Crowdfunding Is Not Investing: How Sticking It to the Man Tends to Backfire

Remy Merritt |

crowdfunding, kickstarter, indiegogo, campaignAs alternative sources for funding, Kickstarter and Indiegogo appeal to people looking to support products that are off the beaten track. Kickstarter is an innovative platform for finding financing, and as such it’s right in line with the era of entrepreneurism and self-directed product development.

However, for all its friendliness and accessibility, crowdfunding is too often mistaken to be an opportunity for investment. What it is, rather, is a marketplace for donations, with small perks depending on the level of generosity but no future ownership in the project’s profits.

The Allure of Crowdfunding

Very few of us will ever be wolves of Wall Street. We earn some extra income here and there from carefully constructed stock portfolios, but nothing that can replace or surpass the salary from full-time job. We will never be angel investors or venture capitalists — hold that thought. What if, rather than relying on one or two wealthy investors to support nascent projects, entrepreneurs and visionaries shifted their fundraising focus to small donations from thousands of sponsors?

Kickstarter opened the investing market to the general public, vastly increasing the number of people likely to pour money into campaign ideas. Rather than having to pitch a new product or service to the scrutinizing eyes of investment sharks, campaigners could use basic terminology and feel-good language to attract wider interest. Through Kickstarter, sponsors are essentially producers paying for the manufacture of an idea that interests them.

Though donation-based, Kickstarter isn’t quite charity, either. The most popular Kickstarter campaigns are not intended to do non-profit work, and donors typically receive the product they’ve funded once it has been successfully constructed. To be sure, there are myriad pity projects on the site, with kickstarters looking for donations to their college tuition or funding their foray into becoming an award-winning novelist. But the most popular have been, unsurprisingly, tech-based. The two most-funded projects thus far have been Pebble, a fully customizable smartwatch, and OUYA, a video game console package intended to refresh consumers’ interest in console gaming from smartphone game apps.

There are safeties Kickstarter has in place to keep investors from losing money on bunk projects. If a campaign fails to reach its fundraising goal by its chosen end date, sponsors are credited all the money they put into the unsuccessful idea. However, if the campaign meets its investment goals, Kickstarter considers the project complete and fully in the hands of the project’s founders. At that point, any money invested is nonrefundable — this is where Kickstarter failures tend to hurt.

A Plan: Some Campaigns Have One, Most Don’t

The key to Pebble’s and OUYA’s successes is their careful and conscientious planning. Much like a standard startup, the two campaigns provided investors with a detailed game plan, addressing FAQs, tech specs and quality connections with outside manufacturers and developers.

The latest addition to Kickstarter’s annals of failed campaigns is Yogventures!, a build-your-own adventure game by The Yogscast duo Simon and Lewis and developers at Winterkewl Games LLC. Given the pitch (which is still viewable on Kickstarter, despite the project’s failure to launch), it’s hard to believe the startup game surpassed its fundraising goals by 100%, earning $567,665 on its original $250,000 goal in May 2012. While most of the 13,647 backers pledged less than $100, five donors pledged $10,000 or more.

Right in line with the trend of customizability, project founders Simon and Lewis of The Yogscast emphasized, “Importantly, we want YOU to be involved at every stage in the development of the game - from funding it here on Kickstarter to guiding the developers on where to focus their efforts.”

Essentially, the makers of Yogventures were offering crowdfunders partial ownership in the development process only. The campaign founders, two popular YouTube (GOOG) gaming vloggers, partnered with and offered Winterkewl developers’ skills in exchange for funds, giving backers the illusion that they were directing the progress of the campaign.

The pitch wasn’t without its caveats, but the two project founders weren’t afraid to disclose their inexperience in programming. They put a positive spin on the knowledge gap, saying, “Lewis and Simon can barely manage a simple jumping puzzle - so the Yogscast aren’t going to be doing any actual coding! We aren't programmers or artists but luckily we have close friends at Winterkewl Games who are.”

More than two years later, what do Winterkewl and Yogscast have to show for the half a million dollars interested investors poured into the project?

Winterkewl founder Kris Vale posted the project’s final progress update on July 18. After disclosing that the project cost him a significant portion of his own income as well as his marriage, Vale conceded, “This is a very good example of how my inexperience caused some problems in the development.” In the letter, he announced that he had shut down Winterkewl and turned all development work back to Yogscast.

Keeping in mind that the Yogscast duo Simon and Lewis have no experience or skill in software development, it is unlikely that Yogventures! will ever be completed, nor will its supporters receive what they purchased. Though inconsistent with promises, the two are more than consistent in their positivity. In a letter to donors, they wrote, "Although we're under no obligation to do anything, instead we're going to do our best to make this right, and make you really glad that you backed the project!"

Are they really under no obligation to do anything? According to Kickstarter’s accountability rules, Yogscast won’t get off quite so easily. Kickstarter's Terms of Use “require creators to fulfill all rewards of their project or refund any backer whose reward they do not or cannot fulfill.” Kickstarter only collects 5% of funds raised by successful campaigns, and thus cannot refund money lost. That is up to the creator; should Yogventures! patrons choose to take legal recourse, Yogscast will have a difficult time proving they are not legally required to refund backers. If they lose the case, they will have an even harder time recovering the $500,000 that has already been sunk into the failed project.

Crowdfunders Get Party Favors from Successful Campaigns

Kickstarter campaigns have become similar to LinkedIn endorsements — most of them are irrelevant and don’t mean much in the grand scheme. The website is reminiscent of Etsy.com, where everyday investors looking to spend money on a vision can filter through categories from art to games. There is even a “# Tags” section where you can invest in what is “trending” as indicated by the most popular hash tags.

What do sponsors get for their donation? Certainly not ownership in the future profits. Benefits vary by amount donated, from a “thank you” credit in a crowdfunded film to a Skype session with the project’s founders. In Yogventures! case, a pledge of $10,000 or more earned patrons a massive selection of game perks including the opportunity to design a character for the game, as well as lunch with the Yogscast in either Los Angeles, Calif. or Bristol, England. Travel arrangements were not provided.

Additionally, as has been demonstrated, all first-generation products run the risk of unforeseen bugs and other issues that are only fixed with successive generations of the same product. These cannot be avoided in many of the tech campaigns Kickstarter hosts.

Kickstarter campaigners are actually not allowed to offered equity in their company. The SEC guidelines for the JOBS Act currently in review make equity crowdfunding extremely difficult, and Kickstarter rules clearly state, “Project creators keep 100% ownership of their work.

And Kickstarter cannot be used to offer financial returns or equity, or to solicit loans. Some projects that are funded on Kickstarter may go on to make money, but backers are supporting projects to help them come to life, not financially profit. These sites are platforms for donations, and while crowdfunding is a form of investment-lite, it is only temporary. Patrons’ benefits from a successful Kickstarter campaign are few and always involve the specific product or service, which makes Kickstarter a marketplace for those looking to fund ideas and purchase products they believe are innovative and interesting.

As of late, the SEC has plans to allow equity crowdfunding for amounts up to $1,000,000, but the bureaucratic hurdles for company approval are significant. The SEC estimates that to raise just $100,000 to start a business, it would cost founders $39,000 in accountants, lawyers and the funding portal. Unlike with Kickstarter, investors involved in equity crowdfunding platforms would own a piece of the business once launched, but the obstacles in place make a daunting task out of launching at all. Given the difficulty, it is unlikely that equity crowdfunding for non-accredited investors will take off any time soon.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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