Bloomberg Businessweek (North America)
Crowdfunding star Kickstarter tries its own spin on VC funding
If an usual move, Kickstarter is quietly paying dividends to investors “I concluded that there was going to be a lot of cash flow, potentially”
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 ticking clock is one reason other venture investors question Kickstarter’s model
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 Indie.vc 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 Indie.vc 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.” �Joshua Brustein
The bottom line Kickstarter’s dividends highlight the growth of alternative VC investment strategies but are likely to remain the exception, not the rule.