SOME SIMPLE ECONOMICS OF CROWDFUNDING Quebec City Conference Toronto, ON December 3, 2013 Ajay Agrawal University of Toronto

President Obama signs the JOBS Act (Apr ‘12)

Google search volume for “crowdfunding”

Pebble Watch raises $10.2M (May ‘12)

First draft of the JOBS Act passes the US House (Nov ‘11) SEC chairman Mary Schapiro: the agency has been “discussing crowd-funding and possible regulatory approaches” WSJ (Apr ‘11)

Sellaband launched (Aug ‘06)

2006

2007

Kickstarter launched (Apr ‘09)

2008

2009

2010

Agrawal, Catalini, Goldfarb
 “The Geography of Crowdfunding”

2011

2012

2013

President Obama signs the JOBS Act (Apr ‘12)

Google search volume for “crowdfunding”

Pebble Watch raises $10.2M (May ‘12)

First draft of the JOBS Act passes the US House (Nov ‘11) SEC chairman Mary Schapiro: the agency has been “discussing crowd-funding and possible regulatory approaches” WSJ (Apr ‘11)

Sellaband launched (Aug ‘06)

2006

2007

Kickstarter launched (Apr ‘09)

2008

2009

2010

Agrawal, Catalini, Goldfarb
 “The Geography of Crowdfunding”

2011

2012

2013

$50,000 -

531 funders - 34 countries

Cumulative Capital Raised on Kickstarter

Now $772m

Mean Size of Projects

Capital Raised by Sector (thousands)

Capital Raised by Sector (thousands)

Kickstarter-funded films headline Sundance Eli Dvorkin · February 1, 2013 · 💬 3 comments

Share this post Like

28

Tweet

Recent posts

Kickstarter in Aus Zealand! Kickstarter in the Year New Roles

We just got back from the 2013 Sundance Film Festival, where 17 films by Kickstarter creators premiered among the world's best and brightest. Of those 17, we're thrilled to report that six films won awards, including top honors for Blood Brother, which took home both the

Five million backe

Kickstarter Transp Copyright

Grand Jury Prize and the Audience Award for U.S. Documentary. Congratulations to everyone who participated in the festival! Here are some of this year's memorable moments. We saw two films receive standing ovations at their premieres (The Square and 99%: The

Browse catego News

Occupy Wall Street Collaborative Film), while the debut of Linsanity brought tears to our co-

Data

founder's eyes. Audiences were talking about Special Jury Prize-winning Inequality For All long

Profiles

after the final screening. Gun, American Promise, and After Tiller all made national news, I

Q&As

Used to Be Darker earned a pair of rave reviews, and The Square's creators announced their

Calendar

Kickstarter project live from the stage during their Q&A.

Video

Charlie Victor Romeo unanimously left hearts racing, everyone we met loved NEXT Audience Award Winner This is Martin Bonner, and Boneshaker’s star Quvenzhané Wallis reminded us all

Tips Awards

Capital Raised by Sector (thousands)

Early-Stage Capital 0

Credit 
 Card Debt

Home
 Equity Loans $10K-$50K

Super
 Angels

Family &
 Friends Angels
 Seed Round! $100K-$1.5M

Venture
 Capital Series A > $10M

Early-Stage Capital 0

Credit 
 Card Debt

Super
 Angels

Family &
 Friends

Home
 Equity Loans $10K-$50K

Angels
 Seed Round! $100K-$1.5M

Venture
 Capital Series A > $10M

Crowdfunding Equity-Crowdfunding

Distribution of Capital is Very Skewed • Sellaband (2006-2009): 61% of all creators did not raise any money, 0.7% of them accounted for more than 73% of the funds!

• Kickstarter (2009-2013): even conditioning the sample on successfully funded projects: 1% (10%) of projects account for 36% (63%) of funds

POLICY

Reference “Some Simple Economics of Crowdfunding” National Bureau of Economic Research (NBER) Working Paper No. 19133 Chapter in forthcoming NBER book Innovation Policy and the Economy, Volume 14, Josh Lerner and Scott Stern, editors, University of Chicago Press

Why is crowdfunding interesting? •  Does crowdfunding influence the rate and direction of

inventive and entrepreneurial activity? •  Does crowdfunding fund projects/companies that would not

otherwise be funded? Different No

Yes

No

Perfect substitute

Same amount of capital, but allocated differently

Yes

More early-stage More capital, risk capital for different types of similar projects projects

More

Why might crowdfunding be different? •  Different information •  E.g., “wisdom of crowds”, social platform, identity of investors •  Different preferences •  Risk/return, non-pecuniary (e.g., participation, customer, fun) •  Different rules •  Provision point mechanism •  Formalize family and friends •  Small investments

ECONOMIC STRUCTURE

Economic Structure 1.  Incentives 1.  Creators 2.  Funders 3.  Platforms 2.  Disincentives 1.  Creators 2.  Funders

Economic Structure 1.  Incentives 1.  Creators 1.  2. 

Lower cost of capital More information

Funders 3.  Platforms 2. 

2.  Disincentives 1.  Creators 2.  Funders

Economic Structure 1.  Incentives 1.  Creators 1. 

Lower cost of capital 1.  2.  3. 

2. 

Better matches Bundling Information

More information

Funders 3.  Platforms 2. 

2.  Disincentives 1.  Creators 2.  Funders

Economic Structure 1.  Incentives 1.  Creators 1.  2. 

Lower cost of capital More information 1.  2. 

Market research information for creator Input from funders and potential users

Funders 3.  Platforms 2. 

2.  Disincentives 1.  Creators 2.  Funders

Economic Structure 1.  Incentives 1.  Creators 2.  Funders 3.  Platforms 2.  Disincentives 1.  Creators 2.  Funders

Funder Incentives 1.  Access to investment opportunities 1.  Global rather than local search 2.  Standardized information and term sheets 3.  Access for non-accredited investors 2.  Early access to new products 3.  Community participation 4.  Support for a product service or idea 5.  Formalization of contracts 6.  Smaller investment sizes

Funder Incentives 1.  Access to investment opportunities 2.  Early access to new products 1.  Evidence from Kickstarter 2.  Crowdcube hybrid model (“rewards”) 3.  Community participation 4.  Support for a product service or idea 5.  Formalization of contracts 6.  Smaller investment sizes

Funder Incentives 1.  Access to investment opportunities 2.  Early access to new products 3.  Community participation 1.  Opportunity to build a reputation (now valuable on AngelList) 2.  Consumption value from community participation (Schwienbacher and Larralde, 2010) 4.  Support for a product service or idea 5.  Formalization of contracts 6.  Smaller investment sizes

Funder Incentives 1.  Access to investment opportunities 2.  Early access to new products 3.  Community participation 4.  Support for a product service or idea 1.  Foster an ecosystem (e.g., Google in Android apps) 2.  Consumption 5.  Formalization of contracts 6.  Smaller investment sizes

Funder Incentives 1.  Access to investment opportunities 2.  Early access to new products 3.  Community participation 4.  Support for a product service or idea 5.  Formalization of contracts 1.  Friends and family important in crowdfunding (Agrawal, Catalini, and Goldfarb, 2011) 2.  Balance benefit and costs of social relationships (Lee and Persson, 2012) 6.  Smaller investment sizes

Funder Incentives 1.  Access to investment opportunities 2.  Early access to new products 3.  Community participation 4.  Support for a product service or idea 5.  Formalization of contracts 6.  Smaller investment sizes 1.  Access to opportunities that may have otherwise been unavailable due to larger minimum investment amounts 2.  Ability to reduce risk due to diversification (spread investments in smaller increments across more projects)

Economic Structure 1.  Incentives 1.  Creators 2.  Funders 3.  Platforms 1. 

2.  3. 

Revenue based on transaction value (Kickstarter, Crowdcube: 5% of transaction value, charged to creator upon closing successful campaign) Revenue based on firm performance (AngelList: 0% management fee, 10% carry [5% on syndicate deals]) Portal: profile, informational advantages (e.g., AngelList: labor market)

2.  Disincentives 1.  Creators 2.  Funders

Economic Structure 1.  Incentives 1.  Creators 2.  Funders 3.  Platforms 2.  Disincentives 1.  Creators Disclosure (early stage)

1.  1.  2. 

Opportunity cost of crowding out professionals

2.  1. 

Industry knowledge, relationships, status (Hsu, 2004)

Investor management

3.  1. 

2. 

Competition Compromise IP

E.g., Pebble: as of March 2013, team had delivered 34 detailed updates and received over 14,000 comments from Kickstarter community

Funders

Economic Structure 1.  Incentives 1.  Creators 2.  Funders 3.  Platforms 2.  Disincentives 1.  Creators 2.  Funders 1. 

Creator incompetence 1. 

2. 

Fraud 1. 

3. 

Out of 247 successful projects on Kickstarter, over 50% were delayed (Mollick, 2012) E.g., Bionym

Project risk 1. 

E.g., Pebble

THE MARKET

Hardware Delays •  Out of 247 successful projects on Kickstarter, over 50%

were delayed (Mollick, 2012)

Kickstarter •  Although the Pebble was the most successful fundraising event

in Kickstarter history (and still is) in terms of amount raised, it highlighted weaknesses of the system •  Estimated shipping date: Sept 2012 •  Christmas 2012, still not a single Pebble shipped •  Pre-orders fully shipped by May 2013

•  “In May 2012 we added additional guidelines and requirements

for Product Development and Technology projects. These include requiring creators to provide information about their background and experience, a manufacturing plan (for hardware projects), and a functional prototype. We made this change to ensure that creators have done their research before launching and backers have sufficient information when deciding whether to back these projects”

New Hardware and Product Design Guidelines •  The development of new products can be especially complex for

creators and seductive to backers. Today we’re adding additional guidelines for Hardware and Product Design projects.

•  They are: •  Product simulations are prohibited. Projects cannot simulate events to

demonstrate what a product might do in the future. Products can only be shown performing actions that they’re able to perform in their current state of development.

•  Product renderings are prohibited. Product images must be photos of

the prototype as it currently exists.

•  Products should be presented as they are. Over-promising leads to

higher expectations for backers. The best rule of thumb: underpromise and over-deliver.

No Multiple Quantities •  We've also added the following guideline for Hardware and Product

Design projects:

•  Offering multiple quantities of a reward is prohibited. Hardware and

Product Design projects can only offer rewards in single quantities or a sensible set (some items only make sense as a pair or as a kit of several items, for instance). The development of new products can be especially complex for creators and offering multiple quantities feels premature, and can imply that products are shrink-wrapped and ready to ship.

•  These guidelines are effective for all Hardware and Product Design

projects that launch starting today.

•  We hope these updates reinforce that Kickstarter isn't a traditional

retail experience and underline the uniqueness of Kickstarter. Thanks for reading, and thanks as always for using Kickstarter.

Enter the dragon •  Dragon Innovation •  Focus, expertise in hardware (design, manufacturing, etc) •  Relationships with manufacturers (China, etc) •  Expertise in estimating costs, time to ship, etc •  Co-founded by Scott N. Miller and Herman Pang, the group has

decades of experience in hardware design and manufacturing. Miller worked on the functional prototype of the Roomba and then led the team to ramp up production and sales. He supervised the building of 3 million Roomba units. Pang worked on Hasbro’s FurReal friends and then helped build the Far East office of iRobot with Miller.

•  “Dragon takes on detailed vetting of each team and project, so that if

the funding threshold is met, the team will deliver on the promise to its backers. This step ensures real people with real products are behind each project. Furthermore, Dragon’s network of service providers, investors and experts in relevant fields is another differentiator.”

THE CROWD

Pebble versus Thalmic

Recap of the familiar Pebble story •  Raised $375k from angel

investors

•  Tim Draper, DFJ •  Paul Buchheit, YC

•  Required capital ($100k) for: •  Production tooling •  Large component order •  Global Bluetooth certification •  “Hardware is much harder to

raise money for. We were hoping we could convince some people to our vision, but it didn’t work out.”

(LA Times, April 18, 2012)

•  Launched campaign on April

11, 2012

•  Target: $100,000 •  $100k in 2 hours •  $1m in 28hrs

•  37 days •  Closed campaign on May 18,

2012

•  $10,266,845 •  68,929 people •  85,000 watches (capped)

Thalmic • May 2012: Company Founded! • Fall 2012: Early Grants & Gov’t programs - $100K 
 (several months of application processes)!

• December 2012: Angel Round - $1M ! • Creative Destruction Lab at the University of Toronto !

• 3 weeks from first conversation to money in the bank!

• June 2013: Venture Capital - $14.5M! • 2.5 months to money in the bank! • Total Equity Financing = $15.5M

Angel Investors (~$1M)

• Marc Benioff! • Paul Graham! • Garry Tan! • Sam Altman! • Geoff Ralston! • Reza Satchu! • Ajay Agrawal! • Lee Lau! • David Ossis! • Dan Debow! • Mike McCauley! • Mike Litt! • Mike Stork! • Bob Rushby! • Dennis Bennie! • Larry Innanen! • Richard Hyatt! • Rubin Osten! • Wojciech Gryc

Institutional Investors ($14.5M)

? Dec 2012

June 2013

• • • • • •

Spark Capital ($6.5M)! Intel Capital ($5.5M)! Formation8! First Round Capital! FundersClub! Y Combinator

Angel Investors (~$1M)

• Marc Benioff! • Paul Graham! • Garry Tan! • Sam Altman! • Geoff Ralston! • Reza Satchu! • Ajay Agrawal! • Lee Lau! • David Ossis! • Dan Debow! • Mike McCauley! • Mike Litt! • Mike Stork! • Bob Rushby! • Dennis Bennie! • Larry Innanen! • Richard Hyatt! • Rubin Osten! • Wojciech Gryc

Institutional Investors ($14.5M)

Dec 2012

Pre-Sales

May 2013

• 30,000 units ($4.5M)!

• 136 countries (only 48% from US/ Canada)

• • • • • •

Spark Capital ($6.5M)! Intel Capital ($5.5M)! Formation8! First Round Capital! FundersClub! Y Combinator

Eric Migicovsky

Stephen Lake

Spot the Differences Eric Migicovsky

Stephen Lake

Dragon Innovation

Spark, Intel, Lee Lau

Kickstarter
 85K units ($10M)

getmyo.com
 30K units ($4.5M)

Information Disclosure! Eric Migicovsky

Stephen Lake

34 detailed
 updates

5 simple
 updates

Detailed Updates • “We have confirmation from our primary

component supplier that the vast majority of our components have departed Arizona, flying towards Hong Kong and ultimately Dongguan, China. There are more than 110 electronic components inside each Pebble. It’s been a lot of fun finding 85,000 sets of
 everything!” (Oct 26, 2012) !

• “I’m heading to our factory in Dongguan, China on

Saturday for 2 weeks of work on the Design Verification (DV) test build. After DV, we have one more test build scheduled in December called Production Verification (PV) before Pebble enters Mass Production (MP). As I mentioned in Update #17, our assembly line will be set up to manufacture 15,000 Pebbles per week. I know each one of you has a burning desire to see Pebble on their wrist, but I want to caution you that even after we begin MP it will still take us several weeks to manufacture all 85,000 Pebbles.” (Nov. 10, 2012)

Mentorship! Eric Migicovsky

Stephen Lake

Dragon Innovation

Spark, Intel, Lee Lau

"Dragon Innovation helped us take our crowdfunding success and translate it into shipping more than 100,000 Pebbles in just over a year,"
 Eric Migicovsky - WSJ, Sept 5, 2013!

ONLINE/OFFLINE

Information •

Two types:!

•

Early-stage capital allocation relies on both types:!

• • •

The cost of acquiring tacit information increases with distance!

- Codified (dramatically affected by digitization)! - Tacit (not affected by digitization)! - Codified: business plans, product specs, track record! - Tacit: founder personalities, team dynamics, smarts! Face-to-face interactions; “kick the tires”! Relative importance of codified vs tacit information is dynamic!

- Search (team, business) vs monitoring (progress)! - Whether to do due diligence versus whether to invest

Local versus Distant Investors Local

Distant

Propensity to invest

2.9%

0.8%

Average investment size

$196

$74

% total investment

13.5%

86.5%

Silicon Valley Startup

Non-Silicon Valley Startup

Silicon Valley Investors

58.2%

48.5%

Non-Silicon Valley Investors

41.8%

51.5%

$26M raised online between 10/12 and 9/13 on AngelList! 2,602 Online Investments ! ! 1,311 Investors! 730 (55.7%) are from Silicon Valley! ! 127 Startups ! 86 (67.8%) are from Silicon Valley

Startups Silicon'Valley New'York'City Los'Angeles Chicago Sea8le Atlanta Arlington Aus:n Belmont Cambridge Cha8anooga Culver'City N/A Nashville Portland Rio'De'Janeiro Salt'Lake'City San'Juan

86 11 10 3 3 2 1 1 1 1 1 1 1 1 1 1 1 1

Source: Agrawal, Catalini, and Goldfarb, “The Geography of Crowdfunding,” National Bureau of Economic Research, Working Paper 16820.

Friends & Family

Source: Agrawal, Catalini, and Goldfarb, “The Geography of Crowdfunding,” National Bureau of Economic Research, Working Paper 16820.

Friends & Family

Source: Agrawal, Catalini, and Goldfarb, “The Geography of Crowdfunding,” National Bureau of Economic Research, Working Paper 16820.

Why?

Information • Relative importance of codified vs tacit information is dynamic!

• Search (team, business) vs monitoring (progress)!

• Whether to do due diligence versus whether to invest

F&F effect is driven by the first investment: An information acquisition explanation

Source: Agrawal, Catalini, and Goldfarb, “The Geography of Crowdfunding,” National Bureau of Economic Research, Working Paper 16820.

How AngelList Aligned Offline and Online •

• •

Invest Online

• •

Requires an initial offline commitment to initiate!

•

The 'lead investor' is a well-known individual, investment firm, seed fund or incubator who has committed at least $100K and has set terms!

The Invest Online fund invests on the same terms as the startup's lead investor!

Syndicates Backers

Syndicates and Backers !

• Creates a market for reputation 
 (rewards with carry)!

• Creates incentives for due diligence and oversight (carry aligns incentives – no management fee)!

• Leverages offline relationships and online scale/reach

Align offline and online •  Leads: any angel can lead a syndicate •  Startup (issuer) assigns the lead an allocation •  Leads get carry (5-20%) and leverage on their personal investment •  Larger investment amounts may also bring major investment rights •  Leads pay 5% carry to AngelList (on total) •  Backers: investors back the syndicate •  Commit to invest in their future deals, and to pay them a carry •  Do not pay a management fee •  Can invest much less than the startup’s minimum for a direct investment •  Startup: access more capital with fewer meetings •  Attention from investor who is investing 5-10x their usual investment amount •  Access to the backers’ network without putting each on the cap table

THANK YOU