Kickstarter, Innovative Funding Platform or The Ultimate Test Market | by Azure Corporation and Rotman Information Solutions

Marlene Bonigut, Azure Corporation
Blair Severn, Azure Corporation
Heather Wilson, Rotman Information Solutions
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Knowing how did they do it, how Kickstarter has become a breakthrough model for funding new ideas, projects and ventures begins with understanding the time-honored business truth about how to successfully raise capital.

‘A great idea gets you my attention, confidence in your ability to make it a reality gets you my money!’

What is Crowdfunding?

Crowdfunding is an emerging unconventional early stage funding model, an alternative to the commonplace approach of hitting up friends and family or selling out a big piece of your future return to a venture capitalist. It involves using the Internet as a more efficient channel (a switchboard if you will) to create a place to connect entrepreneurs with those willing to contribute seed capital. Kickstarter co-founder Yancey Strickler says “The Internet is incredible for harnessing organizational power. The gradual success of many projects has validated this as a real option, a real way to make things”.

Kickstarter and other similar crowdfunding websites bridge philanthropic donors to funding-seekers, taking a small percent of the money raised as their fee, generally between 3 – 5%. The recipient of the funding has no obligation to the donor of the money, legally speaking. It works on the honor system and very similar to the gifting model of the Public Broadcasting Service (PBS) where donors receive gifts of tote bags, magazine subscriptions, videos or books for pledges at certain levels.

Crowdfunding has become a serious challenger to the ‘status quo’ where angel investors and venture capitalists have been the main source, and sometimes only avenue for start-ups that need financial backing. A growing number of roughly 450 crowdsourcing Internet sites worldwide raised $1.5 billion in 2011, according to a report by Crowdsourcing.org. Estimates project this figure to double in 2012. To put this into context, the total amount invested by angel groups in 2011 in Canada was $82.4 million, with an average investment size of $614,847. The total angel investments in the United States in 2011 were $22.5 billion according to the Center for Venture Research at the University of New Hampshire. The number of active angel investors was 318,480 funding 66,230 ventures.

David Rubenstein, partner at the accounting firm WeiserMazars LLP in New York explains it best when he says, “This expands the angel investor model”. We understand Rubenstein to mean crowdfunding takes angel investing beyond the discriminating limits of a relatively small community of investors, generally wealthy individuals who put up money in return for equity, to a more open democratic populous of millions of regular people voting on entrepreneurs’ ideas with a donation. These regular people, many future consumers of the product, just want to be part of the next great thing becoming a reality, often for nothing or only a token in return.

How Did Kickstarter Get Started?

Kickstarter is an example of the old adage — necessity is the mother of invention. Founder and chief executive Perry Chen explained the idea for Kickstarter came to him in 2002 in New Orleans where he wanted to hold a concert but lost his nerve when he became concerned with the money he might lose. Three years later, living in New York, he shared an idea with Kickstarter co-founder Yancey Strickler about a web tool that would have allowed him to raise the money he needed for the concert, without the personal risk.

With a third co-founder Charles Adler, the three spent the next few years getting nowhere with the idea and Strickler readily admits he had basically given up. It was the tenacity of Perry Chen who wouldn’t let the idea go that eventually led to the right set of contacts that led to the right technical skills that finally led to launching April 29, 2009.

With sparse information available about how Kickstarter got funding themselves, it appears that they did it the old fashion way; had an inspiration based on a life experience, articulated the idea into a vision and business concept, overcame inertia and barriers with tenacity, and finally bootstrapping their way to launch with a lot of sweat equity.

Ironically, it took a journey through the conventional construct of the many constraints, barriers and boundaries to starting a new venture, to break apart those same constraints, barriers and boundaries for others starting new ventures.

A Transformation of a Fundamental Construct

Kickstarter claims to be the world’s largest crowdfunding platform for creative projects, focused on artists, filmmakers, musicians, designers, writers, illustrators, explorers, curators, and performers. They have some arresting statistics to support their assertion of industry leadership. Since their launch in April 2009, Kickstarter boasts generating funding for more than 20,000 creative projects with $200 million pledged from 2 million people. They further claim to be on track this year to increase that total to $300 million.

Perhaps the most iconic example of what is possible through Kickstarter is the remarkable story about five guys from Palo Alto and their company Pebble. Originally rejected by institutional investors, Pebble introduced their idea for a smart watch on Kickstarter and set out to raise $100,000. The concept went viral with more than 85,000 people donating $10.2 million.

It is our contention that Kickstarter’s success can be attributed greatly to their understanding of the key questions professional investors seek answers to when evaluating an investment then account for these questions in their platform in a way that is meaningful to the regular person. Namely above all else an investor wants to know: How much total investment is needed to ensure your ability to deliver? How will you be using my money effectively? How long will it take for you to get there? And what is the return I can expect?

How much total investment is needed to ensure your ability to deliver?

The science part of the art and science of being a successful entrepreneur is knowing your economics. Or in other words, knowing the length of ‘runway’ (amount of capital funding) required to get your venture past the incubating period of negative cash flow to the actualizing period of positive cash flow. The most certain way to fail with a new venture is to proceed with insufficient capital that won’t carry you through to the point of positive cash flow.

To address this axiom, Kickstarter has constituted the risk-mitigating criteria that a project creator seeking financial backers must first post a specified project budget and secondly, no money changes hands (donors aren’t charged their pledge) if a project campaign doesn’t achieve enough pledges to reach its specified funding goal. On the flip side, there is no limit to the amount of funds than can be raised above the project funding goal (Pebble being an exceptional example).

This criterion Kickstarter has put in place seems to be an effective screening methodology for weeding out bad ideas with little promise of success. Not all the money that is pledged on Kickstarter actually transfers to the funding seekers. The 20,000 campaigns that were funded, i.e. had enough pledges to reach the specified funding goal, represent only about 44% of all ideas pitched on Kickstarter.

How will you be using my money effectively? And how long will it take you to get there?

To post a pitch on Kickstarter’s site you must define it as a ‘project’ and you must post an allotted time span. According to the Kickstarter website, “A project is something finite with a clear beginning and end. Someone can be held accountable to the framework of a project – a project was either completed or it wasn’t – and there are definable expectations that everyone can agree to”.

By clearly defining the project scope, the project creator assures prospective backers of how the money will be used, over what time commitment and further helps put in context whether or not the specified funding goal make sense relative to the promised outcome.

What is the return I can expect?

In addition to posting a specified budget, project description and timeline, Kickstarter requires an entrepreneur to assign a reward or schedule of rewards for backers who donate specified amounts of money to the project. An approach that has proven successful is rewarding the donor with a gift of the new product being created in return for a donation of some specified amount less than what the product will ultimately sell for once available. In this scenario donors are essentially making a pre-purchase commitment for something they want to see made and be able to use. For example Geode, a digital wallet project by ICache Inc. accumulated 700 pre-purchases this way (of the 933 Geode backers) raising nearly $200,000 and exceeding by 4 times their project budget of $50,000.

In addition, rewards are often about social currency. Other perks offered by funding seekers include Twitter shout-outs and invitations to production sites. Through blog posts and Twitter updates project creators keep donors engaged to further mobilize social notoriety and generate more funds.

But, even with these well thought out risk-abating measures employed by Kickstarter, supporting a project is not without risk to the donor. Caveat emptor (let the buyer beware) remains an intelligent principle for donors to keep in mind when considering offering a pledge. Donors must still evaluate for themselves if the budget goal specified in the pitch by the entrepreneur is reasonable and sufficient to complete the project. It is important to also note that the entrepreneur behind the project does not need to commit any of his or her own money. We contend this is another point of critical reflection for a donor — most professional investors require an entrepreneur have ‘skin in the game’ as testament of their commitment to the success of the venture.

‘Everything Old Is New Again’, How To Get The Funding You Need?

As the famous Peter Allen song lyric says, ‘everything old is new again’, the business critical truths to successfully raising capital are no different through crowdfunding than any other established means of getting seed money. First you need to have connections to the people with money and secondly you need to show you can deliver.

Crowdfunding sites such as Kickstarter are an alternative to conventional funding channels when aspiring entrepreneurs have no relational capital with the investor community. It’s important to understand that crowdfunding doesn’t exclude the requirement for relational capital but simply transforms who provides funding and how you can get it. Brian Meece co-founder of RocketHub another crowdfunding site says; “People who don’t have social capital aren’t able to fundraise online.”

One of Kickstarters early success stories, a musician named Allison Weiss of Athens Georgia raised $7,711 from 205 backers, exceeding her goal of $2000 in just 10 hours. Weiss’s pitch remains a model example of a successful crowdfunding pitch. Not only did she engage the audience with a compelling, funny, down-to-earth video but she demonstrated she was capable of delivering. Kickstarter co-founder and chief executive Peter Chen puts it this way: “Getting heard about entails a second creative project (meaning the pitch) to drive the central one (meaning the project itself)”. Your pitch is how people will evaluate not just your great idea but also your ability to deliver.

The elements of creating a successful pitch through Kickstarter are no different than what is required with any other funding source, be it friends and family, angel investors or venture capitalists. Beyond your great idea you need to be able to; communicate your idea in an engaging and compelling manner, show you have an effective plan for use of their money, convince you are capable of making it a reality and assure an equitable return for their backing.

Kickstarter co-founder Yancey Strickler explains “Money demands answers.” People want to put money into things that they think will be successful, and to be successful you have to participate in the market and the market has very specific rules. Tom Cohlmia M.S. a Stanford Design Program student and entrepreneur using Kickstarter adds, “Kickstarter is just a smaller scale of the real world. Salesmanship, timing, the quality of your video, are all just like if you were selling the product conventionally.” His advice is to demonstrate “a combination of technical expertise with a compelling story behind the product”.

It’s About Much More Than Money, The Ultimate Test Market

To date crowdfunding sites have been mainly for the little guy who needs money. We argue that larger corporations should also take a serious look at the crowdfunding model as a more efficient channel to understanding consumer opinion and market demand. Kickstarer and other crowdfunding platforms change the question from; “Is this a good investment?” as judged by the financial community to, “Do I want this to exist? as judged by the consumer. Sam Gordon co-founder of Brydge, the developer of an IPad keyboard, raised $697,000 on Kickstarter, far surpassing their funding goal of $90,000. Gordon explains, “You have a lot of people who contribute because it’s a product they’d want to use”.

On Kickstarter, a startup can gauge interest with no upfront cost. It is a way to assess real-time demand. Using Kickstarter as a platform for pre-orders, entrepreneurs are able to test consumer interest in their product without making an expensive gamble. Wired Magazine recently assessed Kickstarter as “a lab for daring prototypes and ingenious products”. Jon Ramaci, iCache founder and project creator of the Geode digital wallet, asserts, “We are doing it a bit for the funding part, but we are also able to gauge consumer interest and get some really good questions and feedback”. Nicole Sturgill, a research director in the retail banking and cards practice at Towergroup supports Ramaci’s assertion by adding “you have the wisdom of the crowd” which can make or break any banking technology.”

Crowdfunding platforms are the ultimate test market as Zilvinas Bareisis, Celent senior analyst, states “Kickstarter can be an interesting way to test how your idea might be accepted by the broader public”. If enough donors contribute funds to meet the goal, the idea gets it’s funding. If too few people are willing to pony up a contribution, the idea instead starves to death. On the other hand when you have the market demand and the support of the community for your idea, crowdfunding is the ultimate validation. When a community invests in an idea, it also co-owns its success. In other words it’s not just socially funded; it’s proof it’s socially meaningful.

What About Securities Laws and Regulations?

Although equity deals on crowdfunding sites have been legal in Europe and Australia for some time, U.S. and Canadian security regulations don’t yet allow it. In North America, people who support projects with donations are not permitted to be equity investors in the business.

However, the U.S. is catching up with a new law recently signed on April 5, 2012 by President Obama called the Jumpstart Our Business Startups (JOBS) act. The new law lets companies sell as much as $1 million in securities via crowdfunding sites. Investors may profit by selling shares after a one-year holding period or if the company goes public. The U.S. Securities and Exchange Commission (SEC) has less than a year to craft detailed rules but the law lays out basic guidelines, including the requirement that businesses must get commitments for a minimum amount of investment before backers can receive shares. In addition there will be limits on how much an individual can contribute (based on their income and net worth).

In Canada, according to McMillan LLP, we have some legislative work to do to get on board with where the rest of the world is going. “In Ontario, and other provinces, if policy makers wish to follow the US and permit crowdfunding by Canadian issuers, various amendments would have to be made to the registration and prospectus exemptions under applicable Canadian securities laws. National Policy 47-201, which sets out the views of the Canadian securities regulators on issuance and trading of securities using the internet and other electronic means, would also need amendment, as would certain continuous disclosure requirements. Policy makers could follow the US example, and open the opportunity to all SMEs, or they could limit the opportunity to innovative SMEs.”

Helix Commerce International Inc. adds, there are currently some securities exemptions in Canadian provinces, but crowdfund investing does not fit within them. Outside of Ontario, issuers currently have access to the “offering memorandum” (OM) exemption. An OM is a detailed disclosure document that includes audited financial statements. The OM rules in Canada are inconsistent; these inconsistencies raise the cost of capital for start-ups.

Further reading:

  1. Will crowdfunding beget crowdfrauding?, by Collins Margaret, Bloomberg Businessweek (April 26, 2012)
  2. Liz Holm on the bigger picture of Kickstarter, by Dawson Nick, Filmmaker (June 1, 2012)
  3. Perry Chen: the virtual patron, by Hart Joe, Utne Reader (November/December, 2010)
  4. Zombies, run! Developer worked with Apple to make Kickstarter work in App Store, by Hornshaw Phil, Appolicious (May 19, 2012).
  5. How Kickstarter is saving hardware innovation, by Kessler Sarah, Mashable Business (May 14, 2012)
  6. Pebble watch video, by Maclean Andrew and John McDermott, Inc. (May 2, 2012)
  7. Kickstarted: my conversation with Kickstarter co-founder Perry Chan, by Malik Om, Gigaom (May 22, 2012)
  8. Investment activity by Canadian angel groups, 2011 report, by Mason Colin and Bryan Watson, National Angel Capital Organization (2012)
  9. Kick-starting to success: online platform funds creative projects, by Sekhri Aaron, The Stanford Daily (May 24, 2012)
  10. We’ve just seen the future of shopping, by Shontell Alyson, Business Insider (May 11, 2012)
  11. The angel investor market in 2011: the recovery continues, by Sohl Jeffrey, Center for Venture Research, University of New Hampshire (April 2012)
  12. Consumers – not banks – control new payment tech via Kickstarter, by Sposito Sean , American Banker (March 10, 2012)
  13. Happy 3rd birthday, Kickstarter!, by Strickler Yancey, Kickstarter Blog (April 30,
    2012)
  14. Crowdfunding – could it help finance innovation in Canada?, by Thring David E, MacMillan LLP (April, 2012)
  15. The trivialities and transcendence of Kickstarter, by Walker Rob, New York Times Magazine (August 5, 2011)
  16. Crowd funding fuels businesses, charities, creative ventures, by Yu Roger, USA Today (May 31, 2012)
  17. The crowd comes of age, by Zax David, Fast Company (May 31, 2012)

How Did They Do It

Pablo Picasso has been attributed to saying “good artists borrow, great artists steal”. Not that we are advocating stealing ideas from others but we are advocating what we believe is the intended truth in this statement: to learn, apply and expand upon the intelligence gained from others’ successes. Each month How Did They Do It will showcase how an idea became a success and offer valuable intelligence and insight that may resonate with you as you face similar challenges.

The enabling ideas® How Did They Do It feature is brought to you as a collaborative effort from Azure Corporation and Rotman Information Solutions, Rotman School of Management at the University of Toronto.

Copyright © 2012 Azure Corporation. All rights reserved.

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