WSJ | Jonathan Krim | March 11, 2014

The Instacube is a device for capturing feeds of Instagram photos and projecting the images in a digital picture frame that can sit on a desk, table or countertop. It’s also a cautionary tale for individuals and entrepreneurs who use crowdfunding to help get new products and businesses off the ground.

Increasingly popular, crowdfunding platforms such as Kickstarter and Indiegogo offer individuals a chance to fund projects from niche gadgets to the Veronica Mars movie being released this weekend. In 2013, Kickstarter attracted $480 million from 3 million people to fund nearly 20,000 projects.

Unlike venture capitalists or angel investors, backers of crowdfunded projects don’t receive equity in the company. Instead, they typically get one of the items they helped fund.

But what happens when the item is never produced?

In a Sunday session at the South By Southwest tech conference titled, “I Ran an Extremely Successful Crowdfunding Scam,” social-media marketer Savannah Peterson told how she was hounded and vilified by investors after she led one of Kickstarter’s most successful crowdfunding campaigns, which raised $621,000 within four months. Then the company failed to launch the Instacube as promised.

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According to Peterson, there was no intent to defraud investors. Instead, the company underestimated the difficulty in producing hardware, particularly by overseas manufacturers.

“In the first 24 hours we raised $125,000,” Peterson said of the Kickstarter campaign she launched for Sunnyvale, Calif., incubation studio D2M in August 2012. “It was the most exhilarating day of my professional career,” she said. “We raised our goal of $250,000 in four days.”

Perhaps as important, she explained, the Kickstarter campaign also served as free, viral marketing. Social media drives much of the interest in crowdsourcing ventures.

Backers were told Instacube would ship in March 2013. That date came and went, and contributors soon went from restless to angry.

“When we didn’t ship, there was a lot of rage,” Peterson said. “I was actually getting threats.” Some backers posted her personal email and cell phone number online.

As weeks passed, Peterson grew concerned that the company might not be able to deliver. “I was humiliated,” she told the conference attendees. “I pitched something that wasn’t real yet. I felt horrible.” Contributors included her friends and family members.

Exhausted and feeling “beat up,” she left D2M, as did the product’s lead designer. Peterson said she is bound by a confidentiality agreement not to provide further details on how the company spent the money raised through Kickstarter.

Ultimately, D2M formed a separate entity, NuMatter, to complete the project under new management.

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