Why crowdfunding isn’t just digital fundraising

An brief introduction to funding risk, social metrics, and marketplace management for non-profits.

Non-profits often ask what the difference is between crowdfunding and digital fundraising.

I usually start by explaining that crowdfunding builds on traditional (digital) fundraising by explicitly setting target-based fundraising goals. I then proceed to explain that there are really two types of crowdfunding. One type of crowdfunding is the keep-it-all (KIA) model — where a project creator keeps all of the funds raised regardless of meeting the stated target goal. The other is the all-or-nothing (AON) model, where the project owner must raise enough funds to meet or exceed the stated target.

The former (KIA model) takes an incremental step from traditional fundraising, while the latter (AON model), is where there is the potential for more significant innovation.

In the AON setup, the collective decision made by a group of funders is what determines the monetary success of the project (be it product, film, research, etc).

As a result, new elements are introduced into the non-profit fundraising equation that didn’t necessarily exist before — like the idea of funding risk, social metrics, and marketplace management. These elements, if used properly, can serve to help non-profits achieve different goals.

Non-profits that understand the implications of these 3 elements can then frame crowdfunding in a different lens and identify new strategic opportunities.


Funding risk and choices

Embedded within the AON crowdfunding model is a clear-cut definition of funding success and funding failure. Projects either make it, or they don’t. There are no in-between outcomes. By design, there is an inherent risk that any given AON crowdfunding project may not receive any funding. Let’s call this funding risk.

On the other hand, KIA crowdfunding (i.e. “traditional fundraising”) is not exposed to the same type of funding risk. Stated another way, if you calculate crowdfunding success in terms of dollars — i.e. the total dollars successfully collected divided by the total dollars pledged, KIA crowdfunding always has a success rate of 100%. All the money you raise you keep.

The implication of having funding risk in the AON model is that it leads to more meaningful funder trade-offs and choices. In AON crowdfunding, a funder’s choice to fund one project over another has a cascading impact on the entire crowdfunding ecosystem — be it other funders, project owners and the platform itself.

The projects that end up being successful through AON crowdfunding, on AON crowdfunding platforms, should be a reflection of the best project proposals (amongst the ones presented). The ability to filter ideas is one of the interesting features that is only possible with AON crowdfunding.

Social metrics and new opportunities

Related to the concept of funding risk, AON crowdfunding platforms also offer new social metrics that can be used to evaluate a project’s viability. The number of people who contribute, who they are, endorsements, etc, can all be used as indicators for a project’s viability.

As more funders (i.e. the “crowd” [1]) pledge to an AON project, more information is added to the available pool of social metrics. This then becomes available for the next funder to use in their decision-making process (if they choose to), up until a project hits its stated goal. Not only does this serve as a cost-effective mechanism for socially vetting project ideas, it serves as a template for de-risking projects and ideas that are historically hard to evaluate.

AON crowdfunding platforms at larger scale are already showing how social metrics can be used to de-risk ideas that under traditional methods, are difficult to evaluate in a cost-effective way. Below are two examples from Kickstarter and Kiva Zip [2].

Kickstarter

www.kickstarter.com

Platform overview: Kickstarter is an AON crowdfunding platform where creators post creative projects online (be it for products, film, book, etc) for the crowd to collectively fund. In exchange for a certain level of contribution, funders get a corresponding reward.

Social metric: The social metric that matters most for the project creator is the number of funders that pledge to their project–assuming that the project reward tiers are logically designed.

De-risking: Project creators can validate that there is a minimum level of demand for their idea before investing a more significant amount of time and money into production of said idea. It removes demand-risk, one of the hardest things to gauge beforehand for things like new products, films, books, etc.

The most successful Kickstarter campaigns (by funding raised) were able to vet their idea across hundreds of thousands of people before making a significant investment of time and money. This form of vetting has become so commonplace that it has been termed as “pretail”. This is what makes Kickstarter one of the most valuable testing grounds for new products.

Kiva Zip

https://zip.kiva.org/

Platform overview: Kiva Zip is a crowdfunding platform for micro-loans (~$5,000 on average) to small businesses. Lenders crowdfund a loan that helps a borrower grow his/her business (i.e. buy equipment, raw materials, hire more labor etc). Incremental income generated from the growth is used to repay the loan. Their lending is philanthropic in nature.

Social metric: Different than Kickstarter, Kiva Zip doesn’t rely as much on the number of backers, but rather, who the initial backers are. Before a borrower is allowed to crowdfund their loan publicly, they must first get a minimum number of people they know (called invited lenders) to seed the crowdfunding campaign. A Kiva-authored analysis on loan repayment rates (their measure of project viability) shows that repayment rate generally increase with more invited lenders [3].

Kiva Zip Loan Repayment Rates vs Invited Lenders Chart

De-risking: The Kiva Zip team and their community of lenders are starting to use the invited lender count as a gauge for the borrower’s credit risk (ability to pay back the loan).

This can have significant implications because the Lending industry today (i.e. big banks) does not service borrowers who need relatively small loans to grow their business — mostly due to the underwriting economics.

For example, the fixed-cost associated with assessing a borrower (i.e. pulling a credit file, doing a background check, etc) for a $5,000 loan is roughly comparable to assessing a borrower for a $50,000 loan. Since interest on a loan is relative to the principle size, the evaluation of a micro-loan is not cost-efficient.

Kiva Zip’s use of the social metrics is essentially cost-free, and allows them to economically serve the underserved micro-loan segment of the lending market [4].

Managing a marketplace, not fundraising organization

Often overlooked in the non-profit crowdfunding discussion is the fact that crowdfunding platforms (AON crowdfunding platforms specifically) function more like a marketplace, than a fundraising organization.

Ask any (AON) crowdfunding platform which company they are most similar to, and many would list marketplace businesses like: AirBnb, Coursera, and Uber.

Hallmarks of marketplaces include: the management of supply- and demand-side users as a community, and a focus on a specific vertical. A quick scan of the crowdfunding landscape today reflects this.

Donation Crowdfunding Landscape (excl investment platforms) as of 5/2015

Community management: innovation and strategy

Marketplaces enable innovation from the bottom up, through their community. Their approach to managing the community is to set the rules of engagement, and then create an environment for the community to self-govern as the platform scales and grows. This means that the community will be the ultimate driver of long-term strategic decisions, not the platform’s management team.

Contrast this with a traditional top-down fundraising model, where management typically defines long-term strategic initiatives, and raises funds to make it happen.

An AON crowdfunding platform understands that it only exists to reduce the intermediation friction that exists between people on both sides of their marketplace. They don’t make too many sole decisions on things like strategy, what to fund, what ideas to surface, etc. They merely facilitate it through the platform.

Vertical-specific: ecosystem and partnerships

AON crowdfunding platforms that are vertical-specific, are positioned to engage their community to tackle tough challenges that exists within the broader industry they operate in.

AON crowdfunding platforms can be natural strategic partners for existing incumbents in the industry because they usually service different parts of the funding/innovation pipeline using different funding approaches and philosophies.

This was hinted at earlier with the Kiva Zip example, and their role in the micro-lending segment of the loan industry. Similarly, Kickstarter is filling the earliest parts of the innovation pipeline in creative products.


In closing…

Non-profits interested in tapping into the true potential of crowdfunding must be willing to embrace the all-or-nothing (AON) model, and all the things that come along with it. This means being able to: 1) accept funding risk, 2) leverage social (underwriting) metrics, and 3) adopt a marketplace mentality.

Non-profits that are thinking about crowdfunding should ask themselves the following as they map out their strategy:

  • Do all 3 of the differentiating points presented resonate with the needs of your organization? If yes, you’re probably looking to start your own crowdfunding platform.
  • Do all but the last point resonate with the needs of your organization? If yes, you’re probably looking to strategically partner with an existing AON platform in the vertical you’re interested in–taking advantage of the infrastructure and community they’re building today, and in the future.
  • Anything else? You’re probably looking for a digital fundraising solution [5], and should frame your policies and decision-making as such. Be careful of prematurely defining a crowdfunding strategy that completely misses the innovative elements of the space.

Admittedly, crowdfunding described from an AON lens introduces new ideas, questions and concerns. However, as with any transformative ideas, it by definition has to look different than what has existed before. This is venturing into the territory of the things we’ve never done before — the only place where we can expect real innovation to happen.

Thanks to Phil, Oscar, Lorena for reading versions of this.


Notes

[1] The crowd can be entirely curated, semi-curated, or not curated at all. The point is that there’s some group of people willing put their money where their mouth is.

[2] We won’t cover equity crowdfunding–although, venture capital has effectively operated on a crowdfunding model for a long-time. VCs often look at “who’s investing” as a barometer for the quality of the investment.

[3] This must be qualified to state that correlation does not necessarily signal causation. For causation to be proved, further analysis or published experimental design/data analysis is needed.

[4] Kiva Zip’s average loan size is ~$5,000-$6,000. While that exact figure isn’t important, it is worth noting that many AON crowdfunding platforms typically target smaller funding sizes relative to the broader funding ecosystem they work in.

[5] It’s important to note that this post does not mean to say that digital fundraising is not important. In fact, it’s very important, and critical for non-profit organizations looking for lower cost ways to fundraise.

Also, on average, one might observe that AON crowdfunding tends to bring in restricted funds (which can be good for its application) whereas KIA crowdfunding/digital fundraising, for all intents and purposes, brings in less restricted / unrestricted funds. The importance of this point can’t be overstated. Non-profits need the flexibility to deploy funds where it’s needed most.