The numbers seem astonishing: Last year, Kickstarter, the largest crowdfunding site, raised over $312M from over 2 million backers, funding 18,000 projects. Though raising money from large crowds to fund new artistic and cultural endeavors is not new, the speed at which internet crowdfunding has taken off – from almost nothing to hundreds of millions of dollars in just a couple of years – has caught the notice of policy makers, entrepreneurs, and investors.
On this wave of optimism, in April of 2012, President Obama signed the JOBS act, legalizing equity crowdfunding (previously, crowdfunding investment was strictly a donation, perhaps in return for a product or reward). As of today, the SEC is still writing the rules that will allow equity crowdfunding to occur in practice, and over 1,000 companies appear to be ready to enter the equity crowdfunding space as soon as those regulations are finalized. But not everyone is excited about crowdfunding, a number of pundits and analysts have expressed concern that crowdfunding, especially equity crowdfunding, is likely to lead to a lot of fraudulent projects, failed businesses, and naïve investments.
Though many people have been weighing in on crowdfunding , there have been relatively little hard data about what makes crowdfunding projects succeed (or fail), and how many projects actually deliver on their promised goals. In two draft research papers, “The Dynamics of Crowdfunding” and “Swept Away by the Crowd,” I have used data from Kickstarter to understand the underlying patterns of crowdfunding in the first case, and the ways in which crowdfunding compares to Venture Capital, in the second. Among a number of findings in the papers, I want to highlight two of them:
Project founders try to deliver on their promise.
Fraud in crowdfunding should be easy. People post projects online, without having to prove any deep credentials, and, if they raise the money, have little legal obligation to actually deliver on their promises. With such a perfect environment for people to take the money and run, some observers suspect that fraud might be common. To find out if this is true, I looked at the 381 successful Kickstarter projects in the categories of Design and Technology (these are the projects that most resemble traditional startups) that had promised delivery dates for rewards to funders before July, 2012. I found that fraud was relatively rare. Only 14 out of 381 products, or 3.6%, had stopped responding to backers and could potentially have given up on delivering entirely. To see how small this category is, compared to the amount of money spent on the space, look at the chart below. Dark green projects were those that were delivered, light green were promised projects on schedule, and yellow is projects that were delayed, but were making efforts to deliver. Only the thin red line are those cases that are possibly fraudulent.
But they are often late in doing so.
The large, and growing, yellow section in the graph below illustrates an issue with crowdfunding, however. The majority of projects I studied were late in delivering their promised products. This shouldn’t be a big surprise, as entrepreneurs are over-optimistic, and this is just as true among crowdfunding entrepreneurs. The statistics are fairly stark: only 24.9% of projects delivered on time, and 33% had yet to deliver when I conducted my study. The bigger a project was, and the more successful it was, the longer the delay. After 8 months of delay, only 75% of projects had delivered, though, as CNN pointed out in their examination of the 50 biggest Kickstarter projects, project creators were still working to deliver on their promise. The graph below shows the number of projects delivering over time.
Promise or Peril?
To date, the data seems to show that the worries about fraud in crowdfunding are perhaps more overblown than might be expected (my letter to the SEC on crowdfunding explains some of the reasons why fraud is rare). But, even with the best of intentions, crowdfunded entrepreneurs are like other sorts of entrepreneurs – likely to learn a lot of tough lessons about the reality of their plans in the process of executing them. The challenge for equity crowdfunding will be to ensure that investors in crowdfunding are patient enough to see new ventures through their inevitable evolution, and helpful enough that they can actually provide useful advice and guidance to help their portfolio companies succeed.