Understanding Crowdfunding

By 
Luiz Augusto Buff
Peter Alhadeff

CrowdfundingCrowdfunding projects that reach their pledge goal can still fail to fulfill because of unforeseen expenses. Thorough budget planning is key to success.

Musicians, artists, and music business entrepreneurs need cash to start a project and bring it to fruition. They are hardly unique in this respect, and share many of the challenges that the general public faces. Is the needed money for the short term or the long term? Is there a small or a large amount of risk involved? Today, fortunately, there is greater flexibility in the marketplace. Resources can be marshalled on a piecemeal basis, as needed by entrepreneurs or musicians to achieve a particular and often tactical goal. Crowdfunding and venture capital are two examples of a new type of milestone or ad hoc financing that both blurs the distinction between short and long money and helps defray risk. The implication for artists, musicians, and music business entrepreneurs could be momentous.

This article focuses only on crowdfunding. It suggests a simple methodology for a musician or music entrepreneur to budget his or her own project. The costs of rewards for fans are variable and depend on the number and category of fan pledges. Knowing in advance the possible distribution of such rewards is key, and so is the understanding of the average pledge per contributor gathered from historical data. The authors argue that raising funds online in return for rewards is based on too much guesswork, when it should be more informed. Using recent Kickstarter data, they demonstrate, step by step how to prepare a professional crowdfunding budget that includes taxes, service fees, and contingency arrears. This type of budgeting is not as clear-cut as it seems, so this article strives to fill a gap in the current music business literature in outlining how to budget for a crowdfunding project.

Overview

Luiz Augusto Buff
Luiz Augusto Buff

More than 15 years ago when the World Wide Web was still in its early years and its full potential as a social network was yet to be revealed, the British band Marillon raised $60,000 to finance its U.S. tour through an Internet campaign. In the following years, we witnessed the rise of collective financing online. Launched in 2000, the music website ArtistShare became the first online platform for “fanfunding,” successfully raising funds for a Grammy–winning album by Maria Schneider, among other projects. Since then, raising funds using the Internet has grown by leaps and bounds. Today, crowdfunding is part of the vocabulary and refers to online contributions by the general public, above all, to a diverse pool of creative projects. Gradually, other online platforms actually edged out ArtistShare. Among them was Kickstarter: the initiative that broke the music financing record with Amanda Palmer’s $1.2 million campaign, which paid for her new album and tour.

The power of crowdfunding seems to grow by the day and now the phenomenon now extends well beyond music. Recently, through Kickstarter, Ouya brought an Android-based videogame console to market. The required pledge of $950,000 led to the collection of $8.5 million, with 63,000 contributors advancing, on average, $135 each. The total compares in size with a first round of venture financing.

Peter Alhadeff
Peter Alhadeff

According to the trade organization Crowdsourcing.org, there are currently four categories of crowdfunding platforms available on the Internet: equity-based, lending-based, reward-based, and donation-based. In the first two, contributors expect financial returns in exchange for their pledges. In the reward-based model, a person contributes to a campaign in exchange for a reward and the degree of exclusivity in those rewards generally grows with the size of the contribution. Finally, donation-based crowdfunding participants contribute without expecting anything in return because the project appeals to their personal beliefs. However, the most popular crowdfunding model is still the rewards-based one, representing 43 percent of the global crowdfunding industry, and it’s expected to grow to 5

24 percent during the next year. This category features an increasing number of crowdfunding platforms such as Indiegogo, PledgeMusic, RocketHub, and, of course, Kickstarter, which we will use as a reference in this article because it is the largest and most widely known.

The rewards-based crowdfunding model has a strong appeal for music projects because it permits artists to raise funds before they start working on a project and because a project can be executed only if the goal is met. Artists can then cover their production costs and possibly break even before the project begins. Kickstarter has launched more than 22,000 music campaigns in its four-year lifespan; however, only around 54 percent have succeeded in reaching the campaign goal. That means that one in two projects fails to raise the necessary money. Most important—but discussed less frequently—is the fact that even when project owners succeed in meeting their goal, they may not have budgeted correctly, necessitating access to other funds to conclude the project, delaying the expected delivery date of the campaign, and sometimes never fulfilling the project. Since crowdfunding functions also as a marketing platform, nonfulfillment, or subpar fulfillment jeopardizes the image of artists, and diminishes their credibility with fans.

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