Failing After Having Received Funding
Last updated May 19, 2016.
It’s not because you reach your objective for your crowdfunding campaign that your project is guaranteed to succeed. Sometimes, after several months or years of sustained effort, entrepreneurs are forced to pack up their bags. It happens in the case of both reward-based and equity crowdfunding.
Reward-based crowdfunding projects that do not deliver as promised often attract bad press. But how widespread is the problem?
That’s the question that University of Pennsylvania researcher Ethan Mollick attempted to answer. He sent an online questionnaire to 456,751 users of the Kickstarter platform who had participated in one of 65,326 projects funded between April 2009 and May 2015. In total, 47,188 people having financed a total of 30,323 projects took part in the study.
9% of all projects end in failure
Approximately 9% of all financed projects included in the study may be considered as failures. Such projects are inventoried throughout the world and involve both product creators and manufacturers. Moreover, 8% of the money invested goes to projects that fail and 7% of participants never receive the rewards they were promised.
“The problems that affect unsuccessful entrepreneurs the most involve complications with suppliers,” points out Ethan Mollick during an interview. Other entrepreneurs also sometimes experience difficulty with customer service and have trouble managing product returns, for example.
For creators and more artistic projects such as films and video games, another problem lurks in the shadows: setting targets that are too low.
“Only a fourth of all financed projects obtain more than 10% of what was initially requested. If a company tries to circumvent the system and request less than what it needs to stay afloat [editor’s note: projects that do not reach the target set by Kickstarter do not receive their money], it risks obtaining just enough to survive and will not dispose of the financial resources needed to complete its project,” adds the researcher.
It is worth noting that the 9% failure rate increases among older projects. For example, in the case of those completed before 2012, the rate varies between 8.6% and 13.9% depending on the criteria selected to define what constitutes a failure. According to a more flexible definition, at least one of the participants surveyed estimates that the project is a failure, whereas all of the participants surveyed considered the project as a failure based on a narrower definition.
This variation could be attributable to the fact that companies having received funds before 2012 had more time to fail than those who received funding after 2012. Moreover, 18.82% of respondents claim that they are still waiting to receive their reward. The failure rate among projects underway could therefore also increase over time.
For Ethan Mollick, however, one must take into consideration that the first campaigns were less effective than those underway today. “Creators have climbed the learning curve of how to create successful projects, and backers have become more educated on which projects to support,” as he notes in his study.
Very small and very large projects are more prone to failure
The failure rate varies in accordance with the money received by projects financed by Kickstarter.
As a general rule, projects having obtained US$1,000 or less in funding are those that fail the most often (approximately 13%). The rate then decreases and increases gradually up to projects of $500,000 or more.
“Small projects do not always have the resources they need to reach their goals,” sustains Ethan Mollick. Thus, several projects of less than $1,000 are single events and proponents may lack diligence when it comes to distributing rewards.
Only 19% of people would support a failed creator a second time
Creators often fail “in the wrong way” on Kickstarter. Only 17% of the people who financed a failed project claim to understand why the project failed. Only 13% of them received a reimbursement given they never received the reward that was promised to them.
“It is important to inform the people who helped us along the way. That helps them to understand and they can also provide us with useful advice. The more open communications are, the better your chances are to regain their trust,” explains Ethan Mollick.
According to his study, only 19% of people would be ready to renew their trust in a creator whose project ended in failure, but 73% of them would nevertheless be willing to finance another creator’s project.
Equity crowdfunding: the situation is improving
Through equity crowdfunding, instead of receiving rewards, investors acquire a stake in the company. This is a new process in Canada but it has existed in the United Kingdom since 2011. British research firm Beauhurst recently compared the rate of failure among companies having benefitted from equity crowdfunding to that of companies that received traditional financing (seed capital funds, angel investors, etc.).
Only seed funding was evaluated for the purpose of the study. The results obtained for 2011 (equity crowdfunding was still in its infancy at the time) were not accounted for. All companies having received seed capital in the UK between 2012 and 2015 were included in the analysis (4290 financing rounds in total).
Many failures, but the situation is improving
Failure rates among companies that benefitted from equity crowdfunding in 2012 and 2013 are nevertheless high (21.7% and 25.4% respectively). In comparison, among the companies that were financed by traditional instruments, failure rates only reached 8.6% and 6.2% respectively.
Several reasons could explain this significant discrepancy. “Many companies that ran greater risks attempted to obtain equity crowdfunding at the time,” explains Pedro Madeira, research manager for Beauhurst. “Also, these companies often proposed consumer products at a time when the economy had not yet fully recovered from the meltdown.”
The failure rate stabilized itself greatly in 2014, at 4.5% among companies having received crowdfunding against 3.9% among companies that had benefitted from traditional financing.
The time factor probably explains part of the drop observed in the results for 2014 seeing as not all companies had the time to fail. Moreover, this difference could also be attributable to market maturity.
Indeed, financing platforms have multiplied since 2011 and lessons have been learned from past errors. “In 2011 and 2012, there were fewer companies and fewer platforms. More mediocre projects could therefore nevertheless make their mark and obtain funds. Today, the competition is more intense,” points out Mr. Madeira.
He also believes that there is today’s companies seeking equity crowdfunding are more diverse compared to 2012 or 2013. This fact could also explain the improvement.
The value of successful companies often decreases over time
If the rate of failure among companies that benefitted from equity crowdfunding has decreased over the years, another data point calculated by Beauhurst paints a dimmer picture.
According to the research firm, over half of the companies having benefitted from crowdfunding and received a second round of funding actually see their value decrease. This is in stark contrast compared to traditionally financed companies—only 24% of which lose value over time.
“These companies are still in business but they’re not doing very well,” estimates Pedro Madeira. The researcher recognizes that the companies that have had the time to conduct two rounds of financing are often among the first that benefitted from equity crowdfunding. They are therefore riskier businesses. “But even when that is factored in, the difference remains significant,” he claims.
For Pedro Madeira, companies that are thinking about joining the equity crowdfunding bandwagon must first and foremost set their priorities straight. Is it money or publicity that they want?
“If you’re doing it mainly for the money, you can afford being more aggressive in your evaluation,” sustains the researcher. “But a company looking for angel investments and visibility must offer the best conditions to investors even if that comes at the price of a lower valuation. The risks of devaluation in subsequent rounds of financing will decrease and the company’s first investors may remain evangelists for the company.”
“If the company’s valuation is too high, it is at risk of being devaluated in the future and losing its initial clients. So what good does that do if the goal is to benefit from a good level of visibility?,” summarizes Pedro Medeira.