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How Trendy Funding Puts Pressure on Startups

Source: kickstarter.com

While entrepreneurs are discovering the possibilities of crowdfunding websites such as Kickstarter, upstarts are realizing crowdfunding isn't an easy fix for raising money.

Kickstarter and competitors such as Indiegogo are online funding platforms that connect entrepreneurs with potential backers.

Much attention has been paid to breakout successes such as Pebble, a watch that syncs with smartphones including Apple's iPhone. The venture raised millions this spring on Kickstarter.

But for some upstarts that use crowdfunding to raise early-stage funding, the results can be more mixed. The early buzz wears off and the funding platform may in fact put more pressure on entrepreneurs to deliver — often in a very public forum, where disgruntled comments can quickly go viral via Facebook, Twitter or other social websites.

(Read more: Lockitron: How a Startup Overcame Kickstarter's Rejection)

"A lot of people think Kickstarter is a pot of gold," said Eric Corl, co-founder of Fundable, a company that's applying crowdfunding to the venture capital process. ut crowdfunding doesn't make raising capital easy. "It makes it easier," Corl said.

In a Wharton School of the University of Pennsylvania analysis of Kickstarter campaigns, author Ethan Mollick found 75 percent of design- and technology-related projects on Kickstarter failed to meet promised deadlines. The research was released earlier this summer.

Turns out technology alone can't fix what entrepreneurs have known for decades: starting a new venture is a huge gamble.

New Kickstarter Rules

Since its launch in 2009, Kickstarter — the most prominent crowdfunding site — has grown in popularity. Unlike some competitors, Kickstarter does not accept all projects submitted for promotion on their website. Last month, the company published a blog post that stressed, "Kickstarter is not a store." Kickstarter also launched new guidelines, requiring entrepreneurs outline project "risks and challenges."

Source: Kickstarter.com

The post came as a few, high-profile projects received millions through the site to develop products — then only to miss shipping goals and leave backers frustrated. Smartphone watchmaker Pebble, for example, has faced scrutiny about shipments after receiving more than $10 million in funding from nearly 69,000 backers, according to Pebble's Kickstarter page.

Kickstarter declined to comment, and a spokesman pointed to Kickstarter's Sept. 20 post, which also featured new project guidelines for hardware and product design.

Pebble is not yet in mass production. Updates can be found here. "We've decided to hold off from announcing interim ship dates until we're certain we can hit a given date," Eric Migicovsky, Pebble's creator, said in an email.

Crowdfunding Growing Pains

Pebble's experience illustrates the challenges of seeking funders and managing expectations — essentially through the Internet for all to see and judge. What happens when they come in droves, even before you've built it?

Paul Gerhardt is co-founder of Lockitron, a combination door lock device and smartphone app that transforms your mobile device into a digital house key. When orders for their product exceeded expectations this fall on their crowdfunding website, Gerhardt and his team promptly notified funders about estimated production cycles. Rejected by Kickstarter in September, Lockitron creators fashioned their own online funding platform.

(Read more: Why More Millennials Go Part Time for Full Time Pay)

Overall, Gerhardt said the potential of reaching financial backers through crowdfunding outweighed the risks of sharing their nascent product with the public. The first version of Lockitron attracted roughly $100,000 in sales without crowdfunding. With the second-generation launch of Lockitron this year on their crowdfunding site, they've received more than 13,300 backers with nearly $2 million in pre-order sales, according to their website.

"When starting a business, it all comes down to risk assessment," Gerhardt said. "Letting the public see that other people are buying is very important for a new product."

How Crowdfunding Works

Crowdfunding broadly allows founders of nonprofit, for-profit, artistic and cultural ventures to fund their projects by collecting relatively small contributions from a large number of individuals — often strangers — through the Internet.

Since its founding in 2009, Kickstarter contributors have invested more than $300 million in more than 31,000 projects.

Entrepreneurs set funding goals and deadlines — or risk losing all the money raised that comes under the total target — which is how Kickstarter works. About 44 percent of projects featured on Kickstarter have been successfully funded. In contrast to Kickstarter, Indiegogo lets entrepreneurs keep money raised — even if they fall short of the total funding goals.

In exchange for promotion, both sites pocket between roughly 4 and 9 percent of the total funds raised.

And while Kickstarter's projects are curated, Indiegogo is open to all entrepreneurs and has about 6,000 live campaigns at any given time vying for attention on its website.

Source: The Can Van

Indiegogo has allowed startups such as The Can Van in Belmont, Calif. to move forward as a venture. The Can Van is a mobile business that helps small craft breweries can their beer for distribution. They raised about $4,000 of its $10,000 goal through Indiegogo.

While the funding campaign fell short of their total goal, they pocketed the $4,000 raised — and plenty of local media exposure, said The Can Van co-founder Jenn Coyle Catalano.

A New Path for Upstarts

But for every success story like The Can Van, there are crowdfunding growing pains. With the initial buzz of crowdfunding waning, funders are discovering first-hand the pitfalls of investing in early-stage projects. Crowdfunding sites don't offer refunds of pledges — whether you change your mind, or if the product is delayed for some reason. You're out of luck.

Despite the risks of using crowdfunding, there's no denying the new platform is reimagining the path of upstarts. Crowdfunding is an opportunity for entrepreneurs, who might have been bypassed by traditional investors such as banks and private equity.

The Lockitron team got started with angel investors but other, traditional capital sources were closed to them. Banks don't like to give loans for unproven projects and private equity largely is relegated to projects much larger than Lockitron, Gerhardt said.

That's where crowdfunding can create new opportunities for a group of entrepreneurs, who may have been denied capital in the past.

"Crowdfunding might identify underserved markets and undeserved startups," said Thom Ruhe, vice president of entrepreneurship at the Kauffman Foundation. "It has the potential to lead the traditional funding community into new areas. Smart money likes to follow smart money," Ruhe said.

(Read more: A Tech Apprenticeship to Rival Peter Thiel's?)

As the seed-funding space continues to change and mature, the bottomline so far is: even crowdfunding is a lot of work. Most campaigns raise the first 20 to 30 percent of their total goal from friends and family, said Danae Ringelmann, co-founder of Indiegogo. Entrepreneurs then have to roll up their sleeves and tap their entire network.

Email us at SmallBiz@cnbc.com and follow us on Twitter @SmallBizCNBC.

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