Stock crowd funding poised to play bigger part in markets

— -- Q: Is crowd funding hot start-up projects a good move for investors frustrated by the stock market?

A: Feeling burned by the stock market, some investors are looking for alternatives. And soon, they'll get one: crowd funding.

Crowd funding is a new twist on how people with a business idea can raise money. Using the Internet, entrepreneurs and people with an idea post their concept online. Then interested people with credit cards can donate money to the causes. Currently, crowd funding at websites such as Kickstarter.com are donation-based, meaning the backers give money typically in exchange for a token of appreciation. Backers might get a button or T-shirt as thanks for their donation, or may get access to the fruits of the project when it's done.

But, due to the passage of the American Jobs Act this year, crowd funding is about to take on a bigger role in U.S. capital markets. The Securities and Exchange Commission is developing rules, expected to be rolled out next year, allowing individuals to invest limited amounts of money online in companies.

The promise of stock crowd funding is big. The theory is that there are many entrepreneurs with great ideas who can't get funded by banks, venture capitalists or the initial public offering market. These ideas, or so the thinking goes, might be best served if they can raise relatively small amounts, less than $1 million, using a less formal means.

To be clear, stock crowd funding isn't available yet. Many broker dealers and other portal sites are starting to crop up, but none are allowed to start collecting or dispensing funds until the SEC completes its rulemaking process. It's not legal until the SEC gives it the green flag sometime next year.

That means currently, people are limited to donation-based crowd funding. The biggest site for this kind of thing is Kickstarter. But this hasn't proven to be a place to make money. At best, you can contribute money to a project that looks interesting. If the project pans out, you might get an early copy of the project. Keep in mind, though, that a vast majority of these projects tend to run overbudget or hit major delays, according to an analysis by Ethan Mollick, professor at the Wharton School at the University of Pennsylvania.

Most likely when stock-based crowd funding starts, similar delays and disappointments will be common. And even when stock-based crowd funding is allowed to proceed, it's pretty unlikely to be any friendlier than the stock market. Keep in mind 10% of young initial public offerings never make it to see their third birthday, according to data from Jay Ritter of the University of Florida. And those are even more established companies that had the financial backing to qualify and afford an IPO. Crowd-funded companies are likely to be much younger, immature, and therefore, riskier.

There's no question that crowd funding will garner more interest. And there may be some success stories that will make headlines. But overall, given the riskier nature of the companies seeking money this way, it's likely that losses will be greater in crowd funding than in the stock market. So you might not want to count on crowd funding, when it's available, to be your ticket to early retirement.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz