Equity Crowdfunding for Investors. Matthew R. Nutting

Popular Delusions and the Madness of Crowds 270 years before Kickstarter.

Oculus Rift Highlights the Difference between Rewards and Equity Crowdfunding

      The distinction between rewards- and equity-based crowdfunding zoomed into widespread consciousness in March 2014, when Facebook acquired Oculus VR for more than $2 billion. Oculus had two years earlier run a successful Kickstarter campaign, where it raised more than $2.4 million.

      On March 26, 2014, the Huffington Post posted an article with the intentionally naive title “I Backed Oculus Rift on Kickstarter and All I Got Was This Lousy T-Shirt.”

      Oculus VR, based in Long Beach, California, is an “immersive virtual reality technology” developer. Its very first product was Oculus Rift, a virtual reality headset for 3D gaming, which looks like big, industrial-strength goggles that wrap around the eyes and ears. The company launched its Kickstarter campaign in the summer of 2012 with a relatively modest (in hindsight) goal of raising $250,000. Backers who pledged $25 or more would receive as a reward an Oculus VR T-shirt. Those who pledged $275 or more would receive an unassembled Oculus Rift prototype kit. Several steps up the pledge ladder, backers who pledged $5,000 or more got 10 kits (and a T-shirt, poster, and a few other things) plus a full-day visit to the Oculus lab. Seven backers went for it.

      Oculus blew through its goal and raised $2,437,429 from 9,522 backers in about a month. The campaign closed on September 1, 2012. Backers eventually received their promised rewards. A consumer version of the Rift could be available in the spring of 2015. Everyone was happy.

      Then venture capital firm Spark Partners and hedge fund Matrix Partners each invested $19 million in Oculus. Facebook finally bought Oculus for $300 million in cash, $1.6 billion in Facebook stock, and another few hundred million in incentives (subject to Oculus meeting certain milestones). When that happened, the value of those equity investments by Spark and Matrix grew to about $380 million each, a 20x gain in less than a year.

      The Kickstarter backers had not bought equity in Oculus, but some of them posted crabby and even angry messages on the Oculus Rift Kickstarter page (and elsewhere). One backer, for example, wrote: “You selling out to Facebook is a disgrace. It damages not only your reputation, but the whole of crowdfunding. I cannot put into words how betrayed I feel.” The gist of most of the complaints was that the early backers deserved better rewards because they helped Oculus shareholders strike it rich.

      Mo Koyman, a partner at Spark Capital, responded to the ruckus by explaining: “Just because people say ‘Well I want equity in this company’ doesn't mean it's available. I don't think the Kickstarter backers were backing it because they wanted a financial win… They wanted to try it, wanted to experience it, wanted to see it. They got exactly what they bargained for.”22

      Business media outlets took the opportunity to explain that Kickstarter is not an equity-based platform, and the law did not allow average investors (the crowd) to buy equity on any kind of platform in the United States at that time, so backers (who received the rewards they expected) had no right to expect capital gains from their contributions. Bloomberg posted an article on the same day as the Huffington Post story, in which it distinguished between rewards-based Kickstarter and equity-based CircleUp. Bloomberg said that CircleUp “is among crowdfunding sites focused on letting individuals buy stock in startups,” and quoted CircleUp's CEO Rory Eakin, in a plug for equity-based crowdfunding: “Imagine if those early [Kickstarter] supporters were equity investors …”

Rewards as a Gateway to Equity

      As the Oculus Rift campaign on Kickstarter demonstrated (see sidebar), rewards-based and equity-based crowdfunding are two very different animals in terms of what you can expect in return for the funds you provide to startups. You can't buy equity in companies listed on Kickstarter, and, beyond the specific reward you sign up for, you can't share in the upside if the startup you fund gets acquired by Facebook for billions of dollars.

      Even if your aim is to be an equity crowdfunding investor, by first exploring a few rewards-based crowdfunding platforms you can learn a lot about the crowdfunding infrastructure and vernacular, the social media aspect of crowdfunding, and the collaborative nature of the crowd. It is a valuable orientation that will not cost you much. We recommend that you at least browse through the projects seeking backers, read the updated funding stats and comments posted by other visitors, and then register on the portal that you like most and spend a few tens or hundreds of dollars to experience the process. Perhaps acquire some new music or gadgets while you're at it, and maybe have more fun than you expected. See how it feels to be a member of a crowd. You can find various lists of crowdfunding sites (including “top 10” lists compiled by Forbes, Entrepreneur, GoFundMe, and others) by searching for “crowdfunding sites” on a search engine.23

      We strongly recommend that before you risk thousands of dollars investing via equity-based crowdfunding, you should become familiar with the crowdfunding concept and process in a relatively risk-free environment like the rewards-based version. Rewards-based crowdfunding platforms like Kickstarter can be good training, from a navigation and social point of view, for equity-based crowdfunding portals. We will help you learn the investing aspects of equity crowdfunding in later chapters.

      Debt and Donation Crowdfunding

      Before we introduce the equity-based version, it is worth looking at two more types of large-scale crowdfunding platforms that preceded equity-based crowdfunding in the United States: debt-based and donation-based.

      Debt-based (or what in the United Kingdom is called “lending-based”) crowdfunding began at the nonprofit level in 2005, when Kiva Microfunds was launched by Matt Flannery, a software programmer in San Francisco, and Jessica Jackley, who had worked for a microfinance institution in Africa. Kiva is now the fourth-biggest crowdfunding site in the world in terms of traffic, as measured by Alexa (a website information, analytics, and ranking service).

      Flannery and Jackley, a married couple, call their business model “person-to-person microfinance.” The Kiva website features individuals in the “developing world,” some of them impoverished, who apply for unsecured loans to build or grow small businesses, ranging from amounts as small as $25. In the beginning, Kiva featured only overseas borrowers, especially in Africa and Latin America. In 2009 it broadened its scope to include borrowers in U.S. and Canadian communities that are underserved by banks and traditional lenders, and in 2012 it introduced student loans (in a partnership with Strathmore University in Kenya). Kiva also serves borrowers in the Middle East, Southeast Asia, and India.