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How to Avoid Getting Burned with Crowdfunding

Today’s letter has a quick and dirty guide on how to avoid getting burned with “crowdfunding.”

Before we get to that, here’s a little background on “crowdfunding.”

The good news is that is now easier to raise money for small to medium sized projects than it was in the past.

Why is it easier?

Two recent developments:   Kickstarter and the JOBS Act.

  • Kickstarter is a Web site that makes it easier for people and companies to get funding for their projects.  Recently, the site gained critical mass and some projects, from a computer game to an iPhone accessory, raised millions of dollars in funding.
  • The JOBS Act is a new US law that makes it legal for small companies to “go public” without all of the pesky SEC and accounting paperwork that makes going public so tough and expensive.  So, it’s now possible for companies to sell shares of stock (equity) directly to the public in small amounts.

These developments are great news for those of us building resilient communities.   Why?  It opens up new options for getting resilient infrastructure built and resilient businesses launched.  Unfortunately, this new freedom will come at a cost.

Avoid Crowdfunding

The bad news is that this funding method is going to be terribly abused by the same broken financial system that gave us the financial meltdown of 2008.   Here’s what I mean.

You can see the problem already in the term the press is using to describe this new funding activity.  They are calling it “crowdfunding.”  This name conjures up an image of a nameless faceless mob of people, ready to throw money at any project that makes enough noise, regardless of its merits.

In short, crowdfunding is a recipe for pump and dump.  Boiler rooms and Internet hype selling investments in the next “Facebook” or “Twitter.”  Boom and bust with most people ending up less well off than they were before they invested.  Yuk.

Embrace Community Funding!

The way to avoid getting burned is to avoid crowdfunding completely.  You should only engage in community funding.  Here are the rules successful community funding:

  • COMMUNITY.   If you aren’t part of the community that uses the project or product you are funding, don’t invest in it.  That applies to investments you make online or locally.  Also, make sure the people or company requesting funding is actively engaged with the community in a positive and mutually rewarding way.  If they aren’t, there’s a problem.
  • PRODUCT.   The best reward for an investment in a project or company isn’t stock.  It’s product.  In most of the successful projects on Kickstarter, the investors were customers pre-buying a product they wanted to see made.  The same is true for investments in local farms or aquaponics businesses.  The best way to get a positive and rewarding return from community funding is to get the product you funded the development of.
  • TRUST.   IF you do want to buy equity, don’t invest with any team you don’t know and trust 100%.   In fact, I’d recommend that you limit your community funding investments to only those companies managed by trusted incubators or to local businesses where you know the parties involved.  Why?  It’s very, very tough to get a financial return on a small equity investment in a start-up, since the system is rigged.  Simply, if you can get squeezed out, you will be (take it from an entrepreneur that has raised tens of millions of venture capital).

 

Hope these rules help you in the future.  You are going to hear and read a lot about crowd-funding in the next couple of years.  If people like these rules, I can expand them into a small report.

 

Your hoping RC readers can avoid needless lessons in the school of hard knocks guide,

 

JOHN ROBB

 

PS:  If you didn’t know already, I’m not a certified financial analyst.  I’m just a successful entrepreneur that’s been through the school of hard knocks in start-up funding many times before.

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Comments on this entry are closed.

  • Marcello

    The thing with kickstarter is that it’s not usually (at least I’ve never seen a project that works this way) used as a form of investment for “backers”. You don’t invest your money with the prospect of having it back with a plus, you don’t actually buy shares, you’re basically just preordering a product that’s still in the idea phase.

    It’s great because it allows makers to avoid the whole venture capital step, but you can’t expect to derive gain from it.

    (btw one of the thing I repeat myself I have to do is find out what happens if a project blows up and doesn’t deliver)

    M

    • johnrobb

      Marcello, Exactly, you back it because you are part of the community that wants that product. Some do fail. Lots make it. JR

  • TD

    Here’s a case study for John.

    In some cases, funding may not even be required to launch a product, yet people feel pressured (or greedy) to go that route since it seems to have worked for others and all they end up doing is turning off the marketplace. Sometimes all you need is to keep it simple!

    This guy started producing these really cool pads: http://www.rgft.net/

    Then he got coverage on TechCrunch:
    http://techcrunch.com/2012/04/18/the-noteboard-is-an-amazing-10-foldable-pocket-whiteboard/

    A few days later, when you tried to access his site to buy the product, it redirected to his Kickstarter page, where he was asking for the sum of — get this — US$100,000!

    Needless to say, he didn’t have such a good showing: not even $2000…

    http://www.kickstarter.com/projects/348662866/the-noteboard

    Now when you go onto his website, he has totally changed the pricing and shipping and offers some sort of complicated scheme where if you pay more, the pad will get shipped sometime “this week.” Huh? Or if you pay less, it will get “Shipped when possible”

    And then he also wants a donation for…what exactly? Making you feel bad?

    At this point, after following the product from its inception, I decided I don’t want one and I will not be purchasing one. Had he not changed his entire strategy when he got the press, he’d be sitting pretty right now, no doubt.

    Your blog post is a refreshing reminder about what really matters:
    - Community. There are no client testimonials on the site. No praise.
    - The product was ALREADY MADE RESILIENTLY. And then he wanted 100k for reasons that were not clear.
    - Obviously it’s hard to regain trust once it’s been lost

    Sure, there may have been some other areas where his planning was lacking (overestimated the initial wave of clients, etc), but all in all it represents to me the alternative of what can happen if you jump on the bandwagon without thinking…

    Thank you for your analysis and keep it up good sir!

    • johnrobb

      Thanks TD. John Robb

  • Steve

    Hi John,

    To the best of my knowledge Kickstarter only funds “artistic” projects. I was thinking of using it as a way to make a small amount of money for some of my novels without going through the unending process of finding a publisher. My partner and I are laying the groundwork for an organic farm and herbal medicine business; we have resources in the form of some old friends who are giving us access to land and equipment, but I’d hoped to use some kind of crowdfunding. I didn’t think Kickstarter was an option… Is there a similar platform for non “creative” projects that I don’t know about?

    • johnrobb

      Steve,

      They do fund artistic projects, however, the biggest successes to date include Printrbot: http://www.resilientcommunities.com/maker-monday-the-printrbot-830-k-success-story/ and iphone dock:
      http://www.kickstarter.com/projects/hop/elevation-dock-the-best-dock-for-iphone

      JR

      • John-
        Kickstarter is for “creative” projects, which 95% of the time means book, film, music, etc. “Technology” is one of the ~10 formal categories, which has produced the big hits, including Diaspora, which also happens to be the one that gave Kickstarter the crown for first to mainstream recognition. notable that there are many clones in the space, including IndieGoGo, which has many more options around the types of projects they fund. and, since passage of the crowdfund act, there are multiple startups preparing to go for the required certifications to hit the ground running when it officially becomes possible, likely early next year. Until then, projects will have to be funded through the donation-for-perks-and-love model. and currently, that model does a pretty damn good job of filtering out the pump’n'dumpers, though there are always exceptions.

        and remember that ‘crowdfunding’ (donation or equity) is just one piece of the puzzle. P2P loan marketplaces, mutual credit systems, etc. are far outpacing sites like Kickstarter in terms of their total money velocity.

        I agree with you that the equity crowdfunding side is going to be ugly for a while, but I do think that there is huge room for the donation side to grow, especially in the funding of huge, ambitious technical projects that don’t attract the lemming-angels or VCs here in the bay area. If a passionate genius developer has a plan to make an end run around Monsanto, and can credibly display even a 5% chance of succeeding to fans via a crowdfunding platform, I’m putting my $10 there in a second.

        As far as using crowdfunding for local community resilience projects and businesses, the problem there is one of scale of audience. You have to be able to have near 100% awareness of your potential audience to have any chance at getting a significant % of funders if you can’t use the scale of the internet and the viral power of big ideas to create the necessary avalanche. So, either the localized version of that platform has to be really good at making sure its social tools reach every potential funder, or… well, it has to do that. In any case, there are a number of platforms attempting something like that, including startsomegood.com.

        I’m looking at getting into this space, and I’d be happy to get into a deeper discussion of some of the implications here any time.

        cheers,
        David

        • johnrobb

          Thanks David. Trust is going to be at the center of this. JR

  • Petro

    I responded to the email with this, but it probably should get posted here:

    I’m a “veteran”, if you will, of Sillycon Valley and the dot-com industry there. I even managed to make a ROI on some options I purchased when I left a company.

    Two things you didn’t mention in your crowd-funding letter are:

    * Most new/small business fail in 2-3 years. Running a business (apparently, I’ve never done it) involves a lot of hard work that has little to do with the core function of the business (taxes, payroll, insurance of all kinds, paperwork, paperwork, paperwork) and hence is uninteresting to the guy who just wants to machine parts for folks.

    * Do not throw good money after bad. In the startup world there are generally 2 to 4 rounds of funding (I assume you know these) and VCs generally want to see progress at each stage, or they pull the plug.

    I guess there’s really three things:

    * Because of these DO NOT become emotionally invested in a huge ROI. You probably won’t get it, and the fantasy of a huge payoff will get in the way of you cutting cord when necessary.

    • johnrobb

      Thanks Petro. JR

  • Good post. Kickstarter seems to be working well for already (somewhat) established folks, techno hipster crud, and artsy stuff. Almost 7 million $ for the “e-paper watch for iphone and android?” hmmm… not so much appropriate for RC’s. “RC” appropriate projects are generally best tied to schools, activist groups, community, and social/environmental establishments. the values systems for genuinely resilient techniques and projects tend to be completely alien to capitalists. Perhaps others have had different experience…

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