Last year I wrote about how crowdfunding was changing the way in which people thought about aggregating capital. I suggested, at the time, that as the crowdfunding world grew bigger and bigger, there would be far reaching consequences as the marketplace adjusted to the new reality. Since then, many of those consequences have come to fruition. For example, I predicted that once organizations saw the power of raising money through crowdfunding, a cottage industry would build up around assisting those organizations with their campaigns. Just the other day, on Craigslist, I saw a listing for a campaign manager at a non-profit for the express purpose of managing a Kickstarter campaign. I also predicted that it might be in the best interests of marketing and communications agencies to position themselves to aid organizations looking to make the most of crowdfunding efforts. I recently came across an agency called Command Partners, out of Charlotte, North Carolina, that lists amongst its offerings “start-up marketing” including a specialty in crowdfunding campaigns. I also predicted that we could see crowdfunding come to Hollywood, with famous directors raising money for their films with crowdfunding when they fail to convince studio executives to back their projects. Enter Veronica Mars creator Rob Thomas, along with the main cast of the show, including Kristen Bell and Enrico Colantoni, making an impassioned plea to the show’s diehard fans for funds to do a Veronica Mars movie. Using Kickstarter they aimed to raise $2 million, the largest base sum ever on the site, in order to cover the production costs of the film, with Warner Brothers, the license holder of the Veronica Mars intellectual property (IP), covering the distribution costs in exchange for a piece of the profits. When the campaign was over they had raised just shy of $5.75 million. It was this success, in fact, that got me thinking about the future of crowdfunding again.
Crowdfunding is entirely a product of Internet culture. It is a natural extension of people’s desire to participate in the things that they love. While this predates the Internet, as evidenced by the numerous VHS Star Wars fan videos, the Internet provides a forum in which people can share their creations with other aficionados from across the globe. From selling novelty goods on Etsy to writing fanfiction to spoofs on YouTube, people find a way to express their support on the Internet for their favorite things. Kickstarter takes this behavior and harnesses it for capital aggregation. People now have the ability to support the things they love through direct monetary contribution outside of purchasing the product. In the same way that an angel investor can come in and save a start-up that they believe in, everyday people can come in and put small amounts of money towards seeing something they believe in become a reality. If you are a Veronica Mars fan who has been living with rumors of a movie for years, and you suddenly have the chance to play a part in seeing that movie finally get made, convincing you to put up the money to essentially prepay for a ticket won’t be a hard sell.
Many, including myself, see this as a potentially revolutionary change to the way people raise money to get anything done. Raising funds to start a business or jumpstart a creative endeavor has always been a difficult thing. The status quo, reinforced in part by S.E.C. regulations, left only a few options for aggregating enough capital to cover start-up costs. The most typical three are: founding partners put up the money themselves and maintain total control, venture capital investors give money in exchange for equity, and banks loan money in exchange for interest. Initial public offerings (IPOs), or putting company stock up for sale on the stock market, is a great way to raise money as well, but historically is best for existing companies looking to get enough capital to make a major expansion, not for generating start-up capital. The problem with this status quo is that it isn’t doing a great job of actually supporting the start-up world at the moment, at least in the United States. Very few companies, except small web-only endeavors, can afford to cover their start-up costs out of their own pockets. This means that any start-up idea that requires some infrastructure to get started is going to need to look outward for it’s funding. Venture capital is famous for supporting the start-up world, especially higher risk, higher reward entrepreneurs, but a combination of factors has crimped the venture capital’s ability to give funds. Uncertainty in the market and a faltering economy, amongst others, made venture capital more risk adverse than it was in the early 2000s. Venture capital has other weaknesses too. For all the same reasons it can be hard to get a good movie idea through the studio system, getting a good idea accepted by a venture capital firm can be quite difficult. I had the pleasure of talking with a venture capital partner when I was in high school and he told me a tale of a company that almost didn’t get funded. Their pitch was a device that would take CDs that were scratched to the point where they wouldn’t play and buff the disc to the point where it was playable again, without damaging the original data. For whatever reason, multiple firms, including this guy’s, passed on this idea. Eventually they found someone to take a risk on them, and within a year they were running a multi-million dollar business. Banks aren’t any better. Banks used to have a reputation for handling the low end of business investment, offering loans to small businesses with interest rates and collateral to protect the bank’s stake in the company. Banks began shifting away from small business loans when they realized that there were better profit centers for their investment money, and then when the market crashed, the liquidity and credit crises made it so that almost no money was available for any loans, let alone small business loans.
Crowdfunding is positioned to be incredibly disruptive to this rigid system. In Innovator’s Dilemma, the thesis is presented that big companies focus on their most profitable sectors while ignoring the low profit niche sectors. New companies come along that make that niche sector their bread and butter, and when that niche sector grows to the point where it challenges or overtakes the old high profit sectors, the new companies supplant the old as the kings of the industry. When they were introduced, personal computers were less computationally powerful, had terrible market share compared to the mainframe/terminal system that existed beforehand, and, being cheaper devices, they had a lower profit margin. But PC manufacturers were happy to pick up the low margin business ignored by the mainframe makers, and eventually PCs grew to the point that they usurped mainframes almost completely.
So what is so disruptive about crowdfunding? The truth is that the motivation behind crowdfunding is different than the motivation behind venture capital and bank loans. Traditional investors are looking at returns. Banks want safe, consistent profits so that the company can always make its interest payments. Venture capital wants growth that can be leveraged, either in corporate profits or in market share that drives up the worth of their equity. Crowdfunding just wants to see cool stuff get made. This is especially true now, when the rewards for contributing are restricted to goods associated with the products of the crowdfunding campaign itself. In mid 2012, a bill called the JOBS act was passed that changed the legal standing of crowdfunding under the S.E.C. While all of the provisions haven’t gone into effect, when it is in full force crowdfunding campaigns will be able offer equity, in addition to or in place of traditional rewards, as part of their campaigns. On the creative end, this means that people like moviemakers could put up a percentage of their backend profits as encouragement for top donors. More importantly, perhaps, is that start-ups can crowdfund their seed capital by putting up partial ownership of the resulting company as the sponsorship reward. Essentially, this can turn a crowdfunding campaign into a mini-IPO, where stock is purchased online, instead of on the stock market, and the resulting ownership is a closed corporation, rather than a publicly traded one.
Does this muddy the water, in regards to the motivation of the crowdfunder? Perhaps. Once potential profits enter into things, people may slowly change their relationship with crowdfunding from one of justifiable quasi-charity to another piece of their investment portfolio. On the other hand, crowdfunding without equity still has parallels with the fundamental risk/reward infrastructure of investing, so people may not change at all. In the Kickstarter environment, people give money to a project they believe in. While there are restrictions in Kickstarter’s Terms of Service against fraudulent behavior, there is a definite risk that the thing that was funded will never exist. Even setting aside the possibility of fraud, there are loads of things that could go wrong, such as an accident, natural disaster, the company folds, and so on. So the supporter, or investor, is risking some of their money in the exchange. The reward is not a monetary one, but there is a reward. Should the risk pay off, the backers get the existence of the product they backed. They also get the reward for the reward level they contributed. Let’s look at the second most successful Kickstarter campaign of all time as an example. The campaign was to support the design and manufacture of an affordable, open source gaming system called Ouya. Now let’s pretend that you were a high level backer. Contributors who gave a substantial amount of money were given early access to the SDK, or the tools necessary to program games for the system. So if you were with a game studio, and you invested money in the Ouya, not only would you get to see the Ouya become a reality, you would also be amongst the first to be able to develop for the platform, giving you a major leg up on the competition.
Certainly, these new developments will change things, but are they that disruptive? Are they really revolutionary? Let’s return to the idea of the disruptive idea, from the Innovator’s Dilemma. Banks are focused on high profit loans like big business loans and backing credit cards, and venture capital is focused on those they have vetted as potential winners. Crowdfunding, on the other hand, takes a more pure capitalist approach to aggregating capital. Let the market decide! If enough people believe that something will be worthwhile, and give money to that idea, then it will become a reality. All of the ideas that would slip through the cracks, like the CD polisher from my anecdote earlier, now have another way to get started. Since raising capital is democratized in this system, the same kinds of people who back the projects will buy the project’s results. Therefore, the popularity of the crowdfunding campaign should be proportional to the popularity of the product when it launches. Like with the CD polisher, if it was a good enough idea to be a multi-million dollar company, it stands to reason that it would have been a good enough idea to succeed as a crowdfunding campaign.
There are a couple of potential issues with crowdfunding as it continues to grow in scale and complexity. Right now, the single greatest way to get projects funded is for the people behind the campaigns to make a serious splash on social media. This means that that known quantities, such as established brands, studios, and celebrities, have a much easier time getting people to pay attention to their projects. Let’s assume that there are only so many people who are willing to give money to a crowdfunding environment, and that each of those people have a hard cap on the amount they are willing to venture on crowdfunding ventures annually. As bigger names enter the scene and soak up more and more of that fixed pool of available cash in their mega-successful campaigns, less will be available for the little man. People are naturally conservative and will be more willing to back projects with people they recognize involved. If Apple was offering a competitor project to Pebble’s e-paper watch, there is no way that Pebble would have raised the record-breaking $10 million that they did. This would remove some aspects of the democratisization of crowdfunding and replace it with a form of oligarchy. The rich and famous use sites like Kickstarter to fund more and more of their pet projects, at increasingly high funding levels, while everyone else gets left out in the cold. Hopefully, this will be stalled by growth in the number of people, and amount risked, in crowdfunding annually, but eventually we’ll reach a peak funding level and these problems will be faced yet again.
People get very excited about these kinds of disruptions and begin playing the futurist in their heads about what it could all mean. It’s great to look at this and say “This is the future of indie film!” or “This is the future of capital investment!” but I can’t help but remember when Kevin Smith took his indie darling Red State on a tour across the United States. People claimed that this could be the future of monetizing indie film without having to sell the distribution rights to a major studio. You could fund the movie yourself and arrange for screenings on demand to make your money back. The only problem with that theory is that Kevin Smith was already an established director with Hollywood movies under his belt. He had built up a significant fandom, and a massive twitter following, through his blogs, podcasts, movies, and speaking events that he could turn to for support. A relatively unknown director couldn’t have pulled off the same thing because he or she wouldn’t have been able to sell people on a traveling road show where a movie screening and a director’s Q&A were the main attractions. Not until they had a reputation for excellent films, Q&As, or both.
On the upside, Rob Thomas, creator of Veronica Mars, told Wired in an interview he gave about his Kickstarter campaign after it broke the $5 million mark, that even though they raised millions of dollars, this kind of campaign wasn’t scalable. It was Thomas’s opinion that their project fit into a fairly unique position in the market. It was small enough, both in necessary budget and in estimated national interest, that it couldn’t get the attention of a studio that starts its budgets at $30 million (Warner Brothers), was too big to be funded through independent investors and/or out of pocket like low budget indie films, and already had a built in fan base from its time on TV. Perhaps the same is true for investing in new companies. There will be small family businesses that will continue to be seeded by bank loans. There will be small, niche design projects, like Rhino rails for filmmakers, which will get love from their market on a site like Kickstarter but never in the millions. There will be bigger, wide appeal projects, like Ouya or the Pebble watch, which will run the multi-million dollar campaigns and may eventually be restricted largely to companies or designers that people recognize. And there will be the ultra-expensive companies that require the faith of venture capital to get started.
Regardless of the way the future looks in terms of how the money is distributed, the one thing I am absolutely confident about is that, as more projects are able to raise seven figures from crowdfunding sites, more people will look to exploit crowdfunding for personal gain. The more the marketplace is flooded with people looking to get their million-dollar idea up and running on Kickstarter, the harder it will be for the general public to find the diamonds in the rough. Add in the worries about scammers and other forms of fraud, and people may become skeptical about whether it’s safe to give their money to projects once they’ve found the ones they want to back.
Since this is a blog about marketing and communications, I’ll use this opportunity to bring it back to those topics. As I wrote in my last article, I think it’s going to be important that the people involved in crowdfunding, especially if they are looking to stand out from the pack and come across as a legitimate organization, work with marketing firms and communications agencies to craft their web presence, from social media to corporate website, so that people can investigate them quickly and tell that they are worth trusting. Knowing how to make a pitch video, how to show your credentials when you haven’t necessarily worked as a senior team member at Blizzard Entertainment or Google, how to set your rewards and your stretch goals, and how to get people to spread your campaign through social media are things that don’t necessarily seem that hard on their face, but if they were that easy, why do only a handful of people succeed as big as they do? That is the kind of expertise that the communication world has made their bread and butter, and a small consulting fee is totally worth it for millions of dollars in seed capital, especially when you can raise that money without the downsides that come with bank loans or venture capital.