Published: December 11, 2017
I’ve been doing some more thinking about Patreon’s change to how they will be billing patrons and what it might mean for them, from a financial perspective.
It’s become clear that they are de-aggregating pledges, so instead of charging patrons once per month, they will be charging them per pledge. I am so glad that I was wrong about that, because that would have been beyond basic evil and into the advanced sort of evil. I'm pretty sure that this is your garden-variety incompetent evil.
Previous posts on the subject can be found here and here.
Incidentally, this is all speculation on my part. I don't have any actual proof and I may be interpreting things incorrectly. ¯_(ツ)_/¯
The reason given by Jack Conte was that this shift will reduce the number of people complaining about being double charged when the actual issue is that they don’t know how to read a calendar and they support a creator who has enabled the charge up front method of payment. And the reason why they instituted that is that there are creators who had a problem with people subscribing at the top tiers, pulling out all the patron-only content, and then unsubscribing before they were billed. (Which is an actual problem, but there are other ways around it than making a whole new type of payment method which adds unnecessary complexity.)
Right away it’s clear that one of the reasons behind this change is to placate both high value patrons and high value creators by minimizing complaints by both parties (the rest of us, apparently, can go fuck ourselves). Or, as Patreon’s growth team likes to call them, FSCs (Financially Successful Creators).
Christie Koehler also has a compelling theory about Patreon not wishing to be regulated as if they were a money services business, Jason Yu speculates that this may be a move to reduce “friendly fraud”, and Siderea speculates that Patreon has been losing an awfully of money on the $1 pledges. The reality is this: when a decision this significant which affects so many people is made, there are usually multiple factors influencing it.
But back to my theory about Patreon’s growth strategy, their investors, and FSCs.
As Tal Raviv, the Growth PM at Patreon said back in June to Brian Balfour:
We’d rather have our GMV be made up of fewer, but truly life-changed creators rather than a lot of creators making a few dollars.
Balfour continues:
This is because while active FSCs do bring on significantly more Patrons (the fans who support them), they also bring on more Creators. The bigger their success, the greater the aspirational value it carries.
In an AMA on GrowthHackers back in August, Raviv says:
what we’ve observed in our data and user interviews repeatedly is that the most successful creators on patreon have built established passionate followings online and post regularly (daily, weekly, even monthly) and share with them regularly.
I’m not going to argue with the concept that the people who are most successful on Patreon are people with established followings—that’s basic common sense.
What I am going argue about is Patreon’s definition of what success is.
Raviv again, in Balfour’s essay:
We have very clear, rigorous internal criteria for what we consider financially successful there is a specific threshold that we've found to be "life-changing" for our Creators.
It's a number where we believe the platform has meaningfully changed a creator's life and ability to create more, focus more on their craft, and in many cases go full time.
However, Patreon will not divulge what the financial metric is, but we can get an idea based on the qualitative criteria that was shared in Balfour’s piece:
The criteria for defining a “Financially Successful Creator” are context-driven. Finding Financially Successful Creators hasn't hinged on absolute numbers of followers or an absolute publishing threshold. Instead, the team looks for a qualitative combination of engagement, how consistently the people who are engaging are engaging, and the professionalism of public-facing materials.
Engagement is basically how often you interact with the thing. So the more people you can bring with you to Patreon and the more often you get them to access the content there are leading indicators of success.
And then there’s the professionalism of public-facing materials part. That is a completely subjective criteria and, to be blunt, some gatekeeping bullshit.
Let’s dig into this a little bit more.
GMV stands for Gross Merchandise Value. I thought it was Gross Market Value, but then Kip Manley tweeted that he’d looked it up, and after I responded with that assumption, I thought I should look it up myself.
According to Investopedia—as good a source as any, this is what GMV measures:
Gross merchandise value is the total value of merchandise sold over a given period of time through a customer to customer exchange site. It is a measure of the growth of the business, or use of the site to sell merchandise owned by others.
This metric can be used as an indicator of how well the business is doing in terms of revenue. It’s also useful as comparative measure over time. It also seems to not be metric that many online businesses use anymore.
And here’s the most important part of how GMV is calculated. It is calculated before any fees or expenses are deducted.
I’ll get back to that in a bit—I want to contextualize the importance of that metric to Patreon. And to do that, I need to explain how venture capital works and what market value is.
In September, Patreon received $60M in Series C venture capital. I don’t know a whole lot about the different levels of venture capital, so I headed over to Investopedia again to educate myself.
There are four rounds of funding start-ups can receive from angel investors and venture capital firms. The individuals and firms who invest in start-ups typically get equity in the company, which positions them to recoup their investment and more after a successful IPO or acquisition.
The first round of investment is the seed capital, which is intended to get the business established and helps it become operational. This would include things like market research, paying the founders’ salaries, software development, et cetera.
The end goal of seed capital is a product launched for a target audience. Investors in this round are often angel investors who are comfortable with a high degree of risk and are often investing more in the founders than they are in the product or business.
After this, there are three stages of investment, called Series A, B, and C.
The Series A round happens after the business shows it has some potential and is intended to help the business optimize and refine their product and user base. So you’d see more market research and feature development as well as a plan to build an actual business model beyond “Hey, we want to make this cool thing! Can we have millions of dollars?”
The investors at this stage are more traditional venture capital firms as opposed to individuals and angel investors.
Series B funding is intended to take the business beyond the development stage and into growth. By the time Series B rolls around, the investors have figured out how successful or not the company will be. This is when start-ups typically hire more people to work on the direction functions in a business. (Cynically, I suspect that this is when many start-ups also bring in HR and finance/accounting experts.)
In addition to the previous round’s investors, there will be more investors participating in this round, firms which specialize in late stage venture capital.
And finally, there is Series C funding. This is used to scale the company up in an effort to receive a significant return on investment—this can include acquiring other companies in order to create synergies. Investing in the company is much less risky at this point, so there are a lot more players beyond venture capital firms. This is when investment banks, hedge funds, private equity firms, and the like become involved.
And a large part of how firms decide on Series C funding is market value.
Market value is pretty easy, actually: it’s how much the asset (in this case, the company) would fetch in the market place. This is an indicator of how bullish the investors are on the company’s chances for success. There are a lot of metrics that go into market value and there can be a lot of variability in those metrics.
In September, Patreon received $60 million of Series C funding with a market valuation of $450 million.
There are, altogether, around 15 different firms and individuals who have invested in Patreon, not every firm or individual has invested in each round. There has been a total of $107.1 million of venture capital invested in Patreon.
All those entities would like to see a return on their investment and they believe that the value of Patreon if it were to go on the market is $450 million. There is no way for us to know how that valuation was determined—there are a lot of different methods—but I can draw a few conclusions based on the high valuation of Patreon and on their focus on FSCs to drive their GMV metric.
One point to keep in mind is that the investors have significantly more say in the company’s decisions at this point than the founders. That’s just a fact of life when you choose to accept venture capital--it is unlikely that the founders were able to negotiate anything differently here.
By focusing their growth strategy on FSCs and patrons in the higher subscription tiers and keeping them happy, Patreon recognizes that they can use those FSCs to pull other creators into their platform on both an aspirational basis and on a word of mouth basis.
If Patreon can raise the average patron donation amount from $12 per patron to something higher as well as attract and retain more people who are collecting more money per month, then they look much more attractive to potential buyers or for their IPO. And, of course, the founders and early employees with options stand to make a bundle when that happens.
Discouraging smaller creators and patrons would also reduce the overall number of transactions they need to process per month and, under the old billing plan, fewer transaction fees to absorb and distribute to creators.
If they’re distributing $150 million this year to 50,000 creators from one million patrons that means they are—very roughly—grossing $162.8 million a year. Since the product they sell is the aggregation of micro transactions, that makes their GMV around $162.8 million.
Here’s how I back-calculated that number:
Their valuation for their Series C funding was $450 million.
I was trying to figure out how valuation and GMV are related to each other, because it’s clearly not a one to one correspondence. I found an article by Ryan Caldbeck, the founder of a private equity firm which explained it in a way that I could understand:
Marketplaces, particularly pre-IPO marketplaces, are typically valued off of a multiple of run-rate GMV (i.e. existing month x 12). For our company’s fundraising rounds, we have gathered data on marketplace comps and found the valuation multiple is often 1-2x the run rate GMV, with an average of 1.4x and a median of 1.3x.
Patreon is essentially a marketplace: they connect patrons with creators and take a percentage.
If I go the conservative route and use the 1.4 multiplier provided by Caldbeck, the valuation based on the existing GMV of $162.8 million should be $228 million. That is, of course, not taking the hype multiplier into account—if you divide $450 million by $162.8 million, you have a multiplier of 2.8, which is significantly higher than 1.4. If you divide $450 million by the more conservative 1.4 multiplier, the GMV needs to be $321 million.
Either way you look at it, the numbers don’t work based on the information that Patreon is putting out in their press releases.
How can you increase your GMV? Remember, GMV is a metric calculated before fees and expenses are deducted.
But how do you increase the gross price of your product when your entire product is based upon people deciding how much money they are going to give you?
Easy. You move the fees that aren’t tied to your cut away from the person receiving the funds to the person providing the funds. And when most of the people providing funds are supporting multiple people for a small amount each—between $1 and $5 per month—you can easily increase your GMV.
Or actually, not that much math. Because there’s Graphtreon and they have done all the data-scraping and number crunching I need!
According to Graphtreon, there are 2.9 million individual pledges with a planned monthly payout of $10.1 million for December. Let’s annualize that to $121.1 million and assume that there are, as Patreon says here, that they have 1 million patrons.
Under the old system, creators would get $110.5 million of the $121.1 million paid by creators. Patreon would get $6 million, and the rest would go to the payment processors to the tune of $4.6 million.
With the new system instead of collecting $121.1 million, you collect $136.7 million. Patreon still gets their $6 million, and the payment processors get a whopping $15.5 million.
In terms of improving GMV, this helps, but not very much. And that’s where I get really confused by the strategy here, because the vast majority of the revenue is coming from small donors and is going to small creators. The FSCs are such a small percentage of the total that it doesn’t seem necessary to recruit them in order to improve your financial metrics. You want more small creators and small donors.
You also want to negotiate a better rate with your payment processor than what you’re telling everyone—this is a thing that is possible with Stripe as long as you’re bringing in more than $150,000 a month.
Clever readers will notice that this is a lot less than the $162.8 million I calculated above. So let us pretend that the $150 million target for creator payments is correct.
Annualized income including Patreon’s cut is $158M. When you add the $16.6 million for processor & transaction fees, this brings the total collected to $174.6 million
This brings the conservative valuation on a GMV of $174.6 million to $244.4 million. Still not enough. Patreon needs to nearly double in size prior to their IPO or acquisition unless they want to run the risk of being de-valued and that means they can’t pay back their investors or make bank.
Oh, and about GMV? It appears that businesses that find it important are essentially trying to catch the long tail. Which makes sense, but that needs to be baked into your business model from the very beginning and not a few years in as it seems to be with Patreon. And if you want it to work. you need to make it easy for people to find new projects and people to support—and you need to make it financially viable for them to do so as well.
Patreon’s growth strategy is to attract creators with enthusiastic pre-existing audiences in the hopes that people will see their success and try to grab their own piece of the pie.
They have some of those types of creators, but not enough. And since they’ve been focusing so heavily in that direction, they missed the fact that a lot of the smaller creators, while not making nearly as much as the Amanda Palmers and John and Hank Greens of the world, were making enough for the time spent building and promoting a Patreon to be worth it.
With this decision to shift the fees from the creators to the patrons, they have chosen to destroy the viability of their platform for 98.7% of their creators and I think that’s a damn shame, because that 98.7% is providing them with nearly three quarters of their revenue. Or was.
Patreon has, with this move, essentially committed suicide. They’ve burned all their community goodwill and social capital, they’re still incredibly non-communicative to anyone who isn’t in that top 1.3%, and I can’t see how they will ever be able to get anyone to trust them ever again. Even if they do roll back this decision. That bridge is gone and only ash remains.
This distribution is precisely the opposite of the long tail. I think I’ll call it the Jack(ass) Tail.