Income investors take dividends very seriously, except for one industry – technology – where dividends are an afterthought. It was only in the past few years that some of the market’s top technology stocks like Apple (AAPL ) and Cisco Systems (CSCO ) began paying dividends. Dividends are even rarer among technology startups that retain as much cash flow as possible to reinvest back into the business.
This is why the decision by technology startup Kickstarter in March to pay a dividend to shareholders was so uncommon. Kickstarter – a crowdsourcing platform for funding creative projects – paid a dividend of an unknown quantity to its investors. This was an extremely atypical move that made news headlines because of how unusual it is for a technology company at such an early stage to distribute profits to shareholders.
Technology Startups and Dividends
Dividends are usually reserved for more mature companies in stable industries. Companies that decide to pay dividends to shareholders are usually larger and highly profitable. Any money that gets distributed to shareholders each quarter is money that could have been used to grow the business, which is why dividends are so common in the utility and consumer products industries.
Technology is a much different industry. Trends in the technology landscape evolve so rapidly that companies have high research and development spending needs. It is critical for tech companies to adapt over time – otherwise they are at risk of quickly falling behind the curve.
Many of the market’s biggest technology companies, even some that are highly profitable, do not pay dividends. For example, search giant Google (GOOG ) does not pay a dividend, despite generating more than $17 billion in profit over the past one year.
As a guide to when most tech companies typically start paying dividends, see this article. It is extremely rare for a startup to pay a dividend. It is frequently only several years after a tech company has gone public that it even considers paying dividends.
Rationale for a Startup to Pay Dividends
Even more confusing about Kickstarter’s decision to pay shareholders dividends is that the company has stated its intention to remain a privately held company. The current management team has no plans to go public. The venture capitalists that provide seed financing to tech startups invest in these companies with the hopes of multiplying their money many times over. In order to make this happen, all cash flow is used to expand with new growth initiatives. This raises the question why a private company would even bother paying a dividend if it is not pursuing an IPO?
It’s because a dividend is a way for Kickstarter to return capital to early investors without going public. The IPO is how venture capitalists make huge profits: by selling shares to the public. If that does not happen, Kickstarter’s investors will not receive any return on capital unless they receive dividends. After Kickstarter made the decision not to pursue an IPO, one of its early investors, Union Square Ventures, asked if it would return some of its excess cash flow to shareholders. The request was made only because the company is generating far more cash flow than it will need to fund the business and its most important growth initiatives.
Rather than use the excess cash to lavish employees with stock options or pursue a large acquisition – both of which can often be dilutive to shareholders – management agreed with Union Square that a distribution was both appropriate and feasible.
There is obviously a cost to this decision. If Kickstarter were to go public, it would likely result in a massive return for its venture capital investors like Union Square. Venture capitalists can make four to five times their money back when tech startups IPO, and sometimes even more. It is unlikely that Union Square will earn nearly as high of a return from steady dividend payments. However, it will at least get some capital back. And the reality is that many tech startups fail, leaving their investors with a complete loss.
Another reason is that Kickstarter has an unorthodox corporate culture. It rejects the status quo in many ways, not just the dividend. Kickstarter became a public benefit corporation, meaning it officially included the public good as part of its corporate mission. It has pledged to donate 5% of its profits to charity and vowed not to pursue loopholes to reduce its taxes. These are more examples of how the company has rejected the business-as-usual models.
The Bottom Line
Ultimately, Kickstarter’s decision to pay dividends is a hedge against future risk. Investors are not receiving the big payday by the company going public. Instead, they are receiving incremental capital that can create wealth; albeit, in a slow-and-steady manner. That being said, Kickstarter’s model is not likely to be replicated throughout the industry.