5/25/15

Why crowdfunding isn’t just digital fundraising

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.

1. 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.

2. 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].

Case A: 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 ofdemand 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.

Case B: Kiva Zip (www.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].

3. 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: AirBnbCoursera, 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 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.


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.

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

5/19/15

Science startups and our future

More and more “science startups” are appearing in VC portfolios:
Intuitively, this shift towards science shouldn’t be surprising. We need solutions rooted in science to help us figure out: how to power our planet, treat illnesses, manage our natural resources, and govern our increasingly borderless world.

However, for many VCs, the mention of investing in science startups can conjure up bad memories. Significant capital requirements, politics, and lengthy go-to-market timelines turn many science startups from “good idea in theory”, to “bad idea in practice”.

As VCs continue to build-out their perspectives for science startups, there are three key things that they should be thinking about: 1) Investment in platforms ahead of technologies, 2) Consideration of hybrid capital structures, and 3) Consideration of alternate pathways to exit.

1. Platforms first, breakthrough technologies second
Investors interested in science startups must broaden their scope to not only consider investment in breakthrough technologies (like new drug-delivery systems, advanced materials, and more efficient batteries), but also inplatforms enabling their development.

Many of the science startups surfacing in the most recent tech boom have been platforms built to streamline, automate, and remove process frictions at various parts of the scientific value chain, or “science stack”. These include startups that make the funding process, doing experiments, and sharing of the results, faster and cheaper.


As these platforms (and others to come) mature, investors not only generate returns from investing in the new infrastructure of science, they also set the stage for bringing costs down across the entire value chain.

This opens the door for investors to take more bets on startups developing new breakthrough technologies — while getting diversification and keeping overall investment check sizes small. Getting to capital efficiency, is the only natural hedge against the significant technical risks embedded in pure-technology plays.

This is why focusing on platforms first, before technologies, is important.

2. Hybrid capital structures
Given that developments in science and technology have broad social impacts — it will inevitably catch the attention of government and philanthropic stakeholders.

For investors, this practically means being aware of the philanthropic, government, and investment capital in play at all times. Each type of capital has its own objectives, constraints, and risk-return profile. No one entity can operate in isolation, as the decisions made by one, affect everyone else.

As we’re seeing in other social-impact verticals like recidivism, homelessness, and education, this can actually be an advantage in accelerating the pace of change — if creative solutions to blend these three types of capital are explored.

Take recidivism social impact bonds (SIBs) for example. Governments pay for successful recidivism outcomes; from cost savings generated by the social programs executed by non-profits; seeded by investment capital and philanthropic guarantees. SIBs in this example, are essentially risk-transfer programs that allow for the government to co-invest with the private and philanthropic sector to accelerate a particular social impact.

Similar ideas can be applied for science startups in cases where the risks embedded are too high for investors to bear alone —and require some de-risking using other types of capital. This would be most relevant for the development of breakthrough technologies struggling with the idea to impact gap.

VCs can potentially expand the scope of their investment opportunities if they bring mission-aligned partners (like philanthropic organizations or government) to the table with their unique capital base to create win-win partnerships.

For example, larger foundations could partner with science-focused VCs to co-invest by providing first loss capital, program related investments, or strategic grants. For investors, this would balance out the risk-return profile — making startups developing high impact technologies more “investable”. For foundations, their capital would be “levered up” and directed towards science that has a bias for translation into real societal impact.

3. Alternate pathways to an exit
Many science platforms, like the ones described in the graphic above, will be suited for public offerings — with business models that are fairly similar to other software startups.

However, not all science startups are positioned to exit via traditional pathways like an IPO. For example, startups developing breakthrough technologies may not neatly fit into this bucket.

A new technology may be a good product but not necessarily a good standalone business; the infrastructure needed to scale up a technology may require robust supply chain relationships; or the founders/inventors of a technology may not want to pursue entrepreneurship full-time.

Investors looking to capture the most value from their investments must be flexible and willing to explore alternate exit options. This could include: investing more heavily in corp dev relationships, strategic partnerships with established supply chain players (think Quirky’s model), and/or training managers to step in and build out new businesses.

In conclusion
Science startups have all the makings for VC involvement. They go after big problems, with big markets, and are high risk.

Those developing their investment perspectives for science should look for opportunities to fund enabling platforms ahead of technologies, experiment with hybrid capital structures, and explore alternate pathways to exit.

Addressing the environmental, social, and health challenges that our generation faces in the next 50–100 years requires bold risk taking. The good news is that we’ve never before been in a sustained investment climate where so much risk-capital is available and searching for the “next big thing”. We should take this opportunity to deploy this capital productively.

As a friend of mine liked to often say: “an investment in science, raises all boats”.

5/14/15

A venture capital approach to science grantmaking

One of the major challenges facing the US science ecosystem today is the shortage of funding for novel and risky scientific ideas.

In talking with a number of scientists, the core of the problem seems to lie with the design of the current funding model.

The traditional peer review-like approach to grantmaking, limited funding resources, and political pressure, leave a suboptimal environment for surfacing, cultivating, and funding the types of risk needed for breakthrough science.

Making progress against this reality requires fresh thinking that looks outside-of-the-box for solutions.

One way to start the discussion for change, is to look to other risk-seeking funding models for inspiration. One place where this could be warranted isventure capital. As the most mature funding model that constantly transacts in risk, lessons from how VCs fund startups may be instructive for science.

A comparison of the two provides a foundation for debate around what I call“a venture capital approach to science grantmaking” .

Comparing venture capital investments vs science grantmaking
The VC ecosystem today is highly differentiated and works as a funnel. The top of the funnel is loaded with a large number of risky startup ideas that all receive small amounts of funding.

As ideas become validated with real outcomes data, only the best move onto the next stage of financing. Each stage of financing brings its own types of investors specializing in certain risk-return profiles.

Current VC Funnel For Investments

While the venture capital “funnel” shares some common characteristics with science — mainly, in its segmentation of risk into tiers, there are some notable differences. The main one being: the science funnel (today) is inverted with no robust support (in funders and funding) for “pre-seed” stage research ideas.

Note: Pre-seed stage research ideas are scientific hypotheses that just need a little bit of funding to get some preliminary data — helping to see if the line of research is worth further exploring.

Current Science Funnel For Grantmaking

Many traditional science funders have noted that there are practical constraints to vetting and managing a portfolio of research grants fitting the pre-seed description.

Therefore, changing the risk paradigm in science starts with addressing this crucial gap in the pre-seed space. We must not be afraid to experiment with new and oftentimes unconventional approaches. By addressing the challenges at the top-of-the-funnel, we should see a positive trickle-down effect through the rest of the ecosystem.

Fixing the top-of-funnel by going smaller
Funnels in venture capital work because they help to segment risk, standardize expectations, and most importantly, create right-sized investment opportunities at each risk tier. At the pre-seed stage, small investments are critical for uncovering just enough field data (per idea) to help get to a go/no go point on more significant investment.

Also, by going small, investors can diversify over a larger number of investments, while at the same time providing more “at-bats” for entrepreneurs.

Creating a similar dynamic for science practically means more experimentation with grant structures that are smaller in size, more concise in scope, shorter in duration, and less of an administrative burdento secure.

Those (funders) willing to take up the challenge and opportunity of funding pre-seed research, will need to re-think grantmaking conventions on a number of dimensions:
  • Grant size: What is the appropriate “small” grant size for a pre-seed and seed stage research idea? Does it differ by field? How can we make $5,000, $25,000, $100,000 work consistently?
  • Peer-review: How should we engage “experts” to evaluate high-risk ideas in a constructive and cost-effective manner? Should we engage non-experts? Can crowdsourced review, cross-disciplinary review, and endorsement-based review fit in?
  • Due diligence: How can we design a process where “vetting effort” is inversely proportional to the risk, and proportional to the size of the grant? This means considering short proposals, with fast decision-turnaround times, etc.
  • Overhead: What is the appropriate level of upfront overhead for small grants so as not to stifle innovation? Can overhead be “fairly” recovered from larger follow-on grants if the preliminary ideas are successful?
  • Follow-on funding: How much funding should be made available if the preliminary idea is successful–either by the original funder or other funders within the ecosystem? How can we create more co-ordinated funding partnerships across the ecosystem?

New funding mechanisms
In addition to technical changes and experiments that need to be run when funding smaller, the mechanisms that surface ideas, allocate the funding, and manage the portfolio of research projects will also need to evolve accordingly.

In venture capital, the mechanisms that have been effective in servicing the earliest parts of the funding funnel are accelerators and crowdfundingplatforms. These are distributed community-centric funding mechanisms that involve diverse groups of stakeholders — including domain, and sometimes non-domain experts [1].

Adapting these mechanisms for science may be a good starting point for operationalizing the funding of higher risk early-stage research.

Accelerators: a local focus
Popular startup accelerators (Y Combinator, Tech Stars, etc) bring together startups in batches, in one physical location, and for a short period of time. They surround them with the tools/guidance to develop their ideas (usually a product), and seed them with a small amount of funding to get started.

The environment is collegial, and fosters a strong sense of community amongst the participating entrepreneurs that helps bring up the quality of the companies/ideas.

The general partners running the accelerator are typically long-time startup veterans who source and vet applications for the accelerator, help entrepreneurs think through their challenges, and act as a sounding board to help them see the forest from the trees. They are not there to prescribe step-by-step guides.

A similar setup can be employed for science — building on the types of research collaboration that already happen within universities, colleges and public lab spaces.

Science funders (be it philanthropy or government) can explore partnerships with groups of local institutions to design accelerator programs targeting early-stage research ideas.

Like a tech accelerator, small funds (grants) would be dispersed to a number of scientists (which can be from all experience levels). Professor emeritus/retired scientists associated with these local institutions would be a possible choice as the general partners running the programs, and helping with the process for determining who’s included in each funding batch.

Institutions benefit from this type of partnership, as it strengthens their own early-stage research pipeline, and provides a possible avenue for winning larger grants later on. Funders benefit, as this is a source of local “deal flow” that targets different grant risk-return profiles that they wouldn’t normally have access to.

Crowdfunding platforms: a global focus
AngelList (equity), Kickstarter (donations), Indiegogo (donations), and other platforms have forever changed the landscape for funding startups — or products that later become startups. Crowdfunding platforms rely on the crowd to vet and fund early stage high-risk ideas.

Many of the projects/deals on these platforms are for preliminary (sometimes just “back of the napkin”) ideas that are inherently risky. In the case of the donation-based platforms, some plain-English text and a video explaining the idea is all that’s provided for funders to make decisions.

This is something that is in its nascent stages for science but could have significant implications as platforms scale up.

For example, crowdfunding platforms, opposite of accelerators, are built to be geography agnostic. They allow ideas and funders from around the globe to participate in proposing and funding ideas.

Furthermore, crowdfunding that employs an all-or-nothing (AON) funding approach double as a marketplace that can vet/vote on high-risk ideas at a low cost (addressing some of the above questions around the technical elements of small grants).

Larger science funders could leverage crowdfunding by engaging with platforms to use their community or “crowd” to complement their top-down decision-making (balancing biases), and as a source of global “deal flow”.

This practically would mean experimenting with matched funding, or setting aside portions of their funding for the crowd to allocate on their behalf. The diversity of the community forming around each project would be assets for supporting the scientist, critiquing the science itself, and as an audience for science communication efforts.

In closing
Changing the risk paradigm in science is complicated, and will involve experimentation and new thinking.

Looking to venture capital gives us one model that can be used as the basis for things that could be tried. A venture capital approach to science grantmaking points to the need for new grant structures that target bigger risks in smaller more and incremental ways, and supported by funding mechanisms that are fit-for-purpose.

Though we have a ways to go, the silver lining in all of is that we have the tools, talent, and desire to make this change. We just need to take that first step, and take some risks.


Notes:
[1] Any solution for science funding must also consider one important caveat differing from the investment world: it should try to engage a broader audience in the funding decision-making process.

As an example, the philanthropy of billionaires that directs what research gets funded and what doesn’t is a growing concern from a funding “systems” point-of-view.

Thanks to Trevor for reading versions of this.