Understanding Crowdfunding

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

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.

Guesswork and Misconception versus Method

The reason for these failures is that most campaigns are planned based on guesswork and misconception. As for guesswork, despite the availability of general data provided by some of the crowdfunding platforms, a more professional and statistical approach is missing. New music projects can benefit from the information available in order to realistically set goals and more accurately estimate the number of contributors needed for a successful endeavor.

Successful campaigns fail at the fulfillment stage if the campaign asks only for the amount needed to realize the project, for example seeking only to cover the studio costs to record an album or the price of a van for a band to go on tour. Yet the costs of raising money via crowdfunding far exceed the initial budget goal of the project and include the costs of delivering the rewards, platform fees, taxes, and other unexpected costs.


Figure 1: Average Pledge per Music Genre
Figure 1: Average Pledge per Music Genre

The fact is that budgeting for a crowdfunding campaign is often problematic because it’s difficult to know up front what distribution of rewards fans will choose. Moreover, it is even harder to guess what an average pledge can be, and this is a critical piece for a successful crowdfunding campaign.

We have compiled information from 102 successfully funded Kickstarter music projects completed between February 11, 2013, and February 23, 2013. Any crowdfunding campaign should start with a review of comparable campaigns. The main object of this article is to outline a simple methodology for a musician or music entrepreneur to properly budget his or her own crowdfunding campaign. Therefore, more data points than 102 campaigns would have added only marginally to the value of these findings. If the method is understood, users can add their own data into our Excel budget spreadsheet after the last entry on the “data” tab of the spreadsheet to project the costs of their own campaign [ click here to download the spreadsheet ].

As budgeting properly for crowdfunding rewards is a craft learned only by doing the numbers, we recommend that the reader review the various sheets of this spreadsheet before reading the following section.

General Crowdfunding

Researching campaigns similar to the one you are contemplating is critical. It can bring fresh ideas to the table, perfect a pitch, better define a product, find potential partners, and provide insights for different offerings. In his book The Crowdfunding Bible, Scott Steinberg offers a comprehensive list of what to look for. Additionally, compiling data from similar projects might be useful for correctly budgeting a campaign, especially because it can offer examples of how contributors were distributed among the different tiers of rewards in successful campaigns, and the average amount pledged by each backer. It turns out that these metrics are the two key drivers in the budgeting methodology we recommend.


Attempting to find hard data about music crowdfunding projects is difficult. For instance, the Kickstarter website’s data section gives only aggregate data—not music data—about funding success rates, dollars pledged, and identifiable trends among successful and unsuccessful projects. The Kickstarter School page is more pointed, but music projects are not separately identified: “To date”, it reads, “the most popular pledge amount is $25 and the average pledge is around $70.”

Indiegogo’s help desk suggests a simple calculation to estimate the number of backers a project will require, stating, “divide your goal amount by 100, [and this will be] the estimate of how many people need to donate to your campaign in order to meet your goal.” An Indiegogo blog post does suggest how to price perks. “Perks at the $25 level are the most popular and help you extend your network and boost publicity, perks in the $51 to $100 range will support the bulk of your fundraising.” Two interesting graphics also reveal the percent of pledges by perk amount, and the percent of total dollars raised by perk amount. Once again, however, the data set is not exclusively about music projects.

Another platform, RocketHub, maintains that the average contribution, where music is presumably included, is $75 per person. RocketHub gives a general estimate of the numbers of contributors needed to reach different goals. To raise $1,000 to $10,000, between 40 and 200 contributors are needed. To raise $10,000 to $100,000, 150 or more contributors are necessary. And to raise more than $100,000, a project owner will need to reach more than 1,000 people.

Finally, award-winning filmmaker and seasoned crowdfunder Lucas McNelly has collected substantial disaggregated data for film and video projects. His empirical approach is an inspiration for what follows, but the analysis of music projects is, understandably, lacking.

Music Crowdfunding

As mentioned, we analyzed 102 successfully funded music projects from Kickstarter. Our sample size represents the entire range of music projects on the Kickstarter statistics page, especially considering the pledge categories as defined on the Kickstarter Statistics page. Most successfully funded music projects raised between $1,000 and $9,999. We have excluded sample pledge categories of more than $100,000 because they account for much less than 1 percent of the total. Our analysis revealed that of the campaigns seeking to raise less than $1,000, 13 percent were successful. Of those with a goal between $1,000 and $9,999, 70 percent were successful. Of the campaigns seeking between $10,000 and $19,000, 12 percent met their goal. Only 5 percent of those seeking to raise between $20,000 and $99,999 reached their target.

An important factor extracted from the research is the average amount of money that contributors donate in exchange for the rewards offered, which we call the average pledge per backer. Figure 1 (see page 18) indicates that projects raising larger amounts of money had, on average, larger contributions from their backers. We take note too that the average pledge per backer, in the aggregate, is $62. Some particular music genres, of course, differ from the average.

Another factor is the historical distribution of rewards chosen by contributors. A crowdfunding campaign offers multiple tiers of rewards. In Figure 2 we aggregate the different pledge amounts into reward tiers and calculate the percentage of backers that contributed to each tier (“undisclosed backers” are contributors who decided to simply donate their pledges without receiving any rewards in exchange, or who preferred not to disclose the tier they contributed to). The data set of Figure 2 provides in-depth insight into the history of successful music campaigns.

Sample Recording Budget (Initial Budget Goal)
Figure 3: Sample Recording Budget (Initial Budget Goal)

Budgeting Methodology

Running a crowdfunding campaign can generate significant costs that should be considered when setting a final goal. The formula below factors in these costs and returns a corrected goal value.

The first step in creating a budget is to understand the project, research it, and negotiate prices with service providers and manufacturers. To demonstrate the application of the formula, we will simulate a fictitious campaign in which a band has to develop a budget for the recording of an album. After factoring in all the expenses, including rehearsals, recording studio, equipment rental, producer fees, copyright filings, artwork design, mixing, mastering, transportation expenses and other similar expenses for the recording of the album, the project owner comes up with budget like that shown in Figure 3.

The band already has $12,000 in savings, so only $8,000 will be required. A common crowdfunding mistake would be for the band to set the goal of the campaign at $8,000. According to the statistics mentioned previously, the project would fit into the most successful pledge category, considering that more than 70 percent of the successful music projects raised between $1,000 and $9,999. However, as we will demonstrate, for this campaign to be viable, the goal must account for several other costs beyond the initial budget required for the project.

Reward Costs

Apart from the amount necessary to realize the project there are costs associated with the rewards being offered for different contribution tiers. In crowdfunding campaigns, it is common that as donors progress to a higher tier, a new perk is offered along with the rewards from the previous tiers. Hence, every new tier should include the costs of previous tiers when estimating costs of production. Below is a list of rewards created for our campaign. Figure 4 indicates that the cost of every reward factors in the costs of previous rewards.

In defining rewards, it is important to think creatively by adding value to each level without necessarily increasing the costs. In Figure 4, autographed CDs are more appealing for fans then regular CDs, and there are no significant costs associated with an autograph. Hence, the margins of return are higher, especially for the most popular reward tiers, between $10 and $50. Additionally, don’t underestimate the shipping and handling costs of rewards. As the project gains more backers, and if there is no provision for shipping costs, most of the proceeds from the campaign might ultimately have to be spent in fulfillment instead of financing the project.

Historical data plays an important role in estimating the costs of rewards. Dividing the initial budget goal by the average contribution per backer found in Figure 1 (i.e. $62), we estimate the number of contributors necessary to reach the goal. Then, applying the distribution of backers from our research in Figure 2, we can estimate the number of contributors in each tier, thus predicting the total cost of the rewards. This number can then be expressed as a percentage of the total, and it maintains that proportion in any goal that is set. (See “Data” in Figure 4).


In this example, with the given costs of rewards, the percentage of the total money raised that will be spent on rewards is 12.95 percent. Manipulating the costs of each reward might significantly change the percentage destined to rewards fulfillment. Note that results can be updated from the latest Kickstarter data, extended to other sites such as Indiegogo, and even broken down by musical genres, pledge categories, or other relevant factors. Even when historical data from older projects does not seem relevant for a new crowdfunding campaign, the methodology has its use: a subjective distribution of rewards can be guessed, together with its average backing, to reveal the likely cash goal.

Service Fees and Taxes

The Kickstarter business model is based on retaining a small percentage fee of 5 percent from successful campaigns. Additionally, there are payment-processing fees that in the case of Kickstarter are collected by Amazon Payments. The fees for handling the money average between 3 percent and 5 percent of the total sum raised. Other websites such as Indiegogo and PledgeMusic have different fee structures, and budgets should be properly adjusted to reflect the processing fees of the platform in use.

In addition to the costs of the rewards and the fees charged by platform, project owners should expect to pay taxes on the money raised via crowdfunding. Kickstarter and its payment processor, Amazon Payments, are required to send a 1099-K Form reporting “Merchant Card and Third Party Network Payments” to the IRS for any project that exceeds $20,000 with more than 200 transactions. In every case, the taxes owed for a crowdfunding campaign vary and might include federal income tax, sales tax, gift tax, and self-employment taxes, among others. On the other hand, various deductions and tactics can be applied to reduce the amount owed. Further, the type of business entity chosen by the project manager, as well as the accounting method used—accrual or cash basis—significantly affect how taxes should be handled in any specific campaign.

We think it is reasonable to allocate 10 percent of the final goal for taxes. The figure is speculative and depends on the means of the project manager. If crowdfunding monies are treated as income, we’ve assumed income for less-wealthy individuals, who would not pay the highest income tax rate. A less likely scenario would be that an aggressive tax professional would justify rewards for a particular campaign as donations. In that case, the tax rate would be nonexistent. Consult with a certified accountant to properly estimate the amount owed. And the fees of the tax professional should be factored into the budget costs.

The last item in the budget is a contingency factor for unforeseen expenses. This is an arbitrary percentage set to cover general unexpected costs, including the additional costs of fulfillment or taxes. To illustrate the necessity of a contingency factor, consider this scenario: In one tier, a reward is a T-shirt, and 26 people are expected to receive that reward. But the manufacturer requires that the minimum order to accept is 50 T-shirts; costs would be higher than expected. Once a contingency factor is considered, it can add flexibility to the collection process. In this sample budget, a 5 percent contingency is set.

The Final Goal

In our example, the band collects $8,000 for its recording project. The costs of running a crowdfunding campaign, which we have identified as the rewards costs at 12.95 percent, exceed the initial goal, the fees at 10 percent, the taxes at another 10 percent, and the contingency factor at 5 percent. Figure 5 shows the result: the final goal formula.


As noted, a common mistake is making the goal of the crowdfunding campaign identical, or almost identical, to the initial budget goal. As the projections in Figure 6 indicate, the band would set itself up for economic hardship with $8,000 as its goal. Applying the budget formula, however, it is easy to estimate a breakeven goal. To be conservative, we recommend adjusting results to a round number. Note that, in this example, the band used $12,000 from its savings and needed $8,000 from crowdfunding. So for the band to truly break even it would need to recoup its $12,000 by exceeding its goal with pledges from the campaign or through future sales of the album.

The formula also provides useful insights about the number of contributors necessary to reach a given campaign goal. A project owner can better evaluate his or her chances of success by (1) comparing the number in the model with his or her actual fan base, (2) evaluating Facebook friends and Twitter followers who could be converted into backers, and (3) setting standards for a more targeted marketing and public relations effort.


Conclusion

Crowdfunding is not for the faint of heart, but properly harnessed, it can help artists and creators achieve their goals. Every step of the way involves substantial work, starting with the preproduction of the project, continuing through the execution of the actual campaign. It ends well only after the hurdles of fulfillment are overcome.

Sound budgeting is at the core of any serious attempt at the medium. But currently, crowdfunding needs to be infused with a healthy dose of realism. After that, it can be done better and produce more successful and sustainable campaigns.

We strongly recommend that you use the Excel spreadsheet that may be downloaded by clicking here. It (1) makes our methodology clear, (2) can be adapted for specific music campaigns by desired goal or genre, (3) can be used in the simulation of different scenarios and for data updates, and (4) can be extended to nonmusical projects. Proper planning and budgeting will increase the chances for the success of your crowdfunding campaign.

Luiz Augusto Buff is studying entertainment, media, and intellectual property law at UCLA School of Law. He earned his degree in Music Business/Management at Berklee and has worked for Warner Bros. Pictures, Digital Cowboys, and Ted Kurland Associates.

Professor Peter Alhadeff is a founding faculty member in Berklee’s Music Business/Management Department. He earned his doctorate at Oxford University in England, and is a widely published author and in-demand speaker on music business and economics topics.