When Kickstarter Investors Want Their Money Back
As Neil Singh logged onto his computer one evening in March 2011 to research stands for his iPad, he never imagined he'd end up suing an entrepreneur he had never met--eventually forcing that entrepreneur into bankruptcy.
After surfing the Web for a bit, Singh, a Phoenix, Arizona insurance lawyer, inadvertently ended up on crowdfunding site Kickstarter. He stumbled onto a page promoting an iPad stand called the Hanfree. Singh wasn't familiar with Kickstarter's platform, but he liked what he saw on the screen: a stand with a flexible neck so its user could prop the iPad on any flat surface.
The page included photos of the product, and a sleek video showing the Hanfree propped in various spots around a loft apartment decorated with reclaimed wood credenzas and a designer wall clock. The language on the site appeared sanguine:
- "For a $50 pledge you are pre-ordering Hanfree."
- "Hanfree will be constructed from the highest quality materials and made in the United States."
- "The limited edition Hanfree will be made in San Francisco out of sustainably forested alder, and will be numbered and signed by the designers."
The page included a picture of the early prototype and pictures of the Hanfree's creator, Seth Quest, a designer in San Francisco.
For less than a hundred bucks, Singh thought, why not?
"I didn't know anything about Kickstarter," he says. "I was a typical backer like anyone else. I came across this iPad stand. To me, it looked like a cool thing you could buy. 'If you give me $70, I'll send you one of them.' I didn't do any due diligence. I didn't think I had to. I'm not investing. I'm not doing the same sort of things a potential shareholder would do. I'm just buying a product."
The Hanfree case serves as an allegory for Kickstarter's growing pains as a crowdfunding platform, a largely new and unregulated world in which anyone with any idea--good or bad--can get paid to create it, largely without any vetting or approval process from the site itself. It forces the discussion of what Kickstarter owes to the people who use the service. And the case raises fundamental questions that go to the heart of what means to "crowdfund" in the first place, when there are no customers (just backers), no products (just projects), no business owners (just creators), and no payments (just pledges).
Since its inception, Kickstarter has focused its external messaging as a "funding platform for creative projects," but as more entrepreneurs begin to use the site to fund physical projects, just what constitutes a "project" has been thrown into question.
In Hanfree's case, Singh wasn't the only one who thought the product looked good. By May 11, 2011, the Hanfree reached its $10,000 goal, and then some. In total, Seth Quest, and his business partner, Juan Cespedes, raised $35,004 from 440 backers--an average of about $80 for each investor.
The celebration around the project's funding success, however, was short-lived. Once funded, Quest needed to build the stands, manufacture them, and ship them out to his backers. This quickly became problematic.
"They can tear you down if you fail."
Quest, a product designer by trade, had never started a company before. And he'd never manufactured a product. Weeks--then months--went by with no product and no update for the backers. Hanfree's Kickstarter page, with over 600 comments, became a sounding board for the frustration--and anger--of its most vocal backers, especially Neil Singh.
On August 2, 2011, nearly five months after Singh pledged his $70, Quest wrote: "As far as timeline goes, we are still negotiating with manufacturers and anticipate getting all of the parts to assemble Hanfree mid-October, and are setting a new target to ship November 1st."
November 1st came and went. "I would say it's time for a new update," one backer wrote.
Four weeks later, on Nov 28, 2011, Quest posted an update explaining that the Hanfree project had officially failed, and said he planned to offer refunds to backers.
It wasn't enough for Singh. Kickstarter's terms make it clear that project creators must "refund any backer whose reward they do not or cannot fulfill." So when weeks passed without receiving one, Singh threatened a lawsuit.
Other backers, like Aza Summers, disagreed with Singh's approach. "Those on this thread who are treating Seth with such harsh judgments and threats of lawsuit (over a $50 or $100 pledge?!) are not the kind of people that I would expect to be the usual kickstarter [sic] backer type," Summers wrote. "It seems to me that Seth has acted in good, if naive, faith, and will do his best to compensate us backers, either by moving the project forward or by a settlement offer."
But Singh was adamant.
"Seth just stalled, and stalled, and stalled," Singh says. "For me, this is why I became a lawyer. I guess I'm more of an idealist than anything else. It just ticked me off."
In May 2012, Singh filed paperwork in Arizona's Justice Court citing breach of contract. He sued both Quest and his business partner, Juan Cespedes, though he eventually dropped the case against Cespedes.
Your backers can give you massive support, but they can also tear you down if you fail. -Seth Quest
About 750 miles away in San Francisco, Seth Quest was having chest pains brought on by anxiety. He wasn't sleeping, he says.
Because he never incorporated Hanfree, Quest was personally liable for the refunds. But the money from the backers was gone, spent on engineers and contract manufacturers. The lawsuit forced him into bankruptcy. From there, things only got worse.
Later that year, Quest moved to Brooklyn, but because of the damage to his reputation, he could only find part-time work in what he calls a non-design-related field. To deal with his anxiety and hypertension, he picked up yoga and joined a boxing gym. These days, he's doing better, but it's a part of his life he hopes to move on from.
"When you fail on Kickstarter, it's a very public failure," says Quest. "It definitely derailed my career substantially. Your backers can give you massive support, but they can also tear you down if you fail."
"More stupidity than fraud."
So, what happened? For one, Quest did not have contracts already in place before he went on Kickstarter--a novice mistake. Once the Hanfree was funded, Quest says, he began contracting with accessories manufacturers in China, Singapore, and Los Angeles. But because those manufacturers were able to see precisely how much money Quest had raised on Kickstarter, Quest says they gained too much leverage in negotiations, chipping away at the product's margins. It soon became too expensive to create the product with the funds raised.
At the same time, Quest's relationship with his Hanfree team began falling apart. "One of the people in my team demanded 50% of the company, and held the design files hostage," Quest says. Ultimately, though, Quest says that Hanfree "failed because of complications with engineering."
He was unable to raise outside investment because of the turbulent relationship with his team.
Singh has his own hypothesis. "I'm convinced this was more stupidity than it was fraud. He just didn't think this through."
According to Singh, his lawsuit was the first ever to be brought against a project creator on Kickstarter, but he has a feeling it won't be the last.
Confusion about the site's mission, it seems, is fairly widespread. In September 2012, the New York City-based company's co-founders addressed this issue head-on in a blog post titled "Kickstarter is Not a Store."
"It's hard to know how many people feel like they're shopping at a store when they're backing projects on Kickstarter, but we want to make sure that it's no one," the founders wrote. "Today we're introducing a number of changes to reinforce that Kickstarter isn't a store--it's a new way for creators and audiences to work together to make things. We'd like to walk you through these changes now."
Perhaps the most important change the founders announced that day was that project creators will be required to reference specific "risks and challenges" in their project proposals. (It's unclear if the Hanfree case influenced their decision to make these changes, but it seems likely.) The company also introduced several new hardware and product design project guidelines, which prohibited product simulations and renderings. Today, many of the renderings on Hanfree's Kickstarter page--like that glossy video of the loft apartment--would not be allowed.
The founders concluded the post, saying, "We hope these updates reinforce that Kickstarter isn't a traditional retail experience and underline the uniqueness of Kickstarter."
'Hope,' here, is the operative word. It may not be enough. Kickstarter is quickly becoming one of the most popular methods for entrepreneurs to fund the creation of their products. This week, in a year-end recap, the company boasted that in 2012, 17 projects raised $1 million or more, including the Pebble watch, the most money raised by any crowdfunded project ever, at $10.3 million in pledges.
The founders certainly recognize this issue ("It's not Best Buy," one of the company's co-founders, Perry Chen, recently said of the site), but as it gains popularity, attracting users who may not be familiar with its mission, it's becoming increasingly important that Kickstarter find a way to clearly and succinctly communicate this message throughout its site and on its project pages--letting backers know that they are not actually buying a finished product.
To be fair, Kickstarter is working hard to make the message clearer. In August 2011, the company began requiring project creators to include an "Estimated Delivery Date" for all project deliverables. And as of May 2012, when a user clicks 'Pledge' on a project page, Kickstarter now displays a message in the upper-right hand corner of the page: "Kickstarter does not guarantee projects or investigate a creator's ability to complete their project. It is the responsibility of the project creator to complete their project as promised, and the claims of this project are theirs alone."
Kickstarter wasn't immediately available to comment on this story.
More money, more problems.
Of course, it's not all bad. Kickstarter's origins--in music, art, and film, especially--have funded hundreds, if not thousands of laudable, engaging, and award-winning projects. In fact, the idea for the company originated in 2002 when Perry Chen, one site's co-founders, wanted to organize a $20,000 concert in New Orleans, but didn't have the money to secure a venue. Some projects have gone on to critical acclaim, too: About 10% of the films at Sundance this year, for instance, have Kickstarter roots.
But the knowledge and experience it takes to create a physical product--one that often needs to be manufactured overseas--relies on a different set of skills and relationships. Simply put: Entrepreneurship isn't art.
To the uninitiated, manufacturing physical products can be an incredibly tricky business, especially when it comes to contract manufacturing, designing product runs, managing inventory, shipping, logistics, etc. Quest certainly isn't the only Kickstarter user to discover that.
Take Flint and Tinder, for example. In April 2012, the Brooklyn-based underwear manufacturer set up a $30,000 goal, to create American-made underwear, but raised nearly $300,000. While the outsized backing may seem like a success for its creator, Jake Bronstein, it created a manufacturing and logistical nightmare. With all his new "customers," his manufacturers told him they'd no longer be able to meet his time frame for shipping. He ended up shipping items three months late, and only because he was able to secure nearly $1 million in venture capital.
While "the vast majority of founders attempt to deliver products promised to funders," according to a July 2012 study from University of Pennsylvania professor Ethan Mollick, "relatively few do so in a timely manner, a problem exacerbated in large or overfunded projects." Mollick examined a dataset of 47,000 Kickstarter projects amounting to $198 million in contributions.
In total, Mollick found that 75% of companies deliver products later than promised. Customer satisfaction is also an issue. After all, many backers have high expectations for products that don't even exist yet.
The pitfalls of dumb money
About six months ago, Sam Fellig, a Brooklyn-based entrepreneur, taught himself code and founded Outgrow.me, a marketplace for successfully funded--but not necessarily successfully created--Kickstarter and Indiegogo projects. It's an interesting business, especially in light of these concerns.
For now, Outgrow.me earns revenue by selling successfully funded--and successfully created--projects. Fellig explains he's taken on a small amount of inventory at wholesale prices from these crowdfunding designers, and resells their items directly on his site for profit.
I think most people think there's some designer working late at night at his firm and he has this genius idea for a project related to what he's doing, but the reality is it's generally anyone. Anyone can be that Kickstarter savant. -Sam Fellig
The experience has given Fellig insight into the world of crowdfunding. A few months after Outgrow.me launched, Fellig began receiving interest from the designers themselves, who requested that he feature their items. He met with several of them, and while he recognized the passion these designers had for their products, he was disturbed by their lack of business acumen.
"I'm not sure if I'd use the word naive, but they're definitely inexperienced," he says. "I've sat down with several designers who have been funded--in the hundreds of thousands [range]. And I asked them 'How many of you have experience in the project you created?' There wasn't one. That's pretty remarkable. I think most people think there's some designer working late at night at his firm and he has this genius idea for a project related to what he's doing, but the reality is it's generally anyone. Anyone can be that Kickstarter savant."
He adds, "This whole idea of crowdfunding is that you're getting rid of VC's quite often. It's not just about getting dumb money--you want smart money. And you lose that when you go through the crowdfunding route. You lose the smart money."
Kickstarter's staff recognizes this problem, but seems to view it as a user hazard that isn't their responsibility. Carefully reading Kickstarter's terms, you can see how the company rather bluntly sets up the relationship between backer and creator in order to indemnify themselves against any legal action, should a successfully funded campaign fail to deliver:
By creating a fundraising campaign on Kickstarter, you as the Project Creator are offering the public the opportunity to enter into a contract with you. By backing a fundraising campaign on Kickstarter, you as the Backer accept that offer and the contract between Backer and Project Creator is formed. Kickstarter is not a party to that agreement between the Backer and Project Creator. All dealings are solely between Users.
At the same time, Kickstarter receives a 5% commission on successfully funded projects, regardless of whether or not the project creator delivers on his or her project. This is important, because Kickstarter acknowledges that lawsuits--similar the suit filed by Singh--are within bounds if the project creator fails to deliver a product. Failure to fulfill the product or refund the money "could result in damage to your reputation or even legal action by your backers," the site's terms say.
Quest knows this damage all too well. Today, he's in Costa Rica, researching his next venture, which he says will be a company with a social mission. After Costa Rica, he plans to move to Los Angeles.
He has tips, he says, for other entrepreneurs who want to crowdfund projects on Kickstarter. First, he says, keep the product simple. If the product has multiple parts, the incremental costs of manufacturing can be deadly. It's also essential to have a prototype of the product, and at least three price estimates from manufacturers--in writing.
Kickstarter, he adds, "changed the course of my life and how I operate." It seems obvious now, but "there's a huge gap between having an idea, and designing a product, and actually manufacturing something."
PRINT THIS ARTICLE