Kickstarting New Ideas: How Online Crowdfunding is Disrupting Project Finance

Crowdfunding platforms like Kickstarter have dramatically changed the face of investing by democratizing project finance.

 

In 2009, Kickstarter launched an online platform for innovators to post their creative projects for financing. It essentially built a new global market for investors (“backers”) and innovators (“creators”) to connect. Kickstarter, a website which leverages a rewards-based crowdfunding model and provides rewards to investors rather than equity, has become one of the largest and most well-known online crowdfunding platforms creating immense value for entrepreneurs and artists. This model works especially well for the creative projects Kickstarter promotes by enabling creators to assess customer demand and build a community of early adopters without giving up equity in the business.

Kickstarter is disrupting and circumventing the traditional investment market by democratizing the investing experience. Unlike traditional equity investing, Kickstarter and backers claim no ownership over the creator’s projects and the work they produce. With an accessible, online platform, anyone with access to the internet can invest in an idea. To date, Kickstarter has received more than $2.7 billion in pledges from 12 million backers to successfully fund 115,387 creative projects.[1] Projects range from music, film, technology, art, design, food and publishing.

The Model

First, project creators choose a minimum funding goal and deadline. Then creators post their ideas online and amplify their campaigns via social media platforms like Facebook and YouTube. Backers then review and commit to a project. In this contract, creators are solely responsible for fulfilling their customer promise to backers, not Kickstarter.

Kickstarter selectively accepts only certain types of projects on its website. First, the project must have a clear goal and something must be produced by it. Second, the project must be ‘creative’, think music album, art project, or novel. For example, Kickstarter does not allow projects to fundraise for charity or offer financial incentives.

To incentivize creators and backers to use the platform, Kickstarter only charges backers once creators have reached their fundraising goal. The company also helps resolve any backers’ payment disputes, but does not guarantee that all payments committed by backers will be collected (i.e. there may be fraud or outdated credit card information provided).

Kickstarter actively defines the scope of their customer promise, as developing a marketplace for financing ideas, not ensuring quality or punctuality of project completion. Kickstarter’s pricing model charges creators a flat 5% fee on the total amount of the funds raised before putting funds into the creator’s accounts. Given most successful projects raise between $1,000 and $9,999, Kickstarter nets $50-$499.95 revenue per project. In addition to Kickstarter, payments processors apply a 3–5% fee.[2] If funding isn’t successful, there are no fees instituted. Further if the creator’s project funding goal is not met by the deadline, no funds are collected as a kind of assurance contract. Roughly 9% of funded projects have failed in the past.[3]

This business and operating model is successful due to its ability to easily and quickly connect backers and creators. Further, the site has a good reputation of securing trust throughout the contract. According to Kickstarter’s terms of use, “when a project is successfully funded, the creator must complete the project and fulfill each reward. Once a creator has done so, they’ve satisfied their obligation to their backers.”[4] This clear contract obligation is communicated throughout the online platform. To ensure honest communication and strong, diligent efforts by creators, Kickstarter strongly encourages creators to post regular updates on the project, how funds have been deployed, and potential barriers moving forward in a timely manner. While the good faith between backers and creators keeps the system alive and has built a positive reputation for the platform, it continues to be a large reputational and business risk.

Looking Forward

Crowdfunding has dramatically changed the face of investing by democratizing project finance. Kickstarter has leveraged crowdfunding to build a strong, successful online platform to connect creators with backers. While, the company has instituted several best practices, such as defining its customer promise and economically incentivizing creators and backers to opt-in by reducing barriers to entry, it is still faces great risk in a changing economic environment.

To mitigate risk, Kickstarter should focus on two key actions:

  1. Place more direct quality control requirements to reduce the number of funded projects failed from 9% to 0%.
    • This could involve more rigorous assessment of creators before accepting them.
    • Enhancing transparency of projects for backers. If Kickstarter creates more direct communication channels between backers and creators, for example via strategic partnerships with Skype or WhatsApp, there are more opportunities for backers to ask questions and make smarter investment decisions.
  2. Foster investments in differentiated project categories – not just creatives and the arts.
    • Competitors like Indiegogo have an expansive portfolio of projects on their sites, so to stay relevant and scale, Kickstarter needs to begin accepting other project ideas.

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[1] “Stats”. Kickstarter Website. Retrieved November 2016. https://www.kickstarter.com/help/stats

[2] “Fees”. Kickstarter Website. Retrieved November 2016. https://www.kickstarter.com/help/fees

[3] “Nearly 1 in 10 Kickstarter projects fails to deliver rewards,” Published Dec. 07, 2015. Retrieved November 2016. http://www.entrepreneur.com/article/253649

[4] “Terms of Use.” Kickstarter Website. Retrieved November 2016. https://www.kickstarter.com/terms-of-use

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8 thoughts on “Kickstarting New Ideas: How Online Crowdfunding is Disrupting Project Finance

  1. I agree with your recommendation that Kickstarter should expand the categories of projects it allows. Specifically I wonder how much the current restrictions against charity fundraising unfairly excludes participation by social enterprises, especially hybrid ones with only a percentage of the business focused on non-profit endeavors.

  2. Great post! I’ve personally been on both ends of crowdfunding and KickStarter can definitely expand. I think in a way its seen as the old established brand, but could have sub-marketplaces (e.g., Kickstart Social, Kickstart Personal Donations) that cater to other forms of crowdfunding. In terms of personal donations GoFundMe has had success and could perhaps be purchased and rebranded as a Sub Kickstarter marketplace, similarly w/ Tilt. I think this space is ripe for some mergers and I’d love to see them expand next into either w/ a social platform (e.g., facebook) or mobile payment provider (e.g., venmo). I think the combined access to our digital life and our physical wallets will break all the barriers of crowdfunding.

  3. Great post about Kickstarter! I agree with both Rebecca and EDRM above; Kickstarter should absolutely look into scaling its business and merging with partners that make sense like Venmo/PayPal or other social media platforms. 9% seems like a high number of failed projects; I wonder if Kickstarter can analyze the data of both successful and failed projects in order to give realistic expectations for the creators and backers in terms of achievable goals, proper amount of money to raise, etc. With that type of analysis available, creators can determine whether their goals are achievable based on historical examples and Kickstarter can also use the data to better screen the applications of the creators.

  4. I think Kickstarter is a great idea, and has clearly been successful so far. A couple of questions regarding their business model. What fundamentally differentiates the company. It seems like another company could easily come in and copy their model. I also think that they 5% fee on top of the 3-5% charged by the credit cards is a significant portion of the money contributed.

    I’ve been familiar with kickstarter for a while, but didn’t know that they only allowed creative ideas. I think it’s feasible for them to expand that to other idea types and generate additional revenue.

  5. Fraud and lack of enforceability have become the biggest challenges to Kickstarter. It’s becoming more of a marketing tool and an efficient way to get early market feedback. “Investors” are no longer willing to back projects that will take years to materialize. In my opinion, Kickstarter needs to migrate away from crowdsourcing platform to a market research tool.

  6. I would have to agree with TH above. I think Kickstarter is a great idea fundamentally, but what worries me about it is the barriers to entry. What stops another firm from coming and competing with Kickstarter on fees. I think the company needs to pursue M&A in order to have a more defensible business model. I think Paul Xie is right, what gives kickstarter the edge? Market research might be the answer.

  7. I love this post, Smitha. I have had friends who started equity crowdfunding platforms and worked on something similar myself in microfinance so I appreciate the research that you did on this.

    I’m curious to know if Kickstarter has analyzed the reason for failure behind the 9% of projects. I wonder if the failure was due to targets that were set unrealistically.

    I also wonder how companies that start out with their platform fare in the future. Since investors do not own equity, the funded companies really have no obligation to these “investors” and I wonder how much fiduciary duty they really have in the long-term. I could see a scenario where creative entrepreneurs which no finance background raise funds on the back of excitement/hype on social media just to fund their first prototype for fun and then abandon the project. This doesn’t seem like a sustainable model for long-term investing, and could quickly dissolve in a downturn when consumers become more tight with savings.

    I previously worked on a consulting project for a microfinance crowdfunding platform and our project scope was to figure out how to increase assets under management/amount committed by investors. We found that investors saw microfinance as more of a donation than an investment and were investing very small amounts. In order to grow, we found that the platform needed to sell the “investment” piece and show actual returns in order to position the dollars committed as a true investment. I think Kickstarter should pursue something similar in order to grow this platform.

  8. Thanks for this post! I have enjoyed Kickstarter, and I have used it for many items in my teaching profession. The seamless ability to build a backing of supporters and the ease of receiving funds from the platform are admirable. I have a few concerns: What you find is that people with existing strong networks and relationships are the ones who benefit from the platform most? Unfortunately, there are ideas and low-income spaces that do not move very fast on this platform because of limited exposure. In building on your first action item, I believe that it is essential for Kickstarter to have dedicated personel or local community leaders who can connect these low-income students/families/people/innovators onto the platform better. Without solid relationship (or good luck/network effects), good projects are going unnoticed.

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