A friend e-mailed me a link to a question on Quora, which raises a really interesting question: Would a money-back guarantee on Kickstarter projects work? It got me thinking: Is there a way of offering protection to backers of a Kickstarter campaign?

Those fancy prototypes, crazy ideas, and ambitious spec-sheets never see the light of day.

Offering a money-back guarantee

It would potentially be possible to bake a guarantee into the contract between Kickstarter, the project creator, and the backer, but in trying to figure out how that would work, things get very complicated indeed.

Kickstarter’s current model is designed to enable artists and creators to take a big chance: To create something that wouldn’t otherwise be possible. If no Kickstarter project ever had a chance of failure, I don’t believe there would even be a place for Kickstarter in the funding landscape: The soil in which Kickstarter thrives is the risk of failure and the desire to make dreams a reality.

It is inevitable that more than zero percent of Kickstarter projects will fail, and the question becomes whether there a way of offering a money back guarantee for the projects that fail to deliver?

If you’ve ever been involved in developing a consumer product, you’ll be aware that product management is a seemingly endless series of compromises. Size vs cost vs battery life vs features vs reliability vs delivery timeframes — the list goes on. The universal truth is that no product ever makes it to the market exactly as it was originally envisioned, but usually that’s not a problem to the end user, because the customer never sees the product before it is finished. Those fancy prototypes, crazy ideas, and ambitious spec-sheets never see the light of day.

The one exception to that is the brave new world of crowdfunding. Prototypes and spec-sheets are frequently used in a Kickstarter campaigns, but the universal truth is still true: What gets shipped to early adopters of a Kickstarter campaign is extremely unlikely to be exactly what is pitched in the campaign. The challenge becomes to figure out what this truth represents against a backdrop of a money-back guarantee.

What is a ‘failure’?

If a project cannot deliver, and admits so, it’s a pretty clear-cut case: The product is never going to get delivered in any guise, and would trigger the cash-back guarantee.

But what happens when things are less clear?

1. Who is the arbitrator? There are examples of projects that are horrendously delayed, and where some backers don’t believe that the product is ever going to materialise. But the project creator says otherwise: The delays are explained, and the project is still alive. Who decides at which point the backers are getting their money back?
2. What is a ‘failure’? There are examples of projects that have delivered a product, but in the process of delivering, the scope changed, and perhaps a feature of a product was scrapped. To some users, this might be irrelevant (because they can make do without the feature, or they weren’t interested in that particular feature in the first place), but to others, that might have been the very feature they were hoping to use. In other words: The same product might be a complete failure to one person, and a complete success to another.
3. Is delay a failure? There are examples of products that did deliver, but did so many months — even years — later than originally indicated. At which point does one draw a line and call a project a failure?

It is easy to imagine how a project with 10k backers would end up with some very widely disparate opinions on the above.

Allow me to use the a fictional Smartwatch as an example: What if they had opened up for pre-orders and claimed 7days worth of battery life and shipping in February, but ended up delivering 2 days worth of battery life and shipping in May? Some people are happy to wait, others would want their money back by mid-February. Some people would cry bloody murder over the drop in battery life, others wouldn’t care. It becomes very hard to find out what a ‘failure’ is. This alone, in my mind, is a good reason not to offer a money-back guarantee: The sheer amount of administration and customer service manpower it would take to keep such a guarantee scheme operational is mind-boggling.

But, for the sake of argument, imagine for a moment that there was a way of agreeing on all of the above. That brings us to the next challenge:

Who offers the guarantee?

The other part of that question is, of course, who is offering the guarantee.

1. If Kickstarter had to offer a money-back guarantee, it would shift their risk profile significantly — the way things currently stand, they don’t have any involvement as soon as the campaign is fully funded, and as such, they have no way of policing the project as it goes through to delivery (or not, as the case might be for some projects).
2. If the project creator had to offer a money-back guarantee, I think many project creators would simply stop using Kickstarter. Of course, nobody starts a Kickstarter project with the intention of failing, but there’s always risks and pitfalls. If a creator had to offer a guarantee, they may as well get a bank loan. Should the project fail, there is just one party (the bank) to deal with, with a single contract and a single set of opinions about how a failure should be handled. The bank is unlikely to be emotionally involved in the project, whereas the same cannot be said for the backers (or, indeed, the project creator themselves). More importantly: It’s likely that a project failure would result in a bankruptcy, in which case the bank would only partially recoup its loan. This is a calculated risk from the bank’s point of view — they are used to taking these risks — but it’s difficult to see how this would translate to a group of Kickstarter backers, who have varying knowledge and experience with risk exposure. Put differently: from a backer’s point of view, this means that the ‘money back guarantee’ wouldn’t necessarily be a guarantee of a full refund in the case of a project failure, which is likely to cause even more confusion.

Offering insurance

In trying to think through the advantages and pitfalls of the above, however, it struck me that there is an alternative approach to a money-back guarantee: Insurance.

While it is difficult to know exactly what the risk of each individual Kickstarter project is, there might be enough data available to calculate a risk profile across the various Kickstarter categories. If that were doable, it might be viable to offer an insurance product for crowdfunding backers.

It could work something like this:

• An insurance company charges 15% of the backer value for an insurance scheme — i.e. you pay an additional, optional, $15 to insure your $100 pledge.
• Kickstarter gets a 10% kickback from the insurance company (so, in addition to the 3% ($3) they get from the pledge, they get $1.5 from the insurance company). By doing this, Kickstarter earns additional revenue, and the insurance company gets the marking they need.
• If the project fails, the insured gets the pledge (but not the insurance cost) back. In this example, that means they get $100 back, and in effect pays their insurance fee as a deductible.
• If the project succeeds, the insured over-paid by 15% to get peace of mind.

I’m not particularly well-versed in the world of insurance, so the below might be complete hogwash — but bear with me.

Considering that Kickstarter has so far taken $1.7bn worth of pledges, let’s do a quick calculation on the next $2bn worth of pledges:

• We assume that 10% of people would be willing to take out insurance
• We assume that 10% of projects ‘fail’ (and that we find a way of agreeing what ‘failing’ means)
• We assume that the insurance premium is 15%
• We assume that Kickstarter takes a 10% kickback from the insurance company.

For the first $1.7bn worth of pledges, Kickstarter had a total of 22m pledges, which means that the average pledge was around $75. If we continue with the above assumptions, that means that a 10% failure rate on 10% of insured pledges, you’re looking at around 260,000 claims.

To figure out whether an insurance scheme is viable, the real question becomes whether you’re able to run an insurance company with 260,000 claims per year with $7m worth of earnings, and still expect to operate at a profit. Insurance isn’t a cheap business to be in — there’s a lot of customer service overhead, legal costs, regulatory costs, etc.

I’d be delighted to be proven wrong, but my gut feeling is that there isn’t really a viable business model for running a crowdfunding insurance company.

SHOW ME THE MONEY?

To summarise the above…

• Kickstarter probably couldn’t offer a money back guarantee; it would be too much risk to take on.
• The project creators can’t offer a money back guarantee; If they could, they wouldn’t need Kickstarter in the first place.
• An insurance scheme would probably be too expensive to operate to be a viable business. .

TL;DR: No; it seems unlikely that a money-back guarantee is on the cards for crowdfunding anytime soon.