by : Business, Featured Articles, Oct. '12

Crowdfunding’s Logic

Crowdfunding’s Logic

Crowdfunding is quickly becoming a useful alternative for musicians looking to pay for the production and distribution of their albums and concert tours. As will be shown, crowdfunding is a quantum leap from traditional record label financing. Furthermore, US sites have so far only accepted pledges, i.e. donations against some form of merchandise or service return, when the project is completed. However, the medium will become much more complex when the JOBS Act goes into effect early next year and regulations are relaxed for small businesses seeking to raise equity capital (JOBS stands for Jumpstart Our Business Startups).

Artists seek financial support and fans provide it. But there are upsides and downsides.  We start by exploring three of the best-known music crowdfunding sites: Kickstarter, IndieGoGo, and PledgeMusic. All three feature common elements: the project in an ad-hoc self-contained webpage, a video presentation, an outline of the fundraising goals, and, finally, the list of rewards offered to contributors.

Pledge Music is the most musician-centric website: it is only for musical projects and serves musicians to the exclusion of other creative professionals, like filmmakers or fashion designers. A team of industry experts reviews the project submissions and chooses the most likely to succeed. The selection reduces clutter and guarantees minimum standards, driving contributions up by simplifying searches by genre and other fields. Pledge Music also offers third-party integration with iTunes and gives artists the opportunity to give a portion of the proceeds they make to a charity of their choice (nine-tenths of all the projects fit this category). If the project does not reach its estimated fundraising goal, there are four options: contributors can ask for a refund, send the remainder of their monies to the charity listed under the project, pledge cash toward another project, or pay the project originator anyway. Pledge Music likes to point out that not once has a project failed to be funded in its three-years of existence (www.pledgemusic.com).

IndieGoGo’s model is based instead on a laissez-faire philosophy. Creative projects, personal petitions, and charity campaigns are all game here. There is no filtering process and little effort is required to get a webpage up and running. As projects compete for contributors across multiple categories, browsing for the numerous music ventures is tricky. Recently, the website updated its browsing capabilities by keyword, category, city, and neighborhood (‘near me’). But the sheer variety of non-musical projects and the unevenness of its musical offerings are not conducive to IndieGoGo becoming a standout platform for music financing. Some artists, though, will argue that it is the only site that allows them to keep all the pledges, regardless of whether or not a funding goal has been met (www.indiegogo.com).

Kickstarter is the best run website of the three, and has an effective search engine.  Its analytics underline the value of music, which makes up more than one-fifth of its projects and pushes the activity into a top $1 million + earner (with video games, design, technology products, and comics). Moreover, the site has shown the most potential to tap record-breaking amounts for music. Before May 2012, music led pledges in the $1,000 to $9,999 range, but after Amanda Palmer’s spectacular debut in June, music made Kickstarter’s top ten activity list. Palmer surpassed her goal of $100,000 early and sold high-ticket rewards easily—34 backers gave $5,000 each and another two gave over $10,000.  She collected $1.2 million from fans, many of whom donated as groups for the consideration of special private parties at her home. The success rate of music projects is just above fifty percent, even though the site is curated (www.kickstarter.com).

The Argument

The crowdfunding goal that an artist sets can help her make a profit if the campaign is successful. This is because if she budgets well for the costs of recording, touring, merchandise supplies, and the delivery of the rewards to fans, extra revenue from album or ticket sales becomes pure profit after the goal money is collected. By then, an interest in the project will exist among core fans and all initial marketing objectives will have been largely accomplished.

The fan base may have to be there, because an unknown artist will not be able to raise funds effectively.  Friends and family might help. But the point of crowdfunding is to broadcast the project to a wider audience, and relatives and acquaintances need not go to, say, Kickstarter to give financial assistance. In that case, record deals, if available, are more practical, because a label is willing to take a risk and fund a project in the early stages of an artist’s career. There is no guarantee of recoupment, but the album will get produced and a tour will likely follow.

Yet, if an artist can take a more organic path and grow his fan base slowly, crowdfunding may eventually be the better option for a long-lasting career.  This was Amanda Palmer’s path, and her decision is ultimately explained by the high cost of traditional record-label financing.

In a traditional record deal, a record label has to break even with an artist before it pays out artist royalties of between ten to fifteen percent of the retail price of a track or album. If that does not happen, the label recoups its earlier advance and the artist is not paid her royalty. As there is a lack of transparency in how exactly the record label is determining an artist’s break-even point (for instance, record labels might want to collect on earlier unsold releases by that artist or more dubious packaging deductions), there is a fair amount of conflict between the label and the artist. The presumption is that the label has the power and will err on the side of caution, hurting the artist.

This budgeting resembles a top-down approach, where the label’s loan repayment schedule is determined by forecasts and comparisons that may or may not have validity for a specific project. Instead, artists who use crowdfunding will likely be using some form of a bottom-up budgeting approach. They, not the record label, will determine how much it will cost to produce an album, pay for the perks they give contributors, fund the tour, and buy the merchandise ahead of time.

The break-even point of crowdfunding, in short, is defined in the artist’s own fundraising goal, and to her it is both personally manageable and far less fuzzy than it might appear in her dealings with a label. Moreover, the selling price of her album or track is no longer as critical of a revenue piece as it was in the traditional break-even approach. Finally, crowdfunding tends to steer clear of the new “360 degree” deals that give the record label much more leverage over all types of artists’ income.

Crowdfunding also has an important non-economic value when compared to more traditional record label financing. It allows fans to become involved in the process of creating the very product and service that their artist provides. Fans can take an active role making sure the artist they admire is able to make more of the music they have come to love. Musicians can give fans a way to connect with others through music. This ecology of common bonds deepens the connection of an artist to his fan base, gives it more integrity, and builds loyalty.

There is, no doubt, a darker side to crowdfunding. Amanda Palmer had to justify how she would spend the pledges she received because fans could not be certain that she had not asked for more than she needed in order to put out her next record and run her tour. There is, really, no guarantee that crowdfunding will diminish suspicion about the uses of the money tendered. The burden of proof will now shift to the artist, who will have to account for any perceived lack of transparency. Moreover, because there is still little government oversight, the success of crowdfunding campaigns could be tainted if even a small subset of artists showed little integrity or desire to be accountable to the public. Of course, it would be not be in their best interest to do so, for they could hardly expect to raise more money that way.

The same could be said if there are abuses under the umbrella of the new JOBS Act.  If regulatory procedures are relaxed to encourage online investments in startup businesses, more savings will be tapped. The danger, again, is that the threshold for transparency and accountability will be less than, for instance, in an existing initial public offering of stocks (IPO). The comparison may appear farfetched because there is far more money being invested in a typical IPO than in a crowdfunding project. Yet, there will be many such smaller ventures than IPOs. Moreover, like the New York Stock Exchange or NASDAQ, unless the public feels safe pledging money, a few serious mishaps could eventually taint perceptions and deter pledges.

By Troy Church


 

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  1. sheri says:

    Great article.Well written.

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