the platform would cover you in the event of buyer fraud, and at a minimum, you’d have someone to help present your case to the merchant in order to improve your chances against the credit card company. After all, shouldn’t their Terms of Service and documentation protect you?

Unfortunately, this isn’t the case at all. In fact, chargebacks on a crowdfunding platform can cost you more than you might think.

When Platforms Look the Other Way

In the case of artist Alex Heberling, mentioned in the article link above, Kickstarter’s response was not to defend or represent the project owner in the dispute process, but to merely suggest that she read the Amazon Payments’ FAQ on the subject, a response on-par with Kickstarter’s responses to customer service issues in general.

But if that response doesn’t surprise you, then the following fact might:

Kickstarter does not refund their 5% commission in the event of a chargeback or billing dispute. This means that you’ll not only have to represent yourself against the credit card company, but should you lose, you’ll pay Kickstarter fees on top of chargeback fees, changing the dynamics of the sale completely.

Picture a disputed $500 pledge and a traditional Amazon chargeback fee of $10. Losing the $500 pledge is problematic, but the $10 fee on top is a mere fraction of the overall loss. However, had this transaction occurred on Kickstarter’s platform, you’d pay $25 on top of the $10 fee, converting a one-time $500 transaction into a deficit of $35.

As you can imagine, this is a fact that does not sit well with project owners.

Kickstarter isn’t the only one to blame, as similar situations occur regularly on the Indiegogo platform as a result of a Paypal fraud prevention system that can be overzealous in locking accounts and preventing creators from withdrawing the funds they have received.

Lessons Learned

After the incident began making headlines, Kickstarter eventually swung into action, though only slightly, banning Farhan’s profile while still pocketing the fees resulting from the fraudulent pledge.

In a statement, Kickstarter said it was working together with Amazon Payments to investigate the situation: “We won’t let a single bad apple harm the integrity or goodwill of our incredible community.”

Of course, nothing changes for Heberling, who is still waiting on the result of her appeal against the chargeback. However, her loss has resulted in a gain for the rest of us, as this case highlights an important issue for project creators across all platforms and services.

Mitigating and minimizing risk is a crucial part of any crowdfunding campaign, and signing up with one of the notable names in the field isn’t necessarily a guarantee that you’ll be protected, much less represented, in the event of a chargeback.

Whereas crowdfunding platforms generate terms and procedures to protect their interests, these terms generally do not extend to benefit the project creator. In the case of DIY crowdfunding platforms, the same is true with the exception that they generally do not charge commissions on top of disputed transactions, and more importantly, they extend full campaign control to the creator.

As Heberling notes in a more recent posting: “Kickstarter and Amazon ultimately need to develop a policy and measures to combat this sort of practice that doesn’t leave project creators with the short end of the stick… it’s not like we can prevent a backer from pledging even if we know that they’re going to do something like this.”

Unfortunately, this is something that entrepreneurs must accept should they choose to launch a project on a crowdfunding platform, begging the question:

Does the exposure gained via crowdfunding platforms warrant the hefty fees and surrender of  control?

While this case of backer fraud brings to light yet another issue in an industry so full of promise, the good news is crowdfunding providers, creators, and backers are now well aware of the problem and can work together to prevent it from happening again.

In the meantime, it’s important that you perform your due diligence when investigating crowdfunding opportunities.

If you are going to part with a percentage of your funding for a particular platform, double-check the provision that the company you’re partnering with has made for dealing with unwelcome contributors (such as the now infamous Encik Farhan). In addition, find out what you can do to protect yourself as it relates to preventing purchases from buyers with ill-intent. If the answers you receive are unsatisfactory, consider the benefits of a DIY effort wherein you’re able to maintain complete control of backer entry points.

Platform Obligations

Lastly, it’s important that we continue to put pressure on crowdfunding pltaforms to ensure they keep their interests aligned with backers and creators alike. Simple and transparent reporting measures must be put in place so that scammers can be quickly identified and reported. In addition, platforms need to reconsider the way they manage commissions on disputed pledges.

Even if platforms won’t step up and defend their creators as they should, the more protection that’s put in place to protect them, the better.