Crowd­fund­ing star Kick­starter tries its own spin on VC fund­ing

In an un­usual move, Kick­starter is qui­etly pay­ing dividends to in­vestors “I con­cluded that there was go­ing to be a lot of cash flow, po­ten­tially”

Bloomberg Businessweek (Asia) - - CONTENTS - −Joshua Brustein

The tick­ing clock is one rea­son other ven­ture in­vestors ques­tion Kick­starter’s model

The re­la­tion­ship be­tween star­tups and ven­ture cap­i­tal firms is usu­ally pretty sim­ple. Star­tups plow ev­ery VC dol­lar they get into build­ing their busi­ness. The in­vestors get paid back if and when the com­pany goes pub­lic or is bought. Cash out or go broke—there’s not sup­posed to be any­thing in be­tween. So it’s more than a lit­tle weird that the ven­ture-backed crowd­fund­ing site

Kick­starter has qui­etly be­gun pay­ing in­vestors dividends.

The first checks went out in March. Among pri­vate tech com­pa­nies run on ven­ture fund­ing, this is un­prece­dented, says Anand San­wal, chief ex­ec­u­tive of­fi­cer of re­searcher CB In­sights. “It sounds strange for a VC-backed com­pany, as it means they’re tak­ing out and dis­tribut­ing money vs. in­vest­ing it in the busi­ness,” he says. Kick­starter con­firmed that it is­sued dividends but de­clined to comment be­yond that.

Kick­starter’s dividends fur­ther com­pli­cate its al­ready un­usual pro­file. Last year it be­came a pub­lic ben­e­fit cor­po­ra­tion, promis­ing to al­lo­cate 5 per­cent of prof­its to char­i­ta­ble ven­tures. At the time, Kick­starter’s founders also said it would pay taxes with­out re­sort­ing to loop­holes or other le­gal strate­gies and that they wouldn’t pur­sue an ini­tial pub­lic of­fer­ing. “More and more voices are re­ject­ing busi­ness as usual, and the pur­suit of profit above all,” they wrote in a blog post an­nounc­ing the con­ver­sion.

Since its 2009 found­ing, Kick­starter has told in­vestors it has lit­tle in­ter­est in sell­ing to a larger com­pany. It was co-founder Perry Chen who first sug­gested a div­i­dend as a way to re­ward VCs, says Fred Wil­son, man­ag­ing part­ner of early Kick­starter backer Union Square Ven­tures. Af­ter hear­ing the plan, Wil­son says, “I did the math, and I thought about it, and I con­cluded that there was go­ing to be a lot of cash flow, po­ten­tially, to div­i­dend out.”

The check Union Square re­ceived in March is the first in what should be a steady stream of in­come. Wil­son, who wouldn’t dis­close the ini­tial sum, says he can’t de­ter­mine how long it will take to re­coup his firm’s in­vest­ment be­cause he doesn’t know how big fu­ture dividends will be. “It’s still spec­u­la­tive, still early days to know how this is go­ing to play out,” he says. “Come back to me in 5 to 10 years.” He can’t wait for­ever. Like most ven­ture funds, Union Square’s is set up to op­er­ate for a decade. While that end date is easy enough to post­pone, Wil­son says he’ll have to sell the Kick­starter stake at some point.

The tick­ing clock is one rea­son other ven­ture in­vestors ques­tion Kick­starter’s div­i­dend model. Seth Levine, a man­ag­ing di­rec­tor at the ven­ture firm Foundry Group, says any com­pany ask­ing him for money must have the po­ten­tial to re­turn at least three times his ini­tial in­vest­ment. Levine is com­fort­able push­ing against the stan­dard model— like Kick­starter, Foundry just be­came a pub­lic ben­e­fit cor­po­ra­tion—but he’s skep­ti­cal that dividends are a win­ning strat­egy. “Can they get their in­vestors four, five, six times their money back with dividends over a rel­a­tively short pe­riod of time?” he asks.

Many ven­ture-backed star­tups make high-risk, high-re­ward moves, in­vest­ing heav­ily in growth with­out wor­ry­ing about short-term prof­itabil­ity. Kick­starter is also un­usual in that it’s been prof­itable since its sec­ond year. But its growth is slow­ing, in terms of both the num­ber of projects that get funded and the to­tal pledge money.

The fund­ing that went to Kick­starter projects dou­bled in 2013 but grew less than 50 per­cent last year, to $2.1 bil­lion. By Sil­i­con Val­ley stan­dards, that’s a wor­ri­some trend.

And what about Kick­starter em­ploy­ees? One great at­trac­tion of join­ing a tech startup is get­ting equity that can be­come as­tro­nom­i­cally valu­able if the com­pany goes pub­lic or gets bought. When it of­fered the div­i­dend, Kick­starter also of­fered to buy back equity from em­ploy­ees look­ing to liq­ui­date. “I know that was re­ally im­por­tant to the guys as they thought about this, mak­ing sure the peo­ple who broke their backs to help them get to a more prominent po­si­tion were taken care of fi­nan­cially,” says Joshua Styl­man, an­other Kick­starter in­vestor.

Kick­starter isn’t the only com­pany ex­plor­ing vari­a­tions on the typ­i­cal fund­ing model. Star­tups look­ing to hold on to their equity have be­gun sell­ing in­vestors re­deemable pref­er­ence shares, agree­ing to buy the shares back at a cer­tain point if they can af­ford to. On the other side, emerg­ing ven­ture firm In­ funds com­pa­nies with­out tak­ing an own­er­ship stake. In­stead, it buys an op­tion to con­vert its in­vest­ment into an own­er­ship stake if a com­pany goes pub­lic. Com­pa­nies that stay pri­vate pay the firm cash, al­low­ing it to re­coup up to five times the ini­tial in­vest­ment.

This is fringe stuff, and Wil­son, an In­ in­vestor, pre­dicts it’ll stay that way. “It may be a grow­ing piece of the mix, but I don’t think it will be how all com­pa­nies will op­er­ate in 5 or 10 years,” he says. “Ninety-nine per­cent of en­trepreneur­s are quite happy with the sys­tem as it is now. And, frankly, so are we.”

The bot­tom line Kick­starter’s dividends high­light the growth of al­ter­na­tive VC in­vest­ment strate­gies but are likely to re­main the ex­cep­tion, not the rule.

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