What Is Crowdfunding Really For?

Crowdfunding sites like Kickstarter and Indiegogo are being used by a number of companies (and individuals) to “raise funds” for a product or project. Kickstarter’s origins as a funding site for arts and media projects still shows, with a lot of projects more on artistic projects (making a music CD or video, creating prints, etc), but the number of technology-based projects has grown. Indiegogo appears more “product-oriented” rather than “project-oriented”. These sites have some issues, partly in terms of backer expectations, but I think that the organizations using these sites may be using them for the wrong reasons.

These Aren’t Products, This Isn’t A Store

One of the problems, and probably the biggest issue, for crowdfunding sites is that a lot of people treat them like Amazon: it’s a store to buy stuff at. The difference is that, on crowdfunding sites, you’re getting new, leading-edge or otherwise innovative products at their early stages. This has lead to complaints about projects that never deliver, or projects that deliver late. Take the Pebble watch project, one which I have backed (and one that I am happy with the progress of. I understand why they are late). The tone of the comments from backers appears to be changing, and has done so as the original anticipated ship-date for the watch has come and gone. The problem (if it is a problem) for the Pebble team is that the project got outsized response compared to expectations. The team originally wanted $100,000. They got over $10 million, 100x more than they originally wanted or expected. The result was that their original manufacturing plan (which was to make 1,000 – 2,000 watches) had to scale up to make tens of thousands of watches. That meant abandoning the local manufacturer they were going to use, and instead move to a large-scale provider in China. It also uncovered manufacturability issues in the original design, and ones which they are diligently working on.

What appears to have happened is that a lot of the backers thought they were backing a finished, ready-to-manufacture product, when what they were actually backing was a pre-production prototype that needed time and effort to make manufacturable. Unfortunately, I’m not sure there is much either the Pebble team or Kickstarter could have done. While the act of backing a product looks like a “purchase”, what it really is is actually a pre-purchase commitment for a product that may or may not see the light of day. As with investing in a startup (or any company), there is always the risk that the whole thing fails and nothing is delivered. There are no promises or guarantees made by Kickstarter or other crowdfunding sites, but it appears many backers aren’t paying attention to that.

That means that companies wanting to use crowdfunding as a way to get money have to try to better estimate when they can actually ship, and have to carefully manage the communication with backers as things progress. It’s a tough path to walk. More recent projects I’ve looked at (and occasionally backed) have started to change the rewards and their descriptions, and have made it clearer that some reward levels will see delivery at some much later date, because of the truly new nature of these products. Whether backers are paying attention remains to be seen.

A Better Use For Crowdfunding

Okay, so a company looks at crowdfunding and sees the potential benefits (get millions of dollars) and the pitfalls (unhappy people if you’re late or the product falls short of expectations). What appears to be happening is that most companies look at crowdfunding truly as “funding”, in that it acts as a sort-of “seed round” that gets some customer pre-orders, and gets money up front for product they will build for later release. Basically, they are using crowdfunding to finance their operations. I believe this is a mistake, or at least the wrong way to look at crowdfunding.

I think that a better model is to use crowdfunding as a way to validate potential product interest. Granted, there are caveats: the backers are likely more technologically sophisticated than the average consumer, some are more willing to tolerate risk, and some are more willing to try something because it looks cool. The upshot is that your backers don’t necessarily represent your core customer base. But that may not matter that much, because of what the value of those backers actually means to you.

Using crowdfunding can be a way to gain pre-investment traction, but without necessarily having to have all the “infrastructure” like a full-on PR or advertising campaign in place, and without having to use traditional channels to gain customers. Much like a working prototype (or near production version of your product) is essential to raising money at different stages, having traction is also a requirement to gain certain types of investors. A crowdfunding site like Kickstarter could be a vehicle toward that end. A successfully funded project becomes validation that people want your product. They become “sales” for which you haven’t had to make finished product yet.

But “successfully funded” means that you have to show you didn’t pick a funding target that was “too easy”. Trying to select your funding target is a challenge. Try for too much, and you risk failure. Go too low, and you risk leaving money on the table, or you end up creating an inflated sense of interest. For example, if you pick a low target and just barely make it, but tout it as “we were successfully funded” while leaving out the amount omits the fact that perhaps interest wasn’t nearly as big as you are implying.

The Traction and Value Questions

Done properly, crowdfunding can become that all important pre-investment traction that may be necessary to raise money. As I said before, they are sales (or an indication of consumer interest) in advance of actually funding and building product. It becomes an artifact you use when approaching angels, private investors, VC’s and such to demonstrate “people want this thing”. That helps you justify any sort of valuation, and it can add more value to the work that has already been performed. Ultimately, a backer is a sale at the end of the day, and counts toward revenue numbers. It validates the idea, or at least gives a sense of the interest in the concept.

But to rely on it solely to fund your operations I believe is a mistake. When you raise funds, you aren’t doing so to just make N of some product. You also need to fund the infrastructure behind it (some of which has to be paid for before a single widget is made), but you also want to fund the next product or idea. If you’re not doing that, then you have a bigger problem, because one-product companies are not noted for continued growth over time. Use crowdfunding for what it’s good at (showing traction, gauging interest), but don’t rely on it as your sole funding strategy to build your business.