The benefits of crowdfunding aren’t what you think

Crowdfunding’s appeal is obvious — it’s essentially free money just for having a clever idea. At least, that’s the impression the casual observer gets when they see a guy raise $55,000 to make some potato salad or $6,000 to “hire a man in a plane to write stupid things with clouds in the sky.”

Even with “reward-based” crowdfunding platforms like Kickstarter or Indiegogo, the crowdfunding process allows new companies to gather the capital necessary for their business without giving up equity in their business or taking on expensive debt burdens. It seems like a no-brainer: anyone with sufficient social capital can parlay it into some tangible capital.

But if you speak with the entrepreneurs behind successful crowdfunding projects, most will only mention the cheap money as an afterthought. To them, crowdfunding’s real value isn’t raising funds — it’s raising awareness.

According to a recent survey of Kickstarter projects by Wharton’s Ethan Mollick and the University of North Carolina’s Venkat Kuppuswamy, crowdfunding’s ostensibly ancillary benefits are actually the primary reasons why successful startups use it. “Crowdfunding is not just a means for immediate funds,” said Kuppuswamy. Rather, it’s a way to validate ideas, test markets, launch brands, find customers and impress investors.

I was almost immediately approached by investors following success of the campaign.

When asked why they turned to crowdfunding, 70 percent of successful campaigns said “to see if there was demand for the project,” making it the most popular response, followed by marketing and connecting with a community of supporters. Only 54 percent said “the project could not have been funded without raising the goal,” and a mere 30 percent said they turned to crowdfunding because “other traditional financing options weren’t available.” Among savvy startups — 59 percent of respondents said they were using crowdfunding to launch a new business, and another 17 percent said they were launching a new product for an existing company — the “crowd” is more important than the “funding” in crowdfunding.

 

Is this really a good idea?

So, why crowdfund? “Proof of concept and market validation,” said Lorenzo Buffa of Analog Watch Co., which raised $73,000 on Kickstarter for its Carpenter Collection, an all-natural, soft-strap wood watch.

“Proof of concept” was also “the main reason” why Rooster Soup Co. turned to crowdfunding, according to Steve Cook of CookNSolo Restaurants, the guys behind Federal Donuts, Zahav and a few other esteemed eateries. Their latest is a charitable joint venture with Broad Street Ministry that will uses the profits from selling soup made from Federal Donut’s excess chicken to expand BSM’s hospitality collaborative. Despite having an enviable track record that would make even Allen Iverson levels of over-confidence understandable, Cook said they turned to Kickstarter “basically, to understand whether this was a good idea.” Forty-five days, 1,587 backers and $179,000 later, they knew they had an idea that Philadelphia would get behind.

By going on Kickstarter first, companies obviate the risks of investing a ton of time and money in a product no one wants (sadly, it is too late for AC to crowdfund Revel). “I could have spent a lot of my own money,” said Buffa of Analog Watch. “But that’s such a high risk on my end. On Kickstarter, it’s such a low risk venture.” And even though Buffa “already knew there was demand and interest” for his watches, Kickstarter gave him a better idea of how much demand. “I didn’t know it’d be that popular,” he said.

The risk, of course, is that a failed crowdfunding looks worse to potential investors than a successful campaign looks good.

Crowdfunding “speaks to the desire in the market for your product,” said Molly Hayward of Cora, which raised $30,000 on Plum Alley, a crowdfunding platform specifically for women. Cora delivers a “personalized menstruation management kit” replete with tea and chocolates each month, while also delivering a similar package to a girl in India who would otherwise need to skip school during her period.

Cora went on women-centric Plum Alley to create a customer base. “We were essentially pre-selling our products,” said Hayward, adding that the crowdfunding was really just a bridge to a larger, more traditional capital raise. Crowdfunding “was a way to get some validation, to increase our customer base and sort of get a little bit of money until we could open a few [angel investment] rounds and close a few rounds.”

 

Getting ready for Round 2

Building a larger, and loyal, customer base is critical for Cora’s next project: raising $500,000 in capital this fall. “One of the great benefits of crowdfunding … is that I was almost immediately approached by investors following success of the campaign,” said Hayward. “That was a huge benefit; it opened a lot of doors. If you can galvanize 250 people around what you’re doing, and get them to open up their wallets, it says something about your product that really can’t be conveyed before you have your product. It’s a form of traction that investors usually can’t see and really want to see.”

According to Kuppuswamy of UNC, many businesses use crowdfunding to make themselves more attractive to potential investors. Startups use their crowdfunding success as a way of impressing loan officers, angel investors and venture capitalists. “Assessing demand is a big deal,” he said, not just from an operational standpoint, but also as a way to pique the interest of investors.

Impressing would-be investors was one of the main reasons why Pete Merzbacher of Philly Muffin took out a $5,000 loan on Kiva Zip. By demonstrating he can make those loan payments, Merzbacher says he’ll have an easier time convincing future creditors to loan him money. “It’s a way of building a track record. It’s like very public credit.”

The marketing and exposure is fantastic.

Analog Watch Co. will, in time, turn to investors to ramp up international distribution and marketing, but Buffa is in no rush to give away large chunks of equity. That’s why he’s returning to Kickstarter to launch a second, “more high-end” collection this fall. “If I can say I’ve launched two successful products [on Kickstarter], do you think I’ll hold onto more equity in my company when I go to investors?”

The question was rhetorical. “Hell yeah!”

The risk, of course, is that a failed crowdfunding looks worse to potential investors than a successful campaign looks good. A founder can — and likely will — flub a few investor presentations without causing too much harm, but  “an unsuccessful [crowdfunding] campaign is pretty damning,” said Hayward. The research bears that out: 90 percent of the successful campaigns studied by Kuppuswamy and Mollick turned into ongoing projects, compared to just 60 percent of unsuccessful campaigns.

The same publicity spotlight that sets the stage for a successful company exposes an unsuccessful company’s failure for all to see.

And successfully raising money is just one half of the battle. “Crowdfunding alone isn’t validation, unless you can get enough customers and then keep them,” said Cora’s Hayward. Investors want to see the demand for the product and that you can actual produce and ship it, she said. Otherwise, the successful campaign faces another risk from all its exposure, says Kuppuswamy: failing to deliver on a good idea that you’ve now published for all to see on the Internet invites imposters to take your market-tested concept and run with it.

 

Crowdfunding and marketing

If you ask a marketer, Shakespeare was wrong: A rose™ by any other name does not smell as sweet.

As The Economist recently noted, brands can be the most valuable asset a company owns. And though intangible, brands are built just as surely as inventories, factories and other company assets. Brands are built on words, from stacking the bricks of consumer opinion and the mortar of corporate communications. And in the hands of the right marketing masons, crowdfunding is a powerful tool.

“Performance on Kickstarter can create immense buzz around a product,” said Kuppuswamy. Moreover, that buzz “can just really feed into the success of the product,” creating a virtuous cycle of ever-increasing buzz and funding.

Crowdfunding gives startups shortcuts to building at least two of the three elements of brand equity: consumer awareness and brand loyalty. And it doesn’t necessarily detract from the third: brand association (“association” here refers to the brand’s qualities rather than its associates — e.g. PBR says “cheap,” not “and a shot of Jim Beam.”)

Kuppuswamy pointed to Pebble as a famous example of a company that leveraged its crowdfunding buzz into greater consumer awareness. “Pebble would have had trouble getting into E3 and SXSW without the publicity and attention they received on Kickstarter,” he said.

When Buffa launched Analog Watch on Kickstarter, he “knew [he] was trying to cultivate a brand.” Like Pebble, Buffa was able to leverage its crowdfunding into the kind of advertising that money literally couldn’t pay for: an invitation to show his watches at a Museum of Modern Art show featuring crowdfunded pieces. For Buffa, who said he set out to design watches “for people who shop at MoMA,” crowdfunding gave him access to his ideal audience.

The ability to build awareness among a niche audience was also why Cora’s founder chose Plum Alley for its crowdfunding. For obvious reasons, Hayward was only interested in reaching half of the population. Crowdfunding on Plum Alley provided Cora an automatic hook for the press — Cora wasn’t simply an interesting company, it was a company that needed the reader’s support. Similarly, Rooster Soup and Analog Watch both used the crowdfunding angle to pitch coverage of their campaigns — and, thus, the actual businesses behind the crowdfunding.

But more than just brand awareness, crowdfunding breeds brand loyalty.

When I asked Kuppuswamy whether backers of crowdfunding companies are any more likely to support a business than other customers, he responded with two anecdotes. The first was about a coffee cart in Durham that used crowdfunding to build a brick-and-mortar shop, leading the customers-cum-backers to drag friends to the café to say: “I helped make this happen.”

Successful campaigns are meticulously planned and require huge amounts of personal outreach.

The next anecdote was a bit more famous: Oculus VR, a crowd-funded virtual reality headset maker. Originally backed for nearly $2.5 million, Oculus was subsequently bought by Facebook for $2 billion, causing a huge backlash among its backers. “That sense of violation [of trust]” proved that a sense of community existed, Kuppuswamy said. That sense of community is something major brands like Apple, Coca-Cola and Harley-Davidson spend untold millions cultivating and developing over years. Crowdfunding generated that loyalty almost overnight — and for free.

Well, nearly for free.

Most platforms take a small percentage of the money raised and successful funders need to deliver rewards to backers. But that cost is about the same as what a good marketing company would cost, says Buffa. A good Kickstarter campaign, combined with shipping fees, might take about $9,000 out of a $100,000 campaign, “and that’s what you would have paid a marketing agency to do stuff for you.”

With crowdfunding, “the marketing and exposure is fantastic,” Buffa added.

Still, crowdfunding isn’t for everyone. While many of its benefits — marketing, branding, investor outreach and idea validation — seem free, and the platform fees are low, crowdfunding is extremely costly in one regard: time. Successful campaigns are meticulously planned and require huge amounts of personal outreach. And as some crowdfunding catastrophes have shown, the backlash from a failed crowdfunding can be devastating.

Still, if there is any truth to McLuhan’s famous line, “the medium is the message,” crowdfunding — done right — can say more about a project than how much money it raised.