How Does Kickstarter Work?

This week my friend John O’Nolan launched a new blogging platform called “Ghost” on Kickstarter, raising nearly £100,000 in a week.The project is awesome: check it out. Message for those interested in entrepreneurship? You should read up on crowd-funding. Here are a few useful things to know…

Kickstarter is probably the most widely-known crowd-funding website, and sometimes it’s hard to believe it came into existence as recently as 2009. The site is an incredible resource for startups, allowing projects to skip traditional investment avenues, thereby avoiding the grim pound-of-flesh usually demanded by angel investors and venture capital firms. But it’s kind of baffling too…why would anyone invest through Kickstarter when its rules ban would-be projects from offering financial rewards, and when there are no guarantees that the project-owners will use the money as they say they will?

I think it’s a combination of things. Firstly, crowd-funding draws on interested parties’ desire to live vicariously through theendeavorsof others.Ian Bogost has compared it to a “Like button connected to your wallet”. Since pledges can be for as little as $1, then the barrier to access is very low.

Secondly, projects offer rewards (other than equity) to those who pledge money. These tend to be information-based, such as the chance to be the “first to know” about major new developments/launches etc. People find value in this for the same reason they find value in following people/groups on Twitter – it’s a chance to know things slightly quicker than others, which means you can seize opportunities faster. It also allows you to be part of an “in-group” which comes with all kinds of psychological benefits.

Finally, it’s just convenient. Ten years ago, you would probably have needed to attend some kind of startup fair in person to find such an easy-to-navigate collection of startup ideas. The internet is awesome.

Yet for all the publicity and hype about crowd funding, there is very little hard-research on the subject. What determines whether or not a project is successful? How do you even define “success”? One of the rare pieces of thorough research on the topic by Prof. Ethan Mollick, which you can download for free here, concludes that:

Projects are likely to succeed (get funding) by narrow margins, or else fail by large amounts.
Large numbers of friends on online social networks are associated with success.
Product delays are very common. In a sample of 247 (product producing) projects, the mean delay was 1.28 months.
Overfunded projects are particularly vulnerable to delay due to increased expectations.
Evidence of quality is vital, but it is not yet clear if it is as important as for more traditional startup presentations. The failure to produce a promotional video has a huge detrimental impact on the chance of success (as do typos).
“Even though Kickstarter has no enforcement mechanism to prevent con artists from using the system to raise funds for fake projects, it is clear that with a direct failure rate well below 5%, founders take their obligations seriously.” (p.26).

Some have criticized Kickstarter’s 5% cut from all money invested. Personally, I think that given the incredible opportunity that Kickstarter creates, 5% is a pretty small fee to pay, particularly given thepiranha-like alternatives: A friend of mine was once turned down by corporate financiers because he hadn’t remortgaged his house to fund his project, and therefore “wasn’t serious”.

My gut tells me we’re only seeing the beginning of the possibilities crowd-funding has to offer. I know I’ll be paying close attention to the growth of this fascinating sector.