At one of my recent talks, I got a question about whether crowdfunding (such as Kickstarter) breaks Upstarta Principle #1 (“neither a borrower nor a lender be”). Luckily, it was something I had already thought about quite a bit. Lucky because while it’s perfectly valid to not have an immediate answer to something (you can always follow-up with an individual later), actually having some form of answer – even just one that leads to a useful discussion – is more interesting and beneficial for the crowd present.
But back to the question… it’s not an entirely straightforward as there appears to be a case of borrowing: a group of people interest in what you’re doing give you money in the hope that you’ll succeed. Basics of investment, right? Not quite. The difference is quite interesting and actually goes to the heart of the difference between Upstarta companies and others.
An investor puts money into a company with the objective to get more money back later (either in bulk or over time). While it is certainly also the company’s intent to make money, it may not normally do so at the rate the investor requires, and also it actually has to deliver products or services which are what it makes money with. So this results in a triangular yet in-equal business arrangement where the company needs customers, but it actually operates primarily for the investor. This is in some ways similar to a commercial TV network that needs viewers but actually makes its money by advertising thus its clients are the advertisers not the viewers!
Contrarily, crowd-sourcing is money from future clients. An early crowd-sourcing example I know of about is UK-based Demon Internet (an Internet Service Provider). While the Wikipedia story differs somewhat from the version I heard from an early co-worker of the founder of the company, it went roughly like this: around 1992 people in the UK were asked for interest in a new ISP and they would a cheque to a PO Box; if 100+ people were to do this, the ISP would be sufficiently funded and start its business. This worked exceedingly well and the company’s GBP 10/month became a benchmark for others as in those days Internet was generally time-charged (still is in some places!) rather than flat rate. Revolutionary.
As can be clearly seen from the Demon Internet example, the people who put the money in were also the direct beneficiaries: the company delivered a service they wanted. They simply paid their internet service subscription one year ahead. Apart from company overheads, the funding didn’t go anywhere else.
Kickstarter and other crowd-sourcing “facilitation companies” operate with the same mechanism. They act as an escrow-service, holding on to the money until the project is fully funded. Provided the facilitating company is trusted, this is of course much more reliable than the receiving company just using a PO Box
All that said, that doesn’t mean that all crowd-sourced ventures are Upstarta companies. Funding is not the only thing we look at to see if a business idea makes sense. Some ideas are very interesting but just not viable as a business concept – either outright or in that particular form. When they are put up on a crowd-sourcing site, those ideas in particular might either not achieve their funding goal, or not (be able to) deliver. The latter is of course worse as then the money has been received and spent, but no service or product is delivered to the early investors.
There has been some analysis of Kickstarter outcomes (Behind Kickstarter Crowdfunding Stats) and it shows some of this problem. Exact tracking is apparently difficult because Kickstarters essentially makes projects that don’t reach their finance target disappear. But more than that, I believe the “unable to deliver” fails are a very important and serious aspect that deserve much more scrutiny, and I see no reason to not have all that fully public.
I think that if you have a sane business idea, getting your first 10 or 100 customers through a crowd-sourcing approach is perfectly valid. And it could also be a valid idea as a one-off rather than as an ongoing business.