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A Study on “Scope and launching of Crowdfunding platform.”

By - Abhinav Ravish

Under the Guidance of Dr. Deepa Ray

A dissertation submitted in partial fulfillment of the requirements for the

Degree of Executive Master of Business Administration

School of Business Management

SVKM’s NMIMS, Mumbai - 2014

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Declaration

I, Abhinav Ravish, hereby declare that this dissertation entitled ‘A Study on “Scope and

launching of Crowdfunding platform.” is the outcome of my own study undertaken under the

guidance of Dr. Deepa Ray, Professor, SVKM”s NMIMS, Mumbai. It has not previously

formed the basis for the award of any degree, diploma or certificate of this or any other

university. I have duly acknowledged all the sources used by me in the preparation of this

dissertation. [Date, month, and year]

[Signature of the student]

[Name of the student]

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Certificate

This is to certify that the dissertation entitled A Study on “Scope and launching of

Crowdfunding platform.” is the record of the original work done by Abhinav Ravish under

my guidance. The results of the research presented in this dissertation have not previously

formed the basis for the award of any degree, diploma or certificate of this or any other

university. [Date, month, and year] [Signature of the guide]

Guide (Designation) School of Business Management

SVKM’s NMIMS

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Preface Entrepreneurship is the ‘lifeblood’ of every economic development. It is a process of

identifying ideas and launching a venture, allocating and organizing the needed resources and

facing the risks and rewards of it. As a research field entrepreneurship is one of the most

researched subjects in entrepreneurial finance. Entrepreneurial finance has mainly focused on

formal financing sources, like business angels, banks and venture capitalists. Since 2008,

crowdfunding appeared as a financing source and become very popular. Many people – the

crowd – can fund different ideas, which they think are worth to get realized. The global scale

surpasses $ 5.1 billion in industry revenue by the end of 2013. Compared to traditional

financing, crowdfunding allows not only to get debt and equity-based financed. Also

donation-based or reward-based financing is possible. This thesis involves crowdfunding

in a debate if it is an appropriate tool for ventures. Beyond the obvious financial benefits,

the motivations of entrepreneurs, who opt for crowdfunding, is going to be researched.

Abhinav Ravish Mumbai -September-2014

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Acknowledgements

We take this opportunity to acknowledge the efforts of the many individuals who helped in

making this dissertation possible. First and foremost, we would like to express our heartfelt

appreciation and gratitude to our professor from NMIMS, Dr. Deepa Ray, Professor, SVKM”s

NMIMS, Mumbai. Her vision and expert knowledge aimed at creating a structure, definition

and realism around the dissertation and fostered the ideal environment for us to learn, grow and

explore.

A Special Thanks to Mrs Bindia Maheshweri, Head Western Region of Indian Angel

Network for sharing insights and encouraging me.

Would like to appreciate the support of various other entrepreneurs to provide time and insights

for start-ups.

I am also grateful to all my comrades at NMIMS for the suggestions I received from them

while working on this dissertation and during the period of my academic curriculum at

NMIMS.

Last but not the least I am grateful to all our friends who helped us in the primary data

collection for the dissertation which forms the most important part of our dissertation and

without their help this dissertation would not have been possible given the tight timeline.

This dissertation has provided a lot of learning from academic as well as industry perspective.

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Executive Summary

Entrepreneurship is the ‘lifeblood’ of every economic development. It is a process of

identifying ideas and launching a venture, allocating and organizing the needed resources and

facing the risks and rewards of it. As a research field entrepreneurship is one of the most

researched subjects in entrepreneurial finance. Entrepreneurial finance has mainly focused on

formal financing sources, like business angels, banks and venture capitalists. Since 2008,

crowdfunding appeared as a financing source and become very popular. Many people – the

crowd – can fund different ideas, which they think are worth to get realized. The global scale

surpasses $ 5.1 billion in industry revenue by the end of 2013. Compared to traditional

financing, crowdfunding allows not only to get debt and equity-based financed. Also

donation-based or reward-based financing is possible. This thesis involves crowdfunding

in a debate if it is an appropriate tool for ventures. Beyond the obvious financial benefits,

the motivations of entrepreneurs, who opt for crowdfunding, is going to be researched.

That thesis uses an explorative approach, meaning qualitative method will be used. In order to

get in-depth information, 10 entrepreneurs have been asked to participate in interviews. The

results out of 5 interviews were used. The outcome of this thesis, crowdfunding is perfect to

attract attention and to market ideas or projects. It is an opportunity to sell products or

services to early adopters. Additionally, crowdfunding is ideal to get funded quickly and

can bridge financing gaps. The research is meaningful for the field of entrepreneurial

finance. Still, crowdfunding has its pitfalls, which should not be underestimated. These

findings inspire other scientists to further the analysis on entrepreneurial finance and

motivation by including crowdfunding.

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Table of Contents

Table of Contents ........................................................................................................................................ 1

List of Tables, Graphs & Figures .................................................................................................................. 3

Chapter 1 – Introduction ............................................................................................................................. 4

1.1 Background....................................................................................................................................... 6

1.2 Problem Discussion .......................................................................................................................... 6

1.3 Purpose and Problem Formulation ................................................................................................ 7

1.4 De-limitation ..................................................................................................................................... 8

1.5 Structure .......................................................................................................................................... 8

CHAPTER II - Literature Review ................................................................................................................... 9

2.1 Entrepreneurship ............................................................................................................................ 9

2.1.1 Entrepreneurial Motivation ................................................................................................. 10

2.1.2 Startup .................................................................................................................................... 11

2.2 Entrepreneurial Finance .............................................................................................................. 14

2.2.1 Financing Sources ................................................................................................................... 16

2.2.2 Comparison of Finance Sources ............................................................................................ 20

2.3 Crowdfunding................................................................................................................................. 23

2.3.1 Role of the Crowdfunding Platform ...................................................................................... 25

2.3.2 Crowdfunding Model.............................................................................................................. 26

2.3.3 Motivation ............................................................................................................................... 30

2.3.4 Moral Hazard, Overfunding, Pitfalls ..................................................................................... 32

Chapter III - Theoretical Framework.......................................................................................................... 34

Chapter IV - Research Methodology. ........................................................................................................ 36

Chapter V - Case Analysis .......................................................................................................................... 37

Chapter VI - Case presentation & interviews ............................................................................................. 42

6.1 Crowdfunding websites.................................................................................................................... 42

6.1.1 Kickstarter ................................................................................................................................ 42

6.1.2 IndieGoGo ................................................................................................................................. 43

6.1.3 SellaBand .................................................................................................................................. 43

6.2 Interviewing with project creators .................................................................................................. 44

6.3 Interviewing with Crowdfunders ..................................................................................................... 45

Chapter VII - Empirical results ................................................................................................................... 46

7.1 Empirical results of crowdfunding websites .................................................................................... 46

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7.2 Empirical results of project creators ................................................................................................ 48

7.3 Empirical results of crowdfunders ................................................................................................... 49

7.3.1 Motivations of Crowdfunders .................................................................................................. 50

7.3.2 Evaluation issues ...................................................................................................................... 53

Chapter VIII - Discussion ............................................................................................................................ 55

8.1 Analysis on Literature Research .......................................................................................................... 55

8.2 Analysis of crowdfunding websites and project creators ................................................................ 58

8.3 Analysis of Crowdfunders ................................................................................................................ 59

Chapter IX - Conclusion & Platform Launch ............................................................................................... 61

9.1 Conclusion ....................................................................................................................................... 61

9.2 Platform Launch ............................................................................................................................... 61

Chapter X - References .............................................................................................................................. 63

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List of Tables, Graphs & Figures

Figure - 1.1: Chapter overview of this thesis

Table - 2.1: Funding Options for Startup Companies

Figure - 2.2: Stages of entrepreneurial firm development

Table - 2.3: Differences of financing and its pros and cons

Table - 2.4: Selected Crowdfunding Platforms

Figure - 2.5: Growth of crowdfunding and its shares of the different models

Figure - 3.1: Venture stages and funding

Figure - 6.1: www.kickstarter.com

Figure - 6.2: www.indigogo.com

Figure - 6.3: www.sellaband.com

Table - 7.1: Comparison of Kickstarter, IndieGoGo and SellaBand

Figure - 9.1: Orenda Network (Source: www.orendanetwork.com)

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Chapter 1 – Introduction

Entrepreneurship is the ‘lifeblood’ of every economic development. It is a process of

identifying ideas and launching a venture, allocating and organizing the needed resources and

facing the risks and rewards of it. As Schumpeter (1934) says entrepreneurship is a dynamic

approach that does not invent anything, but it rearranges and converted existing business

models into new innovations. It is characterized by identifying and developing market

opportunities, their implementation and turning them into profit. Within the entrepreneurship

research field entrepreneurial finance takes a major role and is one of the most investigated

parts. Entrepreneurial finance deals mainly with making financing decisions and investing in

new projects. It studies ways to gather resources and identifies the venture’s advantages and

disadvantages for each financing source at the beginning of its life cycle. It is highly

connected to the fields of venture capital, private equity and innovation. Research on

entrepreneurial finance is related to the question ‘where can startups raise capital?’

When realizing an idea or setting up a startup, the question how to finance it comes up

automatically. Starting a business is always related to a high risk of losing money or even

failing. Basically, a startup is a business proposal (Sandler, 2012). There is no proof of

concept so far and the idea on which a new business is built has to be proven by the market.

This risk is the reason why raising money is extremely difficult for ventures. Not so very long

ago entrepreneurs could only go to business angels, venture capitalist, banks or loan giving

institutions for financing their business ideas. These potential financing partners were the only

ones who could believe in the idea – financing the project – or not – denying the money

(Sandler, 2012). If the financing partners did not recognize the whole potential of the idea

there were not many alternative financing solutions left. Since the financial crisis “there has

been a sharp fall in the availability of bank lending to new and small businesses” (Harrison,

2013, 283). Crowdfunding could fill this gap and has changed the funding side for startups

fundamentally (Belleflamme, Lambert, Schwienbacher, 2013). It is a synonym for diversity of

structures under which funding for startups or projects can be gathered from a large number of

individual investors. “Crowdfunding in the venture capital context as a source of start-up

equity capital pooled via small contributions from supporting individuals collaborating through

social media” (Ley, Weaven, 2011, 86). In today’s difficult economic situation, crowdfunding is

attracting the interest of investors and startups by seeing it as an alternative method of funding.

Many people believe in a certain idea and become investors.

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Crowdfunding platforms offer an alternative or a complementary type of funding in smaller

volumes, addressed to startups or freelancers. The investors lend money and mostly do not

acquire any shares of the business model. They receive alternative compensation (Dapp,

2013).

The crowdfunding project PonoPlayer1 by Neil Young for example broke the $ 5.0 million

line within 20 days. The smart watch project Pebble raised $10.3 million in total and is still the

highest funded project so far. Even the non-technological idea The Veronica Mars Movie

Project could gather $5.7 million. Another notable fact is that all mentioned projects

overreached their set goals – Pebble: $100.000, Veronica Mars: $ 2.0 million or PonoPlayer:

$800,000 (kickstarter.com, 2014). This shows clearly that with this method of raising money

new projects, products or business ideas can be realized by the crowd. After the cancelation of

the television series Veronica Mars by the television network the fans wanted the series to

continue. 91,585 people donated for an additional season. 68,929 people saw a need of a

smart watch and 18,220 people longed for a better portable music sound than mp3.

For startups, crowdfunding seems to be the rising star within the sources of financing.

“Crowdfunding has now emerged as a viable, scalable alternative to public and private

finance” (Massolution, 2013, 7). The latest research “has shown that small ventures are

turning to innovative routes of resourcing that largely exclude the support of banks and

traditional external equity financing” (Malmström, 2012, 27). Crowdfunding came up in the US

ten years ago and became popular there very fast. In the last years, the number of funds on

crowdfunding platforms increased and not only in the US the potential of private equity

funding is huge. For the year 2013 it was predicted that crowdfunding platforms would raise

$5.1 billion (Massolution, 2013). Crowdfunding is different to other financing sources. It is

mainly using the Internet and its social media for acquiring finances and the success is highly

depending on the engagement of the crowd. 1 Pono's mission is to provide digital music. It comes with a player and download portal. The player is using the flac codec instead of mp3 and it is offered and distributed by the portal. The audio codec flac delivers a better sound feeling to the audience by using higher bit rates.

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1.1 Background For any entrepreneur, one of the most difficult tasks is to raise enough seed capital. Lavinsky

(2010) says, “The vast majority of entrepreneurs have failed to raise venture capital. There are

two key reasons for this. First, most entrepreneurs don’t qualify for venture capital since they

can’t scale fast enough, nor do they have the potential for a large enough exit. And second,

there are too few venture capitalists versus the masses of entrepreneurs who need money.”

According to a study by the Dutch bank ABN AMRO, startups have difficulties to gather

funding’s between € 35,000 and € 150,000 (Voorbraak, 2011). The study of the U.S Federal

Reserve emphasizes, that the denial rate for loans of less than $ 100,000 is more than twice as

high as for bigger loans (Pagliery, 2012).

The motivation behind this thesis is to show that crowdfunding is a relative new financing

source. Therefore, there is a lack of articles in current academic journals about crowdfunding.

As already mentioned above there is a need for new financing sources for startups and the

author of this thesis wants to outline in what way crowdfunding is an appropriate tool for

startups to get funded. An analysis of the different research sources, like e-journals or

working papers, will be undertaken, to find out how crowdfunding can be used in the future

and if crowdfunding can fill gaps in capital for new ventures.

1.2 Problem Discussion

The financial situation for startups and how they gather funds has changed over the years and is

becoming more attractive to researcher. Each financing instrument brings advantages and

disadvantages to startups. In the field of entrepreneurial finance asymmetric information and

agency costs are major issues and affect the entrepreneurship scene significantly. Venture

capital firms have extensively decreased their involvement in early-stage financing and have

increased their focus on companies that are already in the strong growth phases (Engeln, et al.,

2012). This results in the added value only being provided to a limited set of industries.

Business angels are still more open to new ideas and ventures, but due to their limited number

not all ideas can be realized. At the same time they have to believe in the venture’s idea and see

future potential, otherwise they will deny the fund as well. Commercial banks seem to invest

in a lot of new ventures. And yes they do, but even so it is still quite hard to get financial

funded. 80% of all business plans are denied. If the investment is below € 50.000 the bank will

normally show no interest in the venture’s business plan (Dapp, 2013). From the standpoint of

the potential founders it is a key problem and especially for entrepreneurs with limited

financing resources it can lead to projects being cancelled before they reach the early stages. In

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that stage they typically do not appeal to external investors to get funded, since the startups are

between a stage of potential failure or success (Tomczak, Brem, 2013). Crowdfunding can be

provided as seed money when “friends and family finance may be unavailable or insufficient,

and the amounts required are too small for business angels to get involved and also the gap

above the level where business angels are usually active, but where the capital required is too

small for venture capitalists to get involved” (Collins, Pierrakis, 2012, 18). Crowdfunding

does provide an additional benefit for possibly raising seed money for very early stage

startups and can also fill funding gaps until liquidity is increasing (Tomczak, Brem, 2013). The

idea of crowdfunding has extensive potential to support small, young ventures because the

current financing options available to them are insufficient to overcome the funding

difficulties they face. Furthermore, crowdfunding is able to attract new people, who show an

interest in funding of attractive ideas with private savings.

Crowdfunding offers also pitfalls. Besides asymmetric information between startups and

investors, crowdfunding can change the capital structure of ventures, which effects the future

funding. Many investors are the baggage of the venture when it comes to additional funding

rounds (Stocker, 2012). The expectations can differ and can become to misunderstandings.

Crowdfunding attracts frauds also. Various studies and tests have shown that the general

public is mostly financial illiterate (Siegel, 2013). The illiterate investor is not able to estimate

the risks and uncertainties. Crowdfunding can create unwanted negative impacts to both –

startups and investors. That affects the crowdfunding community completely.

1.3 Purpose and Problem Formulation

Due to the mentioned above arguments, it will be more précised. The lack of motivation of

entrepreneurs to use crowdfunding results from to a lack of understanding crowdfunding and its

beneficial characteristics compared to other sources. The motivations issues among startups to

use crowdfunding will be identified while keeping the focus of this thesis on building a

theoretical foundation by beginning to include crowdfunding as an entrepreneurial financing

source and to see if it can fill the funding gap for startups. The thesis will outline the ideal

phase to get funded through crowdfunding and how startups can deal with pitfalls.

All these considerations affect startups most and end up in the problem statement:

How can Crowdfunding be used for Start-ups?

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1.4 De-limitation

The field of entrepreneurial finance is huge. When it comes to finance startups, there are

many different sources available. This thesis will put the focus of the most common ones –

banks, business angels and venture capitalist firms. Recently, crowdfunding appeared as a

serious financing source. Crowdfunding will be introduced and descripted in detail. Several

familiar terms are used for crowdfunding, such as crowdfinancing and crowdinvesting.

However, in this thesis the term ‘crowdfunding’ will be used exclusively. Crowdfunding for

business ventures rather than creative projects will be investigated. Here, for later research

only equity-based crowdfunding will be considered. In this thesis only entrepreneurs and

startups will be studied. Small medium sized or bigger companies are excluded.

1.5 Structure

In this thesis the entrepreneur will be involved in a debate on financing sources. The literature

review will give the reader an overview of existing research within the scope of this thesis. It

will start to highlight the importance of startups as a field of research. Followed by the

entrepreneurial motivation and its financing, including a selection of different existing sources

of finance. Traditional forms, like banking and venture capitalists versus crowdfunding and its

platforms as an alternative for startups will be analyzed. Consequently, it will be analyzed the

latest published literature and give an introduction to this new subject crowdfunding. All

literature review will end up in the theoretical framework. In the research methodology chapter,

qualitative research is used in this thesis in order to study the problem formulation. A deeper

focus on the subject Germany will be made by a case study. Interviews with experts were

conducted and bring empirical results. In the results chapter, the outcomes will be presented and

finally discussed in the analysis section.

The conclusion chapter will give a brief overview of the thesis, Along with the launch of

new crowdfunding platform. At the end, the limitations and future research chapter

admits the restrictions of that work and gives suggestions for future research.

Figure - 1.1: Chapter overview of this thesis

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CHAPTER II - Literature Review

In this chapter the relevant background literature will be outlined. This chapter will start with

entrepreneurship and its finance sections. Theories of different financing sources and their

applicability to startups will be presented. The analysis of advantages and disadvantages of

crowdfunding will give the reader a first insight into the subject and will determine the

suitability to different startup situations.

2.1 Entrepreneurship

In recent years, entrepreneurship is increasingly recognized as a major element of the

domestic industry and has become an important factor for the modern economic development.

Entrepreneurship drives innovation and technical change, and therefore generates economic

growth (Schumpeter, 1934). The entrepreneurial process is the action through which supply

and demand are equilibrated (Kirzner, 1997). Although the research of entrepreneurship is

still regarded as being in its infancy, the continuing academic’s interests in that subject are

remaining on a high level (Brazael, Herbert, 1999). It is not surprising that entrepreneurship

brings economic and social benefits and drives development of the economy. Until

relatively recent, the research of entrepreneurship focused mostly on the analysis of individual

motivation and behavior but reasons for being startups were mostly not considered (Bolton,

Thompson, 2000). It has become an important vocation and it needs to understand its role in

the development of human and intellectual capital (Zahra, Dess, 2001). Furthermore, since the

1980s the importance of contacting and networking got more attention regarding on

entrepreneurial performance. Since economic activities are embedded in the daily social life,

the entrepreneur develops social capital by building up networks that provide sources of

information and support. An entrepreneur’s network is based on experience, which not only

determines the range of contacts, but may also influence perceptions of opportunities and

courses of action (Cope, Jack, Rose, 2007). Entrepreneurship is an important manner by

which new knowledge is converted into products and services. This thesis adopts the definition

of entrepreneur as a process by which “opportunities to create future goods and services are

discovered, evaluated, and exploited New goods, services, raw materials, and organizing

methods can be introduced and sold at greater value than the cost of their production”

(Shane, Venkataraman, 2000, 220). As these authors explained, entrepreneurs are not

necessarily viewed as founders of new organizations. This definition shows by recombining

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resources in a new way, entrepreneurship is a creative process. People’s willingness

affects the entrepreneurial process (Shane, Locke, Collins, 2003).

2.1.1 Entrepreneurial Motivation

Shane, Locke, Collins (2003) proposed that entrepreneurship is a procedure that begins with

the identification of an entrepreneurial opportunity and is followed by the development of an

idea. This idea can be realized and assembled and will be provided to customers. In common

views, entrepreneurs strive for money and engage in profit making to secure an income. These

rewards can be seen as salary. However, it is not the only driver and startups certainly do not

just work for money. They rather want to solve problems, perform better or just improve things.

However, the following human motivations will influence the entrepreneurial activities.

• Need for achievement

• Locus of control

• Vision

• Desire for independence

• Passion

• Drive

• Other, like risk, self-efficacy

The above mentioned motivations are some of the most common ones identified by

McClelland’s (1961) research. However, they are only a small selection of the human

motivations. Startups, also influenced by human motivation, try to satisfy these needs as well.

The reasons and motivations to setup a startup can be different for each individual. On the one

side all motivations matter but on the other side only a few are concisely. Of course the

entrepreneurial motivations are also related to external factors such as

• Political factors (legal restrictions, political stability, currency changes)

• Market forces (structure of industry, technology regime, and entry barriers)

• Resources (capital, labour market, knowledge, infrastructure)

Most researchers either explicitly or implicitly agree that these categories of factors influence

the entrepreneurial process significantly and need to be controlled to measure the effect of

motivations on the entrepreneurial process (Shane, Locke, Collins, 2003). As the main focus of

this thesis is on finding out if entrepreneurs are motivated to use crowdfunding, the

entrepreneurial finance must be examined.

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2.1.2 Startup

“Success consists of going from failure to failure without loss of enthusiasm.” Winston Churchill

As a major contributor to innovation, startups have been the subject of academic research

(McDaniel 2000; Osnabrugge, 2000). Furthermore, the growth of economies around the world

has shown to largely depend upon the impact of small firms to employment and national

Gross Domestic Product (GDP) (Cumming, 2007; Gans, et al., 2002; Osnabrugge 2000). A

society can benefit from entrepreneurs of all ages. Young people, also called ‘born-digitals’

often have fresh ideas and have received more education than their parents in some regions.

They do not yet have mortgages or families, which generally make individuals more cautious

and risk-averse. Older people are more capitalized because of relevant experience, contacts

and financial resources that they have built over long times (Global Entrepreneurship Monitor,

2013). This chapter will analyze why startups exist and how they have an influence on society.

To define startup as a term is not very easy and the literature gives not a clear hint. For this

reason the concept of startup will be introduced. An idea that can be used to fulfil a commercial

purpose can be called a business idea. These business ideas can be services or items that can be

sold for money. It is the first milestone on the path to found a new venture. A business idea

usually focuses on customer benefits. It can create a totally new industry or just an

improvement of another. However, it has to capture the value and bring it to the customers.

The business idea has to be addressed to interested parties by creating a business model. A

business model describes the motivation of how a venture creates, delivers, and captures

value in business contexts. It constructs a business strategy (Osterwalder, Pigneur, Smith,

2010). A business model is used for a variety of informal and formal descriptions to a certain

core aspect of a business purpose, target customers and operational processes. It is the design of

an organizational structure to commercialize the business idea. A startup is an organization

formed for a repeatable and scalable business model (Blank, 2010). If the customer behaves as

the founder has forecasted the business model is perfect and the startup fulfilled another

milestone on the way to a successful venture. Typical startup goals are to generate revenues

or profits and to attract users or customers. It is very common that startups change their

business model multiple times (ibid.).

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When it comes to financing the startup, usually the first favored option is to turn to family

members. If the FFF (family, friends, fools)-seed investment does not work out, entrepreneurs

can also go to business angels, venture capitalist or banks for financing its business ideas.2

2The description of the financial sources will be presented in the later chapters.

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For these investment sources one needs to provide a business plan – a detailed description

about the business idea and its commercialization. That is the last milestone on the way to a

successful venture. Depending on the idea and its model a release could be money consuming.

Therefore, to bring the business idea to the market it has to be transformed into a business

plan. The business plan can be seen as a decision making tool to convince the investor to

believe in one’s idea and to fund or to support. Formulating a business plan involves the

knowledge from many different business disciplines: finance, human resource management,

intellectual property management, supply chain management, operations management, and

marketing, among others (Siegel, Ford, Bornstein, 1993).

Startups are young and growth-oriented ventures in search for a sustainable and scalable

business model. According to Bundesverband Deutscher Startups3 (BVDS) startups have a

significant growth in key indicators such as sales or customers, have a high level of innovations

and are less than 10 years old. They are influenced by many factors, uncertainties and risks.

However, they have the faith in their idea. In 2013 entrepreneurs who are involved in founding

a business – also called the entrepreneurship rate – in the USA conducted 9.2%, in Sweden

5.9%, in China 5.1% and in Germany 3.1% of economic development. Motivations to setup

businesses differ vastly across the globe. The Global Entrepreneurship Monitor framework

captures the contrast between necessity-driven motives and opportunity-driven motives. The

result indicates that most people found a venture because they want to improve something. In a

certain way they see potential in making things better, cheaper or even smarter. Startups

play a significant role in the generation of innovative ideas. They are innovation-driven and

have ideas developed for a new activity. It is a good economical sign; many ventures survive

the conceptual, pre-seed or seed phase and reach the early-stage of entrepreneurial activity.

The early stage can be defined as where the startups reach their breakeven point, which is

usually within 42 month. In the USA 12.7%, in Sweden 8.2%, in China 14.0% and in

Germany 5.0% of the early-stage entrepreneurial activities drove the economic development. In

all regions the typical age of entrepreneurs is 25 – 44 years. Women are starting a venture

for mainly the same reasons as men do, such as to improve their lives with careers, to support

their family and to attain financial independence (Global Entrepreneurship Monitor, 2014).

Policymakers and governments all over the world see the importance of entrepreneurship for

the economic growth of their countries.

3 Federal Association of German Startups

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They set out different support programs in order to increase their international competiveness.

The European Commission “is focusing on encouraging unemployed people to start businesses;

on improving the sustainability and quality of work of self-employed businesses; and on

supporting social entrepreneurs.” Therefore in its ‘Europe 2020’ program the European

Commission has planned to promote startups and self-employment (European Commission,

2012).

2.2 Entrepreneurial Finance

One big issue for startups is their ability to access financial assets, since they were formed

recently, have no recorded history and are not profitable yet. That is why debt financing is

usually not a suitable option. Consequently, ventures tend to rely on three primary sources

outside of equity financing: venture capital funds, angel investors, and corporate investors.

“Venture capital funds refer to limited partnerships in which the managing partners invest on

behalf of the limited partners. Angel investors refer to high net worth individuals that invest

their own funds in a small set of companies. Corporations invest on behalf of their

shareholders, for financial and/or strategic reasons” (Denis, 2004, 304). Although it is not

easy to precisely quantify the dollar amounts of capital coming from each funding source,

since there are minimal or no reporting requirements, reliable information on venture capital

financing is available because venture capital companies have to make their investments

public (MIT Entrepreneurship, 2000). According to the Centre for Venture Research at the

University of New Hampshire, the angel investor market increased by 1.8% to $ 22.9 billion

between 2011 and 2012. In that time a total of 67,030 ventures received angel funding (Sohl,

2013). According to the MoneyTree Report by PricewaterhouseCoopers LLP and the National

Venture Capital Association, venture capitalists invested $ 29.4 billion in 3,995 deals in 2013.

This represents an increase of 7% compared to 2012. Crowdfunding with its investment of

$2.7 billion (2012) and a predicted growth to $ 5.1 billion (2013) have not reached these

dimensions yet and are rather small when comparing it to the larger investments by venture

capitalists.

When reviewing entrepreneurial finance literature, it can be seen that researchers put a lot of

attention on that topic. It is connected to the most critical decision entrepreneurs have to make at

the beginning of their business, how to finance their venture, and is therefore one of the main

parts of this thesis. Generally sources of financing can be clustered into formal versus informal

finance and equity versus debt. Formal finance includes lending money from, either financial

institutions such as banks and credit unions or from non-financial institutions, subject to

state supervision and regulation. On the other hand informal finance includes lending

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money from sources outside the formal financial sector like own saving, loans from family

members, friends and informal banks (Degryse, Lu, Ongena, 2013). Equity financing can be

seen as an exchange of capital for ownership. Equity includes funds secured through

bootstrapping, angel investors, venture capitalists and investment banking firms. Taking on debt

comes in form of a loan. Debt financing is acquired from a commercial bank (Denis, 2004).

Fundamentally, the founder of startups must select if the business will use outside equity

funds or if the venture can be bootstrapped. When startups bootstrap, they do not access

external equity capital at all. Table 2.1 shows the opportunities available for entrepreneurs to

fund their startups. Usually if there is a need for market growth rapidly, entrepreneurs will

seek outside capital (MIT Entrepreneurship, 2000).

Table 2.1: Funding Options for Startup Companies (Source:MIT Entrepreneurship, 2000)

Academic research on the financing choice and ownership structure is implemented in

entrepreneurial finance and also in the field of corporate finance. In both fields’ asymmetric

information and agency issues are two major factors that affect the choice of financing.

“Funding at this early stage tends to be characterized by greater levels of information

asymmetries and risk” (Ley, Weaven, 2011, 87). Asymmetric information deals with the theory

of decisions in transactions where one party has more or better information than the other. This

creates an imbalance of power in transactions that can sometimes cause the transactions to go

fail (Aboody, Lev, 2000). The main idea, a manager (agent) normally has deeper insights than

an outside investor/shareholder (principles) into the firm’s perspective and its risks and values.

Between the shareholder and the chief executive officer/ manager there exists information

asymmetry and can be seen as a principle - agent problem. Agency costs come up due to the

16

manager’s contract costs, the conflict of losing the control and the separation of ownership and

control of the different objectives (Jensen, Meckling, 1976). Entrepreneurs know they business

better than potential investors. Funders have to believe and trust. Due to that startups do not have

any business history there is a higher risk of asymmetric information in startups than in

companies that are listed on the stock exchange or well known. The model premises that the cost

of financing will increase because the investor wants to get paid for unknown risks. To reduce

the impact of information asymmetry all parties need to cooperate dense and everyone will

leverage its benefits.

In corporate finance companies priorities their finance and businesses remain to a hierarchy of

financing sources and prefer internal financing when available. In a next step debt is issued

and when it is no longer reasonable to get any more debt, new equity is raising as a last resort.

Taking on debt can therefore be seen as a signal that a firm requires external financing (Myers,

Majluf, 1984; Paul, Whittam, Wyper, 2007). From this perspective the usage of internal funds

minimise the freedom of action because it will not be much equity left. Taking on debt has

little affects on the controlling but using equity affects the most regarding on agency costs

(Jensen, Meckling, 1976). According to the study of Paul, Whittam, Wyper (2007) startups

should see their loss of independency as a trade-off when external finance is required.

Investors can add new value and substantial advantages to the business. When looking at

startup this only applies partly since a ‘bridged’ pecking order theory that skips debt is

preferred. Startups “use their own funds first but when external finance is required, equity is

preferred ahead of debt” (Paul, Whittam, Wyper, 2007, 8).

This clearly shows that crowdfunding is not often considered as a financing source. The scope of

this thesis is therefore to find out why crowdfunding as a new form of financing with

different characteristics should be considered as a financing tool for startups. The

entrepreneurial classification will be analyzed in a later chapter.

2.2.1 Financing Sources

This chapter examines how firms can access capital from the investment world. Generally,

financing methods are tied to a firm’s life cycle. Startup firms are often financed via venture

equity. When it comes to seeking money for setting up a new venture two central question

normally appear. How should entrepreneurs value their startup and how do investors value a

prospective entrepreneurial firm? According to their empirical research about ‘early stage

ventures’ Miloud, Aspelund, Cabrol (2012) suggest both parties, investors and entrepreneurs,

value of any asset, value of venture’s future cash flows and the startup performance are the

most important factors for the validation and should be considered in the investment amount. It

17

was indicated that these factors are “useful to explain venture capitalists’ valuation of early-

stage new ventures” (ibid.).

Based on the literature there are different stages and financing round offered in venture capital,

which roughly correspond to the ventures' development stage. Within the seeding stage, new

ideas need to be proved, often financed by equity and FFF-seed. The startup is bootstrapping

itself. After a certain time, once the venture gets started and grows it needs additional funding

for its expenses. Within that early stage ventures are still too small to raise capital in public

markets or to secure a bank loan. Because of its stage of growth, wealthy individuals are now

willing to invest in small projects that fit their intrinsic values and agenda. This makes also

angel investors more attractive to ventures with limited history but proven establishment in

the market. The growth stage of the venture starts once sales are increasing and

manufacturing has to be funded (Series A round). During this stage, more specialized venture

capitalists emerge to support the business. Once the venture hits the break-even point and

raises its market share, it becomes more attractive to venture capitalist firms. The venture

starts the expansion stage once revenues and profit increase. The venture reaches its last stage

once it intends to go public and realize an initial public offering (IPO). Usually at this point

venture capitalist gets paid out and exits the venture (Lehner, 2013). Figure 2.1 shows the

typical financing cycles of a startup.

Figure2.2: Stages of entrepreneurial firm development (Source: Cumming, Johan 2009)

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The authors Ross, Westerfield, Jaffe (2013) use a slightly different classification scheme.

They see the following categorizations of financing stages:

1. Seed money stage: A small amount of financing needed to prove a concept or develop a

product.

2. Start-up: Financing for firms that started within the past year. Funds are likely to pay for

product development expenditures.

3. First-round financing: Additional money to begin sales and manufacturing after a firm has

spent its start-up funds.

4. Second-round financing: Funds earmarked for working capital for a firm that is

currently selling its product.

5. Third-round financing: Financing for a company that is contemplating an expansion.

6. Fourth-round financing: Money provided for firms that are likely to go public within

half a year.

No matter what categorization one looks at, they all have one thing in common: At the

beginning the founders have an idea and a relatively small amount of equity. In the last stage

the venture has the possibility to go public and to collect more money for future projects.

Although previous literature hints that crowdfunding may be an especially appropriate tool in

the start-up phase, the research about its funding growth and expansion potential is in its

‘infancy’ (Firth, 2012; Lambert, Schwienbacher 2010; Ward, Ramachandran, 2010).

Existing literature that focuses on the comparison of financing sources has examined the

different costs and benefits of each one. The most commonly used initial funding by startups is

bootstrapping. In context of setting up a venture bootstrapping refers to starting of a self-

sustaining business, which is supposed to progress without external financing or other input

factors, e.g. knowledge (Lam, 2010). That initial funding suffices for a certain period than

startups has to acquire external funding. When it comes to external financing one also talks

about seed money, seed investing or seed funding. All terms have in common that investors

purchase parts of a business. The term seed means, that this is a very early support to a business

until it is able to generate cash on its own. In some cases seed money is needed as a bridge until

the venture is ready for further investments (Hollow, 2013). The most common external

financing sources are banks, business angels and venture capital firms. They all have individual

benefits and disadvantages. The next section will compare different financing sources and will

give their definition in order to get a better understanding.

19

The business model of a bank consists of accepting deposits and turning those into lending

activities. It is a financial institution, which links clients with capital deficits and clients with

capital surpluses. Both parties will never get in direct contact with each other. The bank gives

out the loan to the lender and the interest to the borrower. Banks are highly regulated by the

government and therefore have the legal right of repayment of the capital and interest on a

loan (McLeay, Radia, Thoma, 2014). According to the Bundesbank4 statistics (2012),

traditional banks have outstanding loans to German corporates and entrepreneurs amounting to

nearly € 1.4 trillion – € 1.0 trillion to corporates and € 385 billion to entrepreneurs (Dapp,

2013). For the following financing sources it is different. The return of the investment is

depending on the ventures profitability and growth and is only earned once the exit is

successful.

A business angel (also known as angel or angel investor) is an individual that is interested in a

certain idea and provides seed-money. Usually, this can be seen as an exchange of convertible

debt or ownership. In his study on how entrepreneurs raise seed capital, Wetzel (1978) began

to use and established the term ‘angel’ to describe the support of these kinds of investors.

Business angels are often retired entrepreneurs, who are interested in mentoring another

generation of entrepreneurs. They want to make use of their experience and network. For

startups, in addition to funds, business angels provide valuable management advices. There

were roughly 460 business angels in Europe in 2012 and the amount invested by them

accounted to around € 509 million, which only equals 30% of the same activity within the

USA. Angel investors normally provide their services in the early stages of a venture, where the

benefit is the greatest (European Commission, 2013).

Venture capitalists on the other hand are normally firms that are acting as a consultant and

manage individual’s or institutional’s money. They are very selective when it comes to the

decision what to invest in. As a result, they are looking for innovative technology with potential

growth and well developed business models. By financing a venture they expect a successful

exit within a timeframe of three to seven years and invest in ventures mostly in the growth

stage. In the year 2012 venture capitalist invested roughly € 36.5 billion in European ventures

(European Commission, 2013a) and $27.4 billion in North-American businesses

(PricewaterhouseCoopers, 2014). Normally, venture capital firm funds invest in 10 – 12 or so

total but despite getting hundreds or even thousands of investment proposals each year

(McKaskill, 2009).

4 Federal Bank of Germany

20

2.2.2 Comparison of Finance Sources

Bank versus Venture Capital

Although venture capitalists are often recognized in the public eye, bank loans are still the most

common financing source for startups. Banks generally provide their funds in form of loans,

whereas venture capitalists involve mainly equity. However, both parties also have similarities.

They have to deal with a high level of uncertainty, are required to monitor the money taker

carefully and try to restrict them by obligations (Winton, Yerramilli, 2008). There are also

many differences between the two financing entities. Banks fund a wide variety of firms,

whereas venture capital firms only provide investments to specific areas such as life science/

biotech, computer & software or energy & environment. These three industries receive more

than half of the total venture capital investment worldwide (European Commission, 2013a;

Ross, Westfield, Jaffe, 2013). Once banks give out loans they constantly monitor their

investment in order to avoid and minimize bad effects. They observe convent violation,

deteriorating performance or worsening collateral quality, which might jeopardize their

outstanding’s. Banks are relatively passive investors without any detailed insights and can

therefore only determine on formal information if startups should be financed or not. By

contrast, venture capital firms can determine if a safe or risky continuation strategy is the best.

They play a more active role and hold voting rights, which influence the cash flows or the

replacement of the entrepreneur with a new manager (Kaplan, Stromberg, 2001; Landier,

2003).

A startup normally seeks investments from one of the two institutions – a bank fund or a

venture capitalists fund. According to Winton, Yerramilli once ventures are funded two

conflicts arise between the startups and the ‘investors’. First, the entrepreneurs desire to keep

control or the institutions desire to liquidate poor performing investments. Second, the question

of if the startup should expand aggressively or conservatively. Shall the venture strive for an

initial public offer or remain in the founder’s hands? Only through intensive monitoring the

startup’s optimal continuation strategy can be found out. History has shown that venture capital

firms are better than banks at evaluating the venture’s strategic situation because they are more

specialized and have more expertise at running firms. Investors normally expect a higher

return on their investment than banks do, since they are more affected by failures or

shocks, due to their specialization on certain industries. To avoid illiquidity, venture capital

firms enforce liquidity restrictions as a shield. This means that the compensation increases as

the amount of uncertainty increases. Banks are more diverse and able to spread the risks of

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failure better. Shocks do only affect a part of their portfolio and they therefore have a lower

required return rate (Lerner, Schoar, 2004; Winton, Yerramilli, 2008). The desirability of

venture capitalists to fund highly depends on the ability to add value to the venture. This

implicates that startups always prefer venture capital as long as the added value is higher than

through bank financing (Bettignies, Brander, 2007).

However, deciding on a financial source is not always related to the added value. It is also

closely linked to the risks and uncertainties. For startups, where uncertainties might be low or

for entrepreneurs who are not willing to grow aggressively, bank financing and passive

monitoring is optimal. Also, if the risk to fail is high, startups tend to take debt to leverage

their own risk. For startups that deal with high strategic uncertainties or for entrepreneurs who

expect fast compensations by going public or selling the venture, venture capital funds and

active monitoring are optimal. The venture can benefit from the venture capitalist’s knowledge.

If the associated failure is low, startups tend to get funded by venture capital firms as well

(Landier, 2003; Winton, Yerramilli, 2008).

Business Angel versus Venture Capital

Most of the academic literature about entrepreneurial finance keeps its focus on venture

capital as a financing source. It seems that angel investors are not recognized as an important

source of startup funding. Nevertheless, an Organization for Economic Co-operation and

Development (OECD, 2011) report notes “while venture capital tends to attract the bulk of the

attention from policy makers, the primary source of external seed and early-stage equity

financing in many countries is angel financing not venture capital”. The report also evaluates

that the angel market is roughly the same size as venture capital markets. However, for

startups both financing instruments can bring value. On the one hand startups get funded to

realize a certain idea. On the other hand business angel or venture capital firms bring

experience. Venture capital firms mostly invest in ventures where the potential of adding

value is the greatest. Meaning, they tend to fund technological driven startups and knowledge

intensive areas, while angels tend to fund projects with less sophistication in technology

(Chemmaur, Chen, 2006). Business angels tend to offer their support in the early stage. They

offer an entourage of people and provide a successful network and enjoy more informal and

relational partnership with their ventures, based on trust and empathy. In comparison, the

venture capital firms are used to enjoy a more formal and distant relationship to their ventures.

They invest a higher amount of money and bring specialized knowledge. They process more

value-adding ability than business angels (Fairchild, 2011). Business angels fund smaller

22

amounts than venture capitalists, which lead to Startups seeking venture capital investment if

they require larger amounts (Wong, 2003).

An interesting insight feature of the Fairchild’s research shows that when entrepreneurs

choose angel as financing source, they are affected by the level of empathy relative to the

venture capital’s value adding abilities. Empathy means, that the startup is more welcoming

for a business angel, which further induces it to choose the angel over the venture capital.

Angel financing has an attractive quality since it promotes mutual trust, which reduces the

asymmetric information problem during the startup’s development. Startups make an inefficient

choice and ignore the value creating potential of venture capital firms. Behavioral beats

economic factors here (Fairchild, 2011). Angel investors appear to startups until the

company is established enough for venture capital firms. But, according to Wong’s research,

there is a likelihood that venture capital firms may not like to co-invest with angels. A

dynamic interaction of both types could have negative effects. Hellmann, Schure, Vo (2013) or

Goldfarb, et al., (2012) argue that the results are driven by split control rights, where

neither business angels nor venture capitalists have firm control over the companies’ board of

directors. The decision making process is intermitted due to different partial interests. Angels

and venture capital firms are substitutes. Only 7% of all financing rounds went successful

while syndication between both parties were involved (Hellmann, Schure, Vo 2013; Goldfarb, et

al., 2012).

Investors can secure certain projects by providing capital that will be partly spent by the

entrepreneur, thus signaling commitment to the entrepreneur and providing more effort in

order to secure the return. Which funding source will be the most appropriated for startups

depends on how much equity the founder already has. If there is only a small amount, it can be

very beneficial to get funded by a business angel. Through their extensive knowledge and

network a startup can increase its business very fast. After a successful raise of the market

share, the venture is already within the growth stage and the consideration of venture capital

can be useful. According to Massachusetts Institute of Technology (MIT) Entrepreneurship

(2000) report angels normally have more operating experience than many venture capital

firms and their guidance and support will impact the company growth between 1 - 18 months

whilst venture capitalists provide guidance for 18 - 36 months and usually bring strong

expertise in financial strategies, but are often found to have little operating experience in new

ventures. If a founder already got sufficient equity to bridge the early stage without major

problems, the realization of growth or new projects can be made through venture capitalists

directly.

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Table 2.3 summarizes the three major financing sources for startups and outlines the advantages

and disadvantages of each one.

Table-2.3: Differences of financing and its pros and cons

This thesis specifically aims at presenting a framework of crowdfunding benefits, which

supports startups to understand the advantages and disadvantages of this source of investment.

This will help their decision making when considering crowdfunding.

2.3 Crowdfunding

There are many different definitions of crowdfunding; however, there is no one accepted or

universal definition. There are several different terms used for crowdfunding, such as

crowdfinancing and crowdinvesting. However, in this thesis the term ‘crowdfunding’ will be

used exclusively. The constant rise of the Internet and its social media have made it possible to

aggregate and connect many people, often called ‘the crowd’. Companies, platforms or

individuals approach theses crowds to raise money for a certain project, business idea or

venture (crowdfunding). Formally, crowdfunding can be seen as the process of raising capital

through the pooling of numerous individuals with small financial contributions. The

contributions of the individuals in the crowd cause the crowdfunding process and affect the

value of the outcome. Usually, the investment will be made via the Internet. Crowdfunding

has its roots in the concept of crowdsourcing, which is a wider concept of an individual

reaching a goal by receiving and leveraging small contributions from many parties (Belt,

Brummer, Gorfine, 2012; Massolution, 2013; Macht, Weatherston, 2014). Besides traditional

funding sources, like loans, business angels or venture capital, crowdfunding platforms are

offering an alternative form of investing. It enables startups to prepare their market entry and to

require micro investments. There are three user roles when it comes to crowdfunding.

24

First, the intermediary serves as a matchmaker between promoters and funders. Intermediaries

are also known as the platforms where the fundraising is taking place.

Second, there are the startups. They are the fundraisers who use the intermediaries to get

direct access to the financial market.

And third, there are the investors themselves, also named crowd, who bear risks and decide to

support ideas. Usually, they expect a certain payoff (Tomczak, Brem, 2013).

Principally, everyone can call for funding for its project or idea using an Internet campaign.

As with the other financing sources crowdfunding is based on the principle of trust, since

funding occurs in the seed or early stage. The project categories for which that money can be

raised reach from films, music, gaming, journalism, fashion to web-based technologies and

many else (Dapp, 2013).

In 2006, the pioneer in this crowdfunding context was the portal Sellaband, a fund raising

website for musician, which allowed individuals to financially support their campaigns in

order to tape a record. In return, the investors got rewards like a free copy of recorded music or

a small proportion of the sales revenue. Over the years, the number of platforms increased,

where people could support their favorites. At the same time, the crowd-based fundraising

model extended to businesses, resulting out of the amount of startups, which aimed at raising

funds. The term ‘crowdfunding’ derived from the application of the Internet crowdsourcing

concept, for both creative projects and ventures (Kappel, 2009; Schwienbacher and Larralde,

2010; Ordanini, et al., 2011; Macht, Weatherston, 2014).

In the crowdfunding context, the startup is the owner of a campaign and the individuals of the

crowd, who has decided to fund the campaign, is the recipient. The startup is placing its

campaign on a crowdfunding platform and proposes for an open call. An open call is

understood as a call for support to fund certain projects. The crowdfunding platform is

providing the place where startups offer their open calls and where the crowd can fund. In

2012 the total funded amount was $ 2.7 billion worldwide, where 59% were collected in

North America and 35% were raised within Europe. The rest goes to Africa, Asia and

Australia (Massolution, 2013). Compared to the above mentioned financing sources, the

amount of funds within the crowdfunding industry is rather small. However, this it is also not

the essence of crowdfunding, since in general it is there for the ‘peewees’ and allows one to

realize its projects or ventures. However, according to the Crowdfunding Industry Report

(2013) the previous growth rates are phenomenal. The worldwide volumes grew around 64%

(2011), around 81% (2012) and a predicted growth rate of an additional 88% in 2013.

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Worldwide, more than 1.1 million campaigns were successful funded (2012) and it can be

expected that is only the beginning of an additional serious financial source. As of 2012, there

were 813 crowdfunding platforms estimated (ibid.).

Also from crowdfunding, investors cannot expect that their money will be well invested.

According to Shikhar Ghosh, a senior lecturer at Harvard Business School, even the best

investors do not have a great success rate. Three-quarters of U.S. startups that get venture

capital investments do not return their investors' money. 25 % - 30 % of ventures that receive

venture funding do fail (CNBC, 2013).

2.3.1 Role of the Crowdfunding Platform

Crowdfunding is classic paradigm of a two-sided market. According to Eisenmann, Parker, Van

Alstyne (2006), a two-sided market links together two individual user groups in a network. In

order to perform well, they have to run on a crowdfunding platform. A platform could be

either a digital marketplace or a certain web page for exchanging funds. It could also be an

intermediary or a broker, who introduces investees to investors (Tomczak, Brem, 2013). This

thesis will not present the technology behind platforms and it will not outline the web

programming either, that is out of the scope of the work. For further readings, there are some

sources such as Aparicio, Costa, Braga (2012) and Franklin, et al., (2011) available, which

describe the technological architecture and the programming of crowdfunding platforms.

The role of the intermediary is to bring together the ideas and the money side. For operating

and providing that service, crowdfunding platforms charge fundraisers a fee from the total

project funding. For example, Kickstarter (2014a) will apply a 5% fee and Seedmatch (2014) is

charging 5-10% of successfully funded campaigns. Therefore, the entrepreneur, here the

fundraiser, has to pay the fee while the subsidized side pays no fees on their investment.

Furthermore, “the platform creates value by facilitating interactions between the different

groups” (Osterwalder, Pigneur, Smith, 2010). This value creation attracts more users, who

will also join the network. This phenomenon is known as the network effect. An increase in

the number of investors leads to an increase in the number of potential fund raising startups

and vice versa. This is important to crowdfunding platforms, as “they require a sufficiently

large crowd from which to draw investment from and enough crowdfunding projects posted to

attract an adequate number of investors” (Tomczak, Brem, 2013, 341). The two areas with the

highest crowdfunding activity in the world, accounting for most of the crowdfunding

campaigns, are Europe and the United States of America. The following table shows a small

selection of crowdfunding platforms, their model and their origin.

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Crowdfunding Platform Crowdfunding Model Country crowdaboutnow.com debt-based Netherlands crowdcube.com equity-based United Kingdom indiegogo.com reward-/ donation-based United States of America kickstarter.com donation-/ reward-based United States of America seedmatch.de equity-based Germany startnext.de reward-based Germany

Table2.4: Selected Crowdfunding Platforms

To get a better understanding of the different crowdfunding models, the next chapter will

explain them in more detail.

2.3.2 Crowdfunding Model

Depending on the kind of reward the startups agree to receive upon giving money, one can

distinguish between at least four established crowdfunding models – donation based, reward

based, lending based and equity based. Additional there is a new royalty based model emerging.

Each of the models has different features which suite different needs of the campaign owner.

The following definitions are introduced by the Crowdfunding Industry Report and point out

these differences:

Donation Based: - Crowdfunders donate money to campaign owners and do not

expect to receive a tangible benefit from the transaction.

Reward Based: - Crowdfunders support campaign owners and receive some kind of

reward in return for their contribution.

Equity Based: - Crowdfunders invest in campaign owners and receive equity or

equity-like shares in return for their investment.

Lending Based: - Crowdfunders lend money to campaign owners and expect the

future repayment or a principal with or without interest.

Royalty Based: - Crowdfunders invest in campaign owners and receive a share of

revenue earned in return for their investment.

The individual advantages and disadvantages must be balanced by the startup individually in

accordance to what method suits the business model most. Not all crowdfunding platforms

provide the whole service portfolio. Many of them are specialized in a certain way and have

their own focus group. That makes crowdfunding a very special tool. Due to these five

models, it is unique in comparison to other financing sources that are basically only used to

give out equity or debts. The crowdfunding growth was almost solely driven by lending based

and donation based funding. As Figure 2.5 shows lending grew to a total volume of $ 1.2

billion and donation based lending grew to a total volume of $ 979 million.

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Figure 2.5: Growth of crowdfunding and its shares of the different models (Source: Massolution, 2013)

“The path from prototype to marketplace drastically shortens for products and services

that can appeal to the crowd” (Massolution, 2013, 26). The typical average crowdfunding

campaign size across the different models $ 1,400 for donation based, $2,300 for a donation-

reward mixture, $2,300 for reward based, $4,700 for lending based and $190,000 for equity

based in 2012. As Figure 2.5 outlines, donation based crowdfunding has smaller funding goals

but 62% of all successful campaigns used that model. A reasonable explanation why equity-

based funding is less popular could be closely related to the JOBS Act by the USA and

Securities Prospectus Act by the EU.* Indeed, applying for equity offering is mostly limited

to public listed equity only. Companies and startups cannot do a general request, unless they

received prior authorization from their national securities regulator. In many countries, there is

also a restriction as to how many private capitalists a company may have (Larralde,

Schwienbacher, 2010).

Pay-out

Many crowdfunding platforms provide the ‘all-or-nothing’ funding model. For crowdfunding,

the startups have to calculate the amount of money they need and set the minimum sum they

are attempt to gather.

* Legal basis: USA: In order the change the way of new funding sources, the Securities and Exchange Commission (SEC) had to revise its Jumpstart Our Business Startups (JOBS) Act. Business startups have always been able to raise money from accredited investors. After to come in operations startups do not have to verify individual investors as long as they support its campaign on registered platforms. Additionally, via crowdfunding, non-accredited investors can put in $ 2.000 and 5% of their annual income if they make less than $ 100,000 a year (Graf, 2014). Germany: According to Section 2(3) of the Vermögensanlagengesetz (Capital Investment Act) the law assumes that the investor does not require special protection if the issuance volume does not exceed € 100.000 in twelve months. With financing via crowdfunding platforms the volume limit of € 100.000 is usually not exceeded, i.e. a sales prospectus does not have to be produced. This provision is also to be found in the Securities Prospectus Act in keeping with the EU Prospectus Directive (Dapp, 2013).

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This projected funding goal has to be reached. The goal is vacate unless the minimum amount

is met before deadline. No money will be paid out when then minimum amount of money is

not funded. In that case, the money returns to the investor’s (Tomczak, Brem, 2013;

Belleflamme, Lambert, Schwienbacher 2010; Collins, Pierrakis, 2012). Generally, the

money, which is funded for different campaigns, will be “transferred to and parked in an

escrow account, which is managed by either the platform or by a partner bank” (Hemer,

2011, 15). That all-or-nothing condition brings startups calculate appropriate realistic project

goals. It protects the startups for their own improvidence and overreaching could end up that

the goal will fail (Bradford, 2012). To avoid fraudulent campaigns by entrepreneurs the

required minimum funding goal is self-adjustment system. The idea here, the crowd will

identify the fraudulent proposal (Collins, Pierrakis, 2012).

Direct versus Indirect crowdfunding

According to Tomczak, Brem (2013), there are two different types of fundraising in

crowdfunding – direct and indirect. Direct crowdfunding is when the entrepreneur makes a

request to a specific audience to their own platform or to its specific supporters (e.g. a band is

gathering money from its fans). Indirect crowdfunding is when the entrepreneur makes a

request to an unknown group of investors or to the crowd. Typically, this is accomplished via

a crowdfunding platform. This distinction between direct and indirect crowdfunding is

important because “at times entrepreneurs make use of crowdfunding platforms instead of

seeking direct contact with the crowd” (Belleflamme, Lambert, Schwienbacher, 2010, 5). If

an entrepreneur chooses the direct crowdfunding way, it has to make sure a large enough

crowd is available to get funded from. Although there is no established averaged minimum

number in successful crowdfunding found, the British crowdfunding platform Crowdcube

(2014) asserts 71 investors.

Ex post facto and ex ante

The two general models of funding at the core of crowdfunding are ex post facto and ex ante.

According to Belleflamme, Lambert, Schwienbacher (2010) ex post facto funding is when a

product is offered after financing. The crowdfundee plans to give the investor a projected

product in exchange for his/ her investment. That could be an existing prototype, a blueprint

or sample in place of the finished product. The initial seed funding can be used toward

production costs. The other type of funding is ex ante. The investor finances an uncompleted

project. The way Kappel (2009, 375) sees ex ante is that “financial support is given on the

29

front end to assist in achieving a mutually desired result”. The crowdfundee has not passed

the stage of creating his/ her product or service. Money will be raised in order to fully fund

the project. Due to funding before a product is accomplished, investors have a direct

connection with the realization of the product as opposed to ex post funding where an

outcome or trial product has already been finished in advance of getting funding (Tomczak,

Brem (2013).

Modes of investment

When it comes to an investment, the money giving person can choose between three different

modes of crowdfunding investments – passive, active or donations (Metzler, 2011). Passive

investments are described as the investor giving money to a startup but not actively deciding

about the venture in general and about the activities that the venture performs, meaning there

is no seeking influence of the business. Therefore, any startup that is seeking out passive

investors is “solely interested in raising money but not using the crowd as active consumers or

giving up some control’ over the product” (Schwienbacher, Larralde, 2012, 13). In their study

of Larralde, Schwienbacher (2010) state that passive investments account for around 60% of

all crowdfunding campaigns.

Through active investments, in contrast to the passive investment, the investor gets the ability

to affect the outcome of a startup’s idea. The investor owns a portion of the company he/she

invested in and might attains voting rights. Active investments account for around 30% of all

crowdfunding campaigns (Lamert, Schwienbacher, 2010).

The last mode of the investment is donation based and as the name implies, the investor is

placing a donation to a crowdfunding campaign. The investor is giving money without

expecting monetary or tangible rewards (Rubinton, 2011). It can be suggested that this kind of

crowdfunders care about social reputation or enjoy the success of the campaign. They do not

look into business plans, but at the core values of the ideas (Lehner, 2012). Unsurprisingly,

the majority of donation campaigns are for charity and non-profit organisations. Compared to

passive or active investing, donation based funding is seen as not being as attractive. Around

20% of all crowdfunding campaigns are pure donations (Lamert, Schwienbacher, 2010).

According to Tomczak, Brem (2013) it may be possible that not all options are covered in the

literature. They say that there is the opportunity for hybridisation. Meaning, a donation can be

turned into an active involvement. The fundraiser allows the investor to determine project

30

decisions. They also mentioned that there is crowdsponsoring, a way for sponsorship

with non-financial returns. To explain both in more detail would be out of focus for this

thesis. For further reading the papers of Hermer (2011) or Kaltenbeck (2011) are

recommended. After the crowdfunding models have now been discussed in detail, the next

section describes the entrepreneur’s motivation to choose crowdfunding.

2.3.3 Motivation

Crowdfunding works best if there is engagement, which means that relational and social

capital is being transformed into financial and innovation capital. Compared to the more

established financing sources crowdfunding is different. The setup differs and basically it has

no limitation of rewards. Campaigns stand and fall with the motivation, mobilization and

engagement of the crowd (Iske, 2010). Successful crowdfunding is depending on the

presentation of the campaign and the integration in social media, where it gathers people’s

attention. Investors in a crowdfunding process are not investors in a traditional sense. They

receive alternative compensation and mostly do not expect financial returns. According to

study of Stiernblad, Skoglund (2013, 27), almost 50% of all asked people invested in

crowdfunding “because I liked the project and wanted to support the idea”. Therefore,

funding campaigns are mainly related to hopes and faith of certain future product deliveries,

public recognition and even positive psychological returns. What they receive in return for

their investments is often intangible (Belt, Brummer, Gorfine, 2012; Dapp, 2013). According

to Dapp (2011) the reward for the crowd in form of tangible goods offers the chance to

interact in the value creation process of the startup. The crowd can support the campaigns

with ideas for design, blueprints or branding. Thereby, crowdfunding acquires a type of open

innovation component (Macht, Weatherston, 2014).

Crowdfunding is still a young fundraising mechanism and research about motivation for

crowdfunding has mostly focused on the interests of the investor. In order to investigate the

motivation of startups to use crowdfunding, one can consider the motivations of the very

close crowdsourcing, a specific form to help the company carry out certain tasks except

financial inputs (Macht, Weatherston, 2014). Therefore, to research the motivations of

startups to use crowdfunding one can start from a similar point. The motivation for

crowdsourcing is explained on being based on enjoyment, autonomy and creativity of the task

(Kleeman, Voss, Rieder, 2008). Additionally, motivation can be involvement or fulfilment to

a certain task, enjoyment and contributing of own competences. Social proof and social

responsible investments drive the motivation more than money returns. According to the

research of Isky (2010) the results showed return of investments as less important than

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affinity with the entrepreneur and his/her project. Startups can also test their product or

service to a closed cycle of audience. If startups have compelling projects they can boost their

reputation (Canada Media Fund, 2012). Startups do not only use crowdfunding platforms for

funding. Some of them use it for promotion, market testing and networking with potential

partners (Rubin, 2011). However, the main motivation is still to get funded. The research of

Lamberdt, Schwienbacher (2010) emphasizes that the motivation is strongly money driven.

Besides raising money by a crowd getting public attention was relevant for 85% and gaining

feedback for the product or service was relevant for 60% of all survey participants. In a

survey about the motivation of crowdfunding conducted by Belt, Brummer, Gorfine (2012),

US-American startups named the lack of access to angel, bank or venture capital, frustration

about the costs and the burdens of raising ‘traditional’ capital as a motivation to get crowd

funded. Startups also might consider crowdfunding as a financial source without giving up

ownership. This is often one of the main reasons for entrepreneur’s decision to reject funding

offers from business angels or venture capitalist, if they are deemed to request too much

equity (Mason, Harrison, 1996). Furthermore, entrepreneurs turn to crowdfunding when the

involvement of external players becomes overwhelming and the founder’s concerns are

increasing about investors in their business (De Noble, 2001). Hermer (2011) argues that

crowdfunding will not replace traditional sources of entrepreneurial finance, particularly in

later stages. In later stages, where high amounts of money will be needed, no investor would

spend money without having rights of co-determination. Crowdfunding can however

complement these other funding sources.

Besides its many benefits crowdfunding also has risks and limitations for the entrepreneur.

Crowdfunding platforms provide non- or little intellectual property (IP) protection. If a startup

sets up a campaign, someone else might copy the idea. As Rubin, founder of IndieGoGo

platform said: “We get asked that all the time, ‘How do you protect me from someone

stealing my idea?’ We’re not liable for any of that stuff” (Rubin, 2011). Due to concerns of

plagiarism, many startups are reluctant to offer their ideas (Canada Media Fund, 2012).

Another barrier is the negative publicity when a campaign fails. When a campaign is failing

or for some reason the startup is unable to deliver a product or service, it can have an impact

on the startup’s reputation. Another negative point is that crowdfunding investors can add

value on a small scale only. The network and useful experience that could be provided by

business angels and venture capital firms, does not exist. Their expertise can leverage up the

success of a startup and will increase its business outcome. Startups should consider this in

their choice of financing source.

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2.3.4 Moral Hazard, Overfunding, Pitfalls

Crowdfunding has its disadvantages as well. Crowdfunders are confronted with the moral

hazard problem and the crowdfundee has to deal with overfunding. Both handicaps will be

presented in more detail. At the end, general pitfalls of crowdfunding will follow and its down

side of crowdfunding will be outlined in more detail now.

Moral Hazard

On crowdfunding platforms the amount of information there are very limited. Investors get

only a specific amount of information about the startup, the project and its valuation. The

providers of crowdfunding platforms are believed that only sophisticated people capable of

evaluating this information (Schwienbacher, Larralde, 2012). The lack of information will

make it very hard for any crowd to determine the value of the startup. The appropriate

successfulness of the idea cannot be estimated right. Due to the less amount of information

the crowd is subjected to a moral hazard problem. According to Krugman (2009, 63) moral

hazard can be defined as: “Any situation in which one person makes the decision about how

much risk to take, while someone else bears the cost if things go badly.” From the lending

point of view, entrepreneurs could take advantage and evaluate their equity inaccurately. They

could use the allocating funds for other things. In order to the early stage and other external

financing partners, investors have access to more insight information than what is presented to

the crowd. The investors can do a better evaluation by themselves. With the crowdfunding,

the crowd has only few opportunities to label the price of the startup. They have to rely on

that one which is offered by the entrepreneur. Regarding to the less information, there is also

a risk tolerance between the crowd and the entrepreneur. The entrepreneur cannot be

monitored well; the crowd takes more risk than willing to pay actually. They have fewer

incentives to govern the startup (Stiernblad, Skoglund, 2013).

Overfunding

It is possible that crowdfunding campaigns surpass their goals. In that case, the intermediate,

the investor and the entrepreneur do benefit. For the intermediate it brings good publicity and

its potion increase with every additional Euro above the target. The investor was able to buy

more shares and the entrepreneur is happy about the fact the campaign was more successful

than expected. That brings attraction to the startup as well. However, it might be “fatal to a

project’s longevity” (Ibberson, 2013).

33

Regarding to reward-based campaigns, overfunding stands for more incentives. In such cases,

startups fail to deliver their product on time, when they met too much capital. Due to the extra

money, crowdfunders expect more advanced than the regular version, because the additional

money should lead to extras. The number of failures increases when the project is still in beta,

where the entrepreneur never projected to achieve that amount (ibid.).

Regarding to equity-based crowdfunding, overfunding faces similar risks. When it comes to

overfunding, investors are in danger to spread their share too thinly (ibid.). Especially startups

might not handle to bring all investors to the table. Only experience can help to deal with

much response (ibid.).

Pitfalls

On pitfall is that potential investors make gut decisions. According to Isenberg (2012), for

equity driven crowdfunding, people do not spend much time on investment decisions. His

study found out “people don't always do their due diligence to determine if it's a sound

investment before investing”. So, popular and in media often presented campaigns are pulling

new ‘fools’, people who are not really in the topic. They think that: ‘So many people who

have decided to invest their hundreds and thousands, or more, cannot possibly be wrong, can

they?’ (Isenberg, 2012). Startups, which use crowdfunding, are mostly interested to get

funded successfully in the first place. But when it comes to growth and additional funding

rounds, too many uninformed investors could become a problem. Potential business partners

or investors will have to pay more for fewer shares, which could bring negative impacts to

startups.

Another pitfall is, that crowdfunding leads to many shareholders, as already known. In some

cases, entrepreneurs may be stuck with this unwanted baggage, because it creates a capital

structure, which is unattractive to other sources for later stage financing. The later stage

financing instruments aiming for key corporate actions and if there is a crowd involved as

shareholder than it can become to misunderstandings (Stocker, 2012).

Crowdfunding may also open the door for frauds. Various studies and tests have shown that

the general public is mostly financial illiterate (Siegel, 2013). Like at the stock exchange

crowdfund investing is having its risks as well. The illiterate investor is not able to estimate

the risks and uncertainties. “Therefore, the combination of the average crowdfunding investor

being naive and being ill equipped will facilitate higher levels of fraud” (Kantor, 2014). Many

incorrect decisions or miss funding can cause that the investor might lose too much money.

Thus, towards crowdfunding it may happen that a negative attitude arises. That could slop

over and will affect the crowdfunding community.

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Chapter III - Theoretical Framework

A framework is used to limit the scope of the theoretical data by focusing on specific

variables and defining the specific point of view. The theoretical framework uses the

introduced theory that explains why the research problem under study exists (USC,

2014). The theoretical framework of this thesis is about the motivation of being an

entrepreneur. Besides considering Schumpeter’s interpretation where these individuals

undertake and manage a venture while applying innovation, management strategies and

setting up a business, will be included also the fact that entrepreneurs are not afraid to

take risks and use their resources in a creative way. They are productive without losing

the scope of their business (Casson, 2010).

What matters for an entrepreneur if its startup is valuable to others and in order to gather

seed money for future growth? The initial assumptions must be confirmed in the first

stages of the startup, as all the decisions and activities undertaken during the seed- and

early stages will influence the path of the company after the startup period.

Entrepreneurs are reliant on external financing mostly. Therefore, they should consider

their financial background and their future funding sources in order to avoid negative

impacts. The business model of traditional financing sources is to fund such entrepreneur.

Due to the venture’s uncertainties and risks, venture capitalists reduce their insolvents in

early stages. Their focus shifts away to later stages (PricewaterhouseCoopers, 2014). There

is a gap for entrepreneurs to raise money (Lavinsky, 2010). Startups have difficulties to

gather money between € 35,000 and € 150,000 (Voorbraak, 2011; Pagliery, 2012).

Recognizing that there is no right stage to get funded from a specific financing source

leaves the room to declare that every source brings its advantages. After reviewing

different financing concepts, crowdfunding is considered as a relatively new financing

source and fits perfect in the early stage. However, over the last years crowdfunding has

quickly become a popular path of funding for investment – seed money and start-up

funding. The growth rates have been amazing over its short life span (Tomczak, Brem,

2013). For entrepreneurs crowdfunding seems to be an attractive and important source. It

minimizes the time consuming fundraising process so entrepreneurs spend more time

where it counts, on their business. In the research, the motivation of crowdfunding has

mostly focused on the interests of the investor. For investigation researcher considered the

motivation of the very close crowdsourcing (Macht, Weatherston, 2014) The motivation

for crowdsourcing is explained on being based on enjoyment, autonomy and creativity

35

of the task (Kleeman, Voss, Rieder, 2008). This thesis examines the motivators why young

entrepreneurs opt for crowdfunding.

Business angels and venture capitalists are able to bring value to startups, besides

financing. They have already networks, expertise and many experts, from which

startups can only benefit (OECD, 2011; Stocker, 2012). Business angels bring more

expertise than venture capitalist, but also fund smaller amounts. Startups that require larger

amount will seek venture capital investment (Fairchild, 2011; Wong, 2003). Crowdfunding

provides other values and cannot be compared to the established funding sources.

Feedback, valuable changes about blueprints or designs are useful information for startups

in order to extend their market share (Macht, Weatherston, 2014). The crowdfunding

campaign and the intermediation can be used for marketing purposes. It brings free

publicity (ECN, 2014). This thesis examines the adding value of crowdfunding.

It is possible that crowdfunding campaigns surpass their goals. In that case, the

intermediate, the investor and the entrepreneur do benefit. That brings attraction to the

startup as well. However, it might be “fatal to a project’s longevity” (Ibberson, 2013).

When it comes to overfunding, investors are in danger to spread their share too thinly.

Especially startups might not handle to bring all investors to the table (ibid.). It creates a

capital structure, which is unattractive to other sources for later stage financing. The later

stage financing instruments aiming for key corporate actions and if there is a crowd

involved as shareholder than it can become to misunderstandings (Stocker, 2012) This

thesis examines how startups deal with overfunding and other pitfalls.

In order to study the research question the following overview shows the stages, where

crowdfunding is considered.

Figure-3.1: Venture stages and funding rounds (Based on: Cumming, Johan, 2009)

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Chapter IV - Research Methodology.

In the same way as other research methods, an expert interview can be used as a stand-alone

method. Hereby, one has to select the relevant people, do enough sufficient interviews and

analyze them. Often, it is not easy to identify the ‘right’ person as an expert. Additionally,

expert interviews are very time consuming and it is therefore not easy to find a good time

frame for having the interview.

Since the purpose of this work is to develop an improved understanding of how crowdfunding

can be used by startups, the interview type applied was the systematizing expert interview.

This type was oriented towards gaining access to exclusive knowledge of startups. It aimed at

knowledge of action and experience that had been achieved from practice and could been

communicated spontaneously.

The goal of the interviews was to get as much in-depth information as possible. Regarding the

research question, the semi-structured interview method was seen as the most appropriated

one since it was most useful to gather wide-ranging information in a systematic way. An

interview guideline in order to keep control over the conversation was developed.

Additionally, without having restrictions only questions were used to frame the different parts

of the interview. The exact questions arose during the interview to adjust the conversation and

to cover the subject in order to be able to make generalizations afterwards. The interviewee

was able to describe its individual situation in its own words. The interview was rounded off

with a debriefing that gave the interviewee the chance to add information. Interviews,

especially expert interviews, were defined; the following chapter will describe the sampling

and the selection of the experts, followed by the presenting the interview design.

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Chapter V - Case Analysis

Crowdfunding projects, as said before, come in wide variety of context, forms etc. but

nevertheless they share common parameters in general. In the following practical examples

are given integrating theory and practice of reward-based and equity crowdfunding.

In 2012 entrepreneur Eric Migicovsky, founder of Pebble Technology, started a

crowdfunding campaign on Kickstarter to raise funds for entering production for his smart

watch project Pebble.5 The Pebble is an infinitely customizable smart watch that connects

to your mobile phone and can run mobile apps according to. The funding goal was 100.000

US Dollar, which was needed to get production tooling, large component order and global

Bluetooth certification. After thirty-seven days the project ended and collected over

10million Dollar backed by about 68.000 crowdfunders. The monetary reward scheme for

crowdfunders of this project included the watch at a price range of 99$ to 125$ for a single

item. It was simultaneously announced to retail for 150 US Dollar. The price discrimination

Migicovsky signaled was financially very attractive to become a crowdfunder. He did this

because the project constituted a product innovation and had no reliable signal of sufficient

demand at that time. Further the funding goal was relatively ambitious to finance via

reward-based crowdfunding. The information asymmetry led to an inefficient campaign on

financial terms despite the project’s huge success. This example opposes the argumentation

based on Belleflamme et al. (2012) where project’s under pre-ordering mechanism rather

offer the product at a premium and retail it at a discounted price (Lucky Packet Project).

The Pebble project had further appealing signals to tab a wider range of audience. The

project also allowed interested individuals to participate in a non-monetary reward scheme

by donating 1 US Dollar or more for getting exclusive Pebble updates on technology

developments, availability and more. Finally 2.615 people went for this option and backers

posted about 15.000 comments. It signaled back that people want to participate in such

innovative project even if they cannot commit to pre-purchase by whatsoever reasons.

Additionally Migicovsky signaled to let Pebble be an open source platform addressing

developers to make the project successful if they are looking to launch their apps on the

smart watch. 5 See: www.kickstarter.com/projects/597507018/pebble-e-paper-watch-for-iphone-and-android

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Another project with similar attention but smaller in final volume is Stoersender.tv6. It is

an independent crossover project across cabaret, journalism, satire, and campaigns including

actions of civil disobedience. The founders asked for 125.000 Euro using the Berlin

based crowdfunding platform Startnext to produce an independent TV magazine. The

money was intended to produce a total of twenty episodes of thirty minutes length

throughout the year. The project did surpass the goal and raised over 150.000 Euro from

about 3000 individual crowdfunders in thirty days. The program itself was meant to be free

for the general public afterwards, leaving it with just one period of market, the campaign.

Different tiers of compensation were offered signaling to different levels of willingness to

pay and personal budget. The stoersender.tv project asked for example to donate 20 Euro to

get 3 month exclusive pre-access to their newest content. The perk itself was not that

attractive on financial terms. More appealing was certainly the opportunity to be one of the

backers who made the program available free of charge for the general public. Here the

price discrimination was applied the other way around. The difference is that Stoersender.tv

signaled to pre-order for a positive cause and Pebble did rather signal to the financial

rationale. There was also an additional participatory signal allowing crowdfunders to have a

say in the program.

In the Vagabund project a similar participation opportunity was signaled. 7 Craft beer

enthusiasts could buy a membership for a new community based brewpub. In the course of

this membership crowdfunders were compensated with regular beer deliveries of new

brews throughout the year. The financial offering was rather weak if one compares the

offered delivery to beer prices per volume. But as mentioned, crowdfunders gained the right

of participation. They were granted a say in which beers are brewed as the time of their

membership. The project did raise 18.500 Euro from crowdfunders and asked for 15.000

Euro. Stoersender.tv and Vagabund can both be considered efficient projects betting on the

giving-for-a-cause motivation and offering perks of participation. To be fair, a new

technology product like Pebble is accompanied by more risk and needed to balance the risk

on the cost of less efficiency. 6 See: www.startnext.de/stoersender 7 See: www.startnext.de/vagabund

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These two cases highlight the success of technology/entertainment and beer campaigns

indicating financial-, cause-, and participation based motivations. Some other successful

examples of reward-based crowdfunding from other industries on Startnext were: Karma

Chakhs8 in fair fashion and foodsharing.de9 in food, both addressing the motivation for

cause mainly. The hardware project iCrane10 was overfunded by more than 900% offering

an innovative product for a financial bargain compared to the announced retail price. On

Kickstarter a very successful project was the Ouya11 game console with over 900%

funding. It raised more than 8.5 million US Dollar. This project announced to have the

same price in the campaign and retail later but scored crowdfunders like iCrane did. The

strong signal here was fairness. It was explained that Ouya will be an open source game

console and crowdfunders were asked and integrated for feedback to make it their console.

Further developers saw the potential of creating their own games for Ouya. It can be

assumed that the target customers were attracted by this transparent and open approach. At

least it balanced the financial unattractiveness and led to an enormous success.

On Startnext entrepreneurs can also apply with projects applying the profit-sharing process.

A compelling example is Fairnopoly12. They founders led a crowdfunding campaign to start

an e-commerce cooperative especially dedicated to fair trade and transparency.

Crowdfunders could purchase shares in the business and thereby join the cooperative.

Fairnopoly raised equity capital from 854 investors who purchased 5 shares for 250 Euro

on average. Nevertheless in a cooperative every single investor got one vote although they

bought more shares. In financial means it will still pay out according to share volume due

to the profit sharing agreement closed with every investment. But Fairnopoly reduced the

investor base by signaling that profits will mostly be re-invested. This signal weakened the

financial appeal and let investors feel pivotal to make the project happened if they were

already hooked by Fairnopoly’s vision. It could also be expected that these investors

comply with the proposed guidelines and probably would be a good fit considering their

future voting right in the cooperative. As a result they were attracted to join this special

community.

Like Belleflamme et al. (2012) already reckons, the online community experience between

investors allowed crowdfunders to enjoy additional rewards beside purely financial return

from their investment. 8 See: www.startnext.de/karma-chakhs 9 See: www.startnext.de/foodsharing 10 See: www.startnext.de/icrane 11 See: www.kickstarter.com/projects/ouya/ouya-a-new-kind-of-video-game-console?ref=live 12 See: www.startnext.de/fairnopoly

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More popular projects are managed on the equity-based crowdfunding platform Seedmatch

(seedmatch.de, Germany. When they started two years ago they offered investors to invest

via a participation agreement in a financial construct that bundled all investors in one entity

that bought shares in startups Belleflamme et al. (2012). Unfortunately this construct was

limited to a total investment of 100.000 Euro. Under these circumstances startups attracted

80-160 investors on average. One of the last startups under this construct was

betandsleep.com that just filed for bankruptcy in august 2013 (Carstens, 2013). Their

problem was to get a follow up investment that was needed to pursue the business model.

This can be seen as a problem of equity crowdfunding. Traditional sources of finance

hesitate to invest in project that already did a founding round via crowdfunding. It is

assumed that traditional investors fear the risk of a packed investor’s table. Since

November 2012 the investment on Seedmatch is done via a subordinated profit-

participation loan. It allows for higher investments and therefore gives startups the

opportunity to ask for what they need in capital right away postponing potential follow up

investments (Carstens, 2013)

The first startup to benefit from the new construct innovation was Protonet13, a cloud

service provider who offers a special server-box to use at home. The common funding

threshold to successfully complete a project is 50.000 Euros on Seedmatch. After one hour

the self-set maximum of shares to be issued was reached at 200.000 Euros. Projects like

Protonet signaling quality on terms like, finance, managing team or technology are quite

similar on Seedmatch. To launch a profit-sharing crowdfunding campaign on Seedmatch

certain measures must be met. Seedmatch applies due diligence and has a strict selection to

be able to signal valid quality measures to potential investors. Often startups already have

launched their product/service on a small scale and did generate first revenues. This is a

good measure for proof of concept and signals quality. Nevertheless it is still very early to

invest and high risks are accompanied with investments at that stage. 13 See: www.seedmatch.de/startups/Protonet/uebersicht

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Besides getting return on investment, investors can exclusively interact with entrepreneurs

to get the latest news on developments etc. that let them feel like belonging to an

exclusive community. As a result an entrepreneur needs to actively manage this community

and develop it to ensure continuous community benefits to keep access. Investors might be

willing to invest in a next round of financing if traditional sources are still hesitant.

One of the rather rare profit-sharing (no equity issued) projects on Startnext (ein-Fach.de)

went a step further in investor engagement. The founders let individuals decide where to

put their locker system containing twenty single boxes within the city.14 Potential investors

could propose a location where they think to get the best return on investment. Consumers

probably proposed a location where they would use the service the most. Then the crowd

could vote for their favorite locations. At this point individuals become even marketers for

their location to ensure it gets selected and might be financed afterwards. All signals bet on

participation in the first instance. The startup didn’t offer equity but agreed to have investors

buy a time limited (2 years) share in their locker system and for that time get the 100%

profit of sales made from the very box they invested in. The profit payout though was

constraint to a maximum limit that replaced the two-year agreement when reached.

Further the threshold to have a project funded was rather low but many projects at different

locations were available to reach maximum diffusion. Nevertheless the huge give away and

diffusion supports that crowdfunding is not just about funding but also about information.

Entrepreneurs use crowdfunding campaigns to test, promote and market their products, in

gaining a better knowledge of their consumers’ tastes (Belleflamme et al., 2010; Gerber

et.al. 2012). In the following chapter the information provided in chapter two and chapter

three are discussed.

14 See: http://einfach.startnext.de/

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Chapter VI - Case presentation & interviews

In this chapter presents three crowdfunding websites including Kickstarter, IndieGoGo

and SellaBand, interviews with project creators and interviews with crowdfunders.

6.1 Crowdfunding websites

6.1.1 Kickstarter

Figure 6.1: www.kickstarter.com

The New York-based crowdfunding website Kickstarter was founded in 2008 with a clear aim - to fund creative projects (everything from traditional forms of art such as theatre and music, to contemporary forms such as design and games). After four years’ development, t has grown up from a small endeavor to a sizable business, which has backed up more than 27,000 projects, has hit $270 million pledged overall and now raises $1 million per week in pledges. Until now, the largest successfully completed Kickstarter project is ‘Pebble: E-paper watch for iPhone and Android’ which has pledged $10,266,845 by 68,928 backers.15 At the time when the author collects data, over 3,800 projects being actively fundraised and about 250 to 300 new projects come to set up per day through Kickstarter with the aim of constructing a pool of supporters in possession of more than 600,000 people. In one word, the achievement Kickstarter received during such a short period has proven that it is a powerful tool in helping ideas bloom.16

15 http://www.kickstarter.com/projects/597507018/pebble‐e‐paper‐watch‐for‐iphone‐and‐android?ref=category 16 http://gigaom.com/2011/02/18/kickstarter‐crowd‐funding‐hits‐1m‐a‐week/

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6.1.2 IndieGoGo

Figure 6.2: www.indigogo.com

IndieGoGo is an international crowdfunding website that was founded in San Francisco

2008. There are more than 9,000 projects from over 134 countries on their site. It was born

with the belief: the crowdfunding solution that empowers ideas and enables people to

donate funds easily.17 As of 2012, it has launched over 100,000 funding campaigns

belonging to three main categories raising ‘million per month’.18 In February 2012,

President Barack Obama's Startup America partnered with IndieGoGo to offer

crowdfunding to entrepreneurs in the U.S.19

6.1.3 SellaBand

Figure 6.3: www.sellaband.com

17 http://www.indiegogo.com 18 http://online.wsj.com/article/SB10001424052970204528204577007781568296346.html?mod=googlenews_wsj 19 http://blogs.wsj.com/in‐charge/2011/04/22/%E2%80%98startup‐america%E2%80%99‐embraces‐crowd‐funding/

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SellaBand self-defining as a fan-funded music crowdfunding website based in Munich and

Berlin. Since its launch in August 2006, there are over $4,000,000 have been invested in

independent bands and more than 80 artists or acts have been funded by their fans.20

There are over 700 artists currently registered on SellaBand raising funds.

SellaBand announced that the lead currency would be changed from US dollar to euro

from 1st September 2010 on. So far, Public Enemy was the first major artist that signed

up on SellaBand and reached the highest target of $75,000 on 28th October 2010.21

6.2 Interviewing with project creators

In this part, the author conducts 9 interviews with projects creators from the

aforementioned crowdfunding websites. And the underlying condition is all of these projects

are fully funded and they all reached a minimum goal of $2000. In order to collect more

various experiences and opinions about the crowd-fundraising, the author attempts to widen

the theme variety of crowdfunding projects as much as possible. So the author selects a

design project, a fashion project and a photography project from Kickstarter while a

film campaign, a community campaign and a small business campaign from IndieGoGo.

Since the SellaBand is only designed for music-relevant projects, the author chooses two

singers and one band projects to interview. Compare to searching crowdfunders, it is easier

to contact project creators because all of project creators on crowdfunding sites leave

contact methods such as email, homepage, Facebook or Twitter on the project page.

Based on interviews, the author mainly discusses with these project creators about

experiences and issues relevant to crowdfunding websites which will be presented in the next

chapter.

20 https://www.sellaband.com/en/pages/about_us 21 https://hiphop.sellaband.com/en/news/213‐congratulations‐public‐enemy

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6.3 Interviewing with Crowdfunders

Of the 45 participants interviewed, the age range is quite wide, from college student to

retired writer, and the oldest up to 57-year-old. According to their profiles on website, 24

interviewees had contributed to at least five different projects, not including their own

project(s) in the past. The other 21 crowdfunders had backed up only one project until

the interview conducted, though they might have funded on other crowdfunding platform.

Furthermore, although the 21 participants only had backed up one project, there still have

evidences showing their active participations in the crowdfunding activities. For example,

they have posted comments to other crowdfunding projects or have tagged interested

projects as the favorite. In fact, 32 of participants indicated that they do not have families or

friends started any crowdfunding projects, those interviewees who had supported their

friends’ and families’ projects also have contributed to other irrelevant projects. Therefore, it

is believed that the research information collected from the interviews is based on their own

experiences and reflections, and neither largely influenced by the family & friend factor.

46

Chapter VII - Empirical results In this chapter, the author summarizes the empirical results through case study and structured interviews.

7.1 Empirical results of crowdfunding websites Kickstarter IndieGoGo SellaBand

Business model ‘all-or-nothing’ ‘all-or-nothing’ & ‘keep-it-all’

‘all-or-nothing’

Fee 5% of fully-funded price

3-5% credit card processing fee by Amazon

4% of fully-funded price or 9% of partially-funded price

3% credit card processing fee

$25 wire fee for non-US projects

1. No direct fee from successful projects

online shopping transaction costs

But more Parts at the same time, pay less transaction costs

A fixed fee for bank and credit card

Payment credit card PayPal PayPal

Blog & Data statistics

Have blog and data release

Have blog but no systematic data release

No blog or data release

Category 13 categories, 36 subcategories

3 main categories, 24 subcategories

Only for music products

Prohibition charity or cause funding project

2. ‘fund my life’ projects

Other prohibited contents

No No

Partnership No 16 partners 9 partners

Restraint Only open to US Campaign

Open to global campaign Open to global campaign

Table 7.1: Comparison of Kickstarter, IndieGoGo and SellaBand

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First of all, Kickstarter, IndieGoGo and SellaBand all claim no ownership over the projects

and the products but the public can access the launch site after the deadline. And

another requirement is that they all refer to project-oriented which means a “product” will

be made, it requires project creator to set a deadline and a minimum funding goal.

According to the author’s observation, the three websites attempt to provide sufficient

information to project creators and crowdfunders but not all of them set a specific blog

and release related data. Kickstarter set a blog which cover tips for project creators, media

press about the website and also systematic data release while IndieGoGo only has a blog

with promotion of projects, media press and relevant features but no data release. And

SellaBand does not have a blog and data release.

In terms of business model, they all use the “all-or-nothing” model which means projects

must be fully funded during the funding period, otherwise no money is collected. It is

worthy to mention that IndieGoGo at the same time adopts the “keep-it-all” model

which means the project creator could keep the money even the project did not reach the

funding goal. But IndieGoGo cuts half of fee on cooperative projects with partner Startup

America. Unlike Kickstarter and IndieGoGo, SellaBand gives crowdfunders the right that

before the music project has reached the funding goal they can withdraw the money from

an escrow account and move to another project. Under almost the same business model,

three websites charge different fees. Once the project is successful, Kickstarter will take 5%

of the funds and Amazon will apply 3-5% credit card processing fees. Meanwhile,

IndieGoGo applies 4% fee for successful campaigns but unsuccessful projects can choose

flexible funding model means keeping what projects got with 9% fee or fixed funding model

means returning all money back at no charge. At the same time, a third party applies 3%

fee for credit card processing and $25 wire fee for non-US campaigns.22

Although Kickstarter and IndieGoGo are large-scale comprehensive crowdfunding websites,

the categories they cover vary a lot. Projects on Kickstarter must fulfill one of 13 categories

and 36 subcategories and need to follow the guidelines. It is important to notice that the

charity or the cause funding project, “fund my life” projects and projects refer prohibited

contents are not allowed to be raised in Kickstarter. Not like Kickstarter, IndieGoGo opens

to cause and entrepreneurial projects.

22 http://www.indiegogo.com/learn/pricing

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7.2 Empirical results of project creators In this thesis, the author does not plan to study project creators separately but use this as

supportive evidence of crowdfunding website. So the interview questions with project

creators are designed according to the website which the project belongs to. Since there are

only 9 interviews with project creator, it is clear to present the interview results according to

the website and the theme.

- Project creator from Kickstarter

Design: “Kickstarter is a large crowdfunding website and has good performance on various

themes. The idea of Kickstarter is to fund creative projects, so I believe crowdfunders on the

site are fond of creative works. My project is design work, so I hope to test the market

response before production and get some opinions of future consumers through the

comments.”

Fashion: “I also raised the same project on IndieGoGo. Of course, I expect to increase the

fund and also promote the popularity of my work. One of the reasons I chose Kickstarter is

its clear aim of supporting creative projects.”

Photography: “I knew Kickstarter because my friend successfully raised a project there, so I

did not do much research work before the campaign, only studied the business model. After I

started the campaign, I researched the site, especially the blog in detail. I think this is a

good platform to fundraise project. There are many articles about how to raise a

successful project and many reports on the statistics of the site.”

- Project creator from IndieGoGo

Film: “IndieGoGo is a really good platform to fundraise an independent film because it

opens to the globe. I knew this fundraising method before starting the case. And I noticed

that there are many big records of independent film projects on IndieGoGo and they

summarized successful experiences. Before creating the case, I studied the tips and its

business model. In my opinion, these tips are really helpful and the combination of

‘all-or-nothing’ and ‘keep-it-all’ provides a flexible option.”

Community: “The reason to raise project on the site is simple, because IndieGoGo is one of

few crowdfunding websites could accept non-US campaigns, in particular with the theme of

community. So I read many articles on the site about how to increase the success possibility.

By the way, I think more data and statistics on previous projects could increase the

confidence of project creator”

Small business: “I knew IndieGoGo until I read the news that IndieGoGo starts to cooperate

with Startup America initiative and discounts 50% of the fee. Until now, I think the

49

IndieGoGo did a good job on small business and the instruction assists me in the

crowdfunding process.”

- Project creator from SellaBand

Singer 1: “I know SellaBand is a professional crowdfunding website aiming to support music

projects, so I believe these fans (that) have common interests easily get together. Then there

is bigger possibility to get fully-funded. But I really do not appreciate their website design,

because I cannot find some information before I started the project.”

Singer 2: “Actually this project is raised by my management company. We decided to raise

a campaign (on SellaBand) because we think the crowd of fans really has great

potential. They contribute money to artist’s album and also increase the popularity of the

singer and the album. Before raising the project, the company compared different

crowdfunding websites and found SellaBand provides a good business model. They won’t

get fees directly from projects and the money pledged by believers (crowdfunder) is managed

by the third party.”

Band: “We expect to have a large pool of long-term fans, so we believe the website with

specialty like SellaBand is much better than other ordinary crowdfunding websites. More

importantly, SellaBand and its partners provide services for other phases of making an

album at reasonable price. It is really convenient for me.”

7.3 Empirical results of crowdfunders

According to all answers of crowdfunders’ interviews, five motivations emerge from

the interview data which could inform the research question that why crowdfunders

participate in crowdfunding activities: (1) the opportunity to support an attractive idea or the

producer they know; (2) the altruistic intentions for funding the project; (3) the opportunity to

help others realize dreams; (4) the reward-oriented intentions of crowdfunders; and (5) the

reciprocity and cross investment between project creators and crowdfunders. Moreover, there

also summarized some significant issues relevant to how they evaluate their decisions

in crowdfunding participation.

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7.3.1 Motivations of Crowdfunders (1) To support an attractive idea or the producer they know

First of all, the favor of projects is a strong motivator to crowdfunders. If take a look at those initial

successful crowdfunding projects, it is easy to see that the attractiveness of projects is the underlying

motivator because most of earlier successful project are creative works. Also, all of the

participants mention that they really think the project(s) they had backed up fulfill their

interests, regardless of the interviewee’s cultural background, job or educational level.

David Drexler, a 44-year-old musician noted that:

“I also like being able to support a lot of interesting projects with small donations, whether it's

something unique that seems worthwhile, something with a local connection, or something

where I know the people involved.”

Robert Clements, a man living in Chester Hill, Sydney, answered that:

“Generally - the idea has to amuse me in some way; & (more generally) needs to make some

sense beyond the obvious.”

Justin Chung, a professional illustrator living in San Francisco, California, mentioned that:

“Most projects I back are the projects I finding interesting and would like to see completed or be

a part of.”

Apart from the favor of appealing projects, the acquaintance with project creators is also

another strong motivator of crowdfunders. 20 participants even indicated that they will start

to contribute right away when they know their friends need help. In response to the question

about why he has funded the crowdfunding project, Christopher, an artist man living in

London, England, replied that:

“A musician's CD and a book by someone I met whose philosophy I like.”

Alison, a 29-year-old woman living in Hicksville, New York, also studying to be in film

production, noted that:

“I am friends with a couple of people whose projects I have funded. Actually that is how I found

out about crowdfunding in the first place. I had volunteered at a film festival in Dallas TX

and happened to catch a film called ‘The Other Side of Paradise’. That is where I met the

writer and actors. That is also when I decided to like their film on Facebook. After I saw

the website I started to look at other projects that caught my eye. I saw what the projects

were about and decided if I liked the concept enough to fund it.” Joseph Huang Do simply stated that:

“Support peers.”

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(2) Altruism

Actually, the pure philanthropy is also a strong motivator in crowdfunding. 22 interviewees’

answers show their altruistic intentions when they response to the question. Ron, a one-

time funder supported one project for both IndieGoGo and Kickstarter, noted that:

“I fund projects that I feel are creative and have the potential to make a difference in the

world and/or are a great alternative to content produced through the Hollywood Studio

System.”

Alana’s answer showed her altruistic intention of repeated backed-up:

“IndieGoGo is wonderful because it enables change in the world. Many people have ideas

but find too many obstacles in their way to implement them. I am proud to be a part of the

fulfillment of these ideas.”

Frank, a one-time funder comes from New York even stated that:

“We are on this planet for a very finite period. In this period if we can foster positive change

and social awareness, we have been productive.”

Although some crowdfunding websites like Kickstarter try to avoid those pure

charitable projects, such as “campaigning for my dog got a cancer”, with the development of

crowdfunding, the altruism enables the prevalence of non-governmental charitable

campaigns through crowdfunding. A Canadian repeated funder said that he participated in

crowdfunding for self-marketing research, but he still contributed one philanthropy project

for Haiti.

(3) The pride of helping people realize dreams

Eighteen crowdfunders specifically mention that they really enjoy the pride of helping

others realize their dreams. Ron mentioned that:

“My motivation is to help others achieve their goals; I think independent producers often

have great ideas and would like to see them expressed. I want to help anyone who boldly

takes the independent path to produce their idea, there are too many talented people who are

held back because of lack of funds or because a studio executive does not have the

imagination to see their talent.”

Sheilagh noted with her personal experiences that:

“I funded the project because I remember being in art school and remembering how artistic

supplies and materials cost so much. I just wanted to help out a young artist achieve her

goal for an art exhibit in school. I would have been satisfied seeing the final outcome of what

I funded it was more important to help her see her goal through to the end successfully.”

Alison stated that:

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“The idea that I am helping someone or a group of some ones realize their dreams is

something that gives me great pride. The feeling of helping make someone’s dream a reality

gives me an overwhelming sense of joy.”

(4) Reward-oriented intention

According to interviews with crowdfunder, the first attitude is that some crowdfunders

consider the reward as a perk not a goal, which means the reward is not a decisive factor.

Even the project they like does not offer any reward, they still donate. For example, Ron

noted that:

“I like the rewards, they are a good incentive. If I believe strongly in a project, I would

contribute without rewards.”

Katie noted that:

“I don't really care about rewards. I don't donate in hopes of getting a reward. I do

think it's nice when rewards are offered, as it shows that the group is trying to give you some

perks for having donated, but it's not a deal breaker for me.”

Gary King answered that:

“I usually donate because of the person if I see they have passion for the project - the reward

is rarely on my mind.”

The second attitude is that the crowdfunders want to get the reward which might be the

product of the project. For those funders, they contribute for purchasing something

interesting or unique rather than a donation. For example, Alison answered that:

“The projects I donate toward are comics, graphic novels or movies. If my funding helps

them get produced then I would be able to purchase it later. So I guess in the end I still get

my prize.”

David Drexler replied that:

“I do like the rewards, especially if it's something like a limited-edition CD, book, or video.

Some projects I have contributed solely for the reward - it's more like pre-ordering

the item than making a charitable contribution. Others I might contribute more in

order to get a preferred reward.”

Adam indicated that:

“I chose the amount of contribution based on the perks offered. If it offered no reward at all, I would not have contributed.”

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Furthermore, a repeated funder Alison specifically emphasized that acknowledgment from

the producer afterwards is one of the most important aspects of the crowdfunding:

“Sometimes people send me messages through Facebook based on my likes or like you have

seen my profile and know what I donate towards. I typically donate to them just because they

took the time to reach out. Sometimes a simple acknowledgement goes a long way. It is so

important for independent artists to get out there...and is always very thankful for the people

who helped them get to where they are. That is the reason I volunteer for film festivals

and THAT is the reason I donate to projects. Not just for the "free swag" but also for the

opportunity to help showcase their projects.”

(5) Reciprocity & Cross investment

Finally, 27 out of all interviewees indicated that they have contributed to projects in order to

get credits for their own projects in the future. There is even a repeated funder said he wants

to gain the investment experiences for his future campaigns. Paul specifically explained that:

“My crowdfunding is not mainly philanthropy. It is mainly part of a marketing strategy, and

a research project. I also wanted the ‘producer’ experience. To see how the guys on the

other side of the investment decision felt. Someday I may want to seek such funds. And like

investment banking, where a low percentage of projects pay for the whole stable of choices, I

decided to have a large sample size for this aspect. I want to truly explore the new

crowdfunding thing.”

Adam figured that:

“I wanted to get on the film set and get my first film credit. This was what influenced my

decision.”

Joseph Huang Do explained the reason of crowdfunding:

“Also investment for support in the future on my own projects”

7.3.2 Evaluation issues

From the interviews with both one-time funders and repeated funders, the author also

draws several issues relevant to how they evaluate the decision to any projects. Sheilagh

explained how her own experiences influence her involvements:

“Any contribution I make to any cause or project is usually because it is something personal

to my own life or background. For example, my mother has had breast cancer so I will likely

make a donation to a breast cancer fund if asked. On the other hand, a young friend of mine

was also diagnosed with it well before my mother - I donated to a cause devoted to helping

young women with breast cancer because it was something personal to my friend. It also

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troubled me to know that so many younger women (under age 30) might be facing the same -

and that just sounded scary. So I wanted to help.” Katie expressed that:

“For me, it mostly has to do with how I have a connection to the project. I'm less likely to randomly fund something than I am to throw some money at a project whose leader I am acquainted with.” Justin Chung stated how he evaluated interesting projects:

“I care most about the skills, competency and reliability of the people behind the proposed

project. If I contribute or how much I contribute depends on what sort of quality I think the

final project will be like.” Sheilagh expressed that:

“I just feel passionate about helping a cause I believe in and something like this project

touched my heart. I figured I have some resources/money to help someone who is struggling

so, why not? Especially if I am passionate about it personally.”

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Chapter VIII - Discussion This chapter, the author discusses the literature research; empirical results derive from case study and structured interviews, in order to reflect on the big picture and selected implications. Analysis of crowdfunding websites, project creators and crowdfunders will be given.

8.1 Analysis on Literature Research

The birth of the phenomenon crowdfunding as we know it is obviously due to a conjunction

of different fundamental shifts and accompanied by temporary triggers. The concept of

crowdfunding as such can take the body of capitalism as well as altruism using modern

technologies to apply its particular marketing strategies. It also raises social questions about

financing entrepreneurial ventures. The current era of connectedness due to today’s

technology (web 2.0) led to people’s rise in empathy, self-determination and consciousness

about global problems. Likewise technology formed a carrier to develop a geographically

independent social movement (Agrawal et al. 2011, Gerber et al., 2012, Adams and Ramos,

2010, Rifkin, 2010, Rao and Giorgi, 2006). The carrier technology lets people experience

faster and simpler solutions to problems and addresses their “desire for convenience”.23

Further factors as well supported the birth of crowdfunding. For sure the lack in specific

legal structures did hinder the phenomenon in some ways (profit-sharing). Finally, due to

the financial crisis and strapped budgets entrepreneurs needed to take things in their hands

and raise money independently. Crowdfunding was born.

Concluding one can assume the phenomenon is there to stay and grow importance due to its

anchorage of- and in fundamental shifts. Temporary accelerators like limited availability of

traditional funds and initial success and media coverage might be seen to give

crowdfunding the time to develop its potential for changing society and business practices

(Gerber et al., 2012). The crowdfunding process consists of a variety of interconnected

concepts and has three different stakeholders, the entrepreneur, the platform and the

crowdfunder. The platform is rather neglected in this paper so it is in the current research.

This is unfavorable and needs more attention. The platform as a two-sided market defines

the framework for stakeholders participating in a project regardless on which side. It builds

the touch point for consumers to experience crowdfunding and may build the lever to

reduce information asymmetry influencing the success of a project (Eisenmann, 2006,

2011, Belleflamme et al., 2012). 23 Cf: Williams, E. in Ryan Tate, 2013. Twitter Founder Reveals Secret Formula for Getting Rich Online http://www.wired.com/business/2013/09/ev-williams-xoxo/

56

Considering the sheer amount of platforms out there by now and the continuing trend of

growth (Massolution, 2012) research is very much needed for understanding platform’s role

and impact.

Reflecting on the mentioned concepts one can recognize a framework of behavioral

finance. Crowdfunding at its core is about the social, emotional and rational effects on

economic decisions and the behavior on the bottom of it (e.g. contract theory). Signaling

serves as the umbrella concept under these theories when it comes to the exchange of

information between individuals and decision making via a platform.24 A signal provides

information the other party for example can use either to buy or not, or increase the price or

not. Both considered mechanism of crowdfunding partly apply different signals but

ultimately each recognizes the importance of signals. Though the credibility of the source

of this information should be given a second thought considering the risk and uncertainty

about the product service or business model at that stage. In the pre-purchase mechanism

signaling theory becomes important if one considers the example of the Pebble watch.

The founders saw their product rather as a niche product but through crowdfunding they

had enormous success so that planning needed to be adjusted. Even though it didn’t go to

well to ship the watches on time the signal of demand allowed the entrepreneurs to adjust

their output in the pre-production phase. In the profit-sharing mechanism signaling is

important in the first place to get initial information but new information is not expected to

be such likely as in reward-based crowdfunding. Consequently it stays more risky on both

sides. Investors, considering the average crowdfunding investor, could overlook a

promising startup and vice versa be fooled. Therefore one can see a pre-selection of

projects by quality measures of the platform.

Next to the mostly rational signals there are those triggering the social

(participation) and emotional (cause driven) side of entrepreneurs and investors. Since

the word, people live by narrative. Storytelling (dialogue) regardless of the form that

changed over the years is the tools of communication by those individuals seeks for

affection, sociability and create relationships (Rifkin, 2010). Since the technological

revolution and a dawning transformation towards an empathic society crowdfunding is

another milestone on this path. As we learned earlier that cause trumps cash and people are

tremendously motivated for intrinsic reasons crowdfunding finds itself as the socio-cultural

context facilitating self- determination theory. 24 See: Vance, S., spinnakr blog, 16th of July 2013, http://spinnakr.com/blog/ideas/2013/07/crowdfunding-

success-a-closer-look-at-economic-models/

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Crowdfunding serves as a vehicle to be pro-active and engaged answering the needs of

individuals for competence, autonomy and relatedness (Ryan and Deci, 2000).

Reward-based crowdfunding is mostly occupied by participation for cause and performs best

if appealing to the crowdfunders belief and passion whereas profit sharing addresses more

rational motivations performing best for example in digital goods, scoring the highest results

(Crowdfunding Industry Report, 2012). Nevertheless if the entrepreneur restricts the issued

shares potential investors might get additionally motivated by feeling pivotal to the project,

which is a good tactic to hack the investor’s rationale code. These emotional or rationale

decisions can accelerate or slow up a project when an indifferent individual decides if

the product or investment is more or less worth than a “nice to have“.25

Speaking of crowdfunders rationale or emotional appeal price psychology, another concept

of behavioral finance, affiliates to this discussion where the entrepreneur applies the

concept by price discrimination. In reward-based projects the price is by rationale matters

probably to high but the emotional appeal of additional utility covers the gap. So the price

one pays is not the purchasing price it is the price plus the experience, as one will. In profit-

sharing projects this is just possible if investors consider being consumers later on or make

the project happen beyond financial considerations but other cause. The Fairnopoly project is

such a case that offered shares including voting rights but set the business framework

straight to cooperation where profits are reinvested in the company without a payout.

Furthermore if the required amount of capital is large than it might be a burden to charge a

high price when many crowdfunders are needed to complete the sum called. The Pebble

project was against entrepreneur’s odds overly successful and retailed later at a 30% higher

price. Did the entrepreneurs just exploit the former success at the retail level or did they

rather intend to launch with a lower price to attract enough individuals? Anyway in relation

to the requested capital they raised far too much for too less. As a result price

discrimination can determine the efficiency of an entrepreneurs project.

25 Cf: Matthew Benson, Kickstarter Capitalism. http://matthewbenson.wordpress.com/2013/01/12/kickstarter- capitalism/#more-2642, 12 January 2013.

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8.2 Analysis of crowdfunding websites and project creators

According to the empirical results, it is not difficult to find that the “all-or-nothing” is the

most common business model in crowdfunding websites. The author reckons that the “all-or-

nothing” model provides a sense of trust to crowdfunders. And most of crowdfunders

mentioned that they felt good about the “all-or-nothing” model. On the other hand, as a

large-scale crowdfunding website, IndieGoGo within both “all-or-nothing” and “keep-it-all”

models provides flexibility to project creators, especially when it is open to global campaigns.

From the perspective of platform, Kickstarter is still quite a simple crowdfunding platform

because it has geographic restraint that it only opens to US citizens and US campaigns as

well as subject limitation to creative projects. Although there are 13 categories and 36

subcategories as well as a large amount of crowdfunders, the projects and the

crowdfunders connected by the platform are respectively the same type. Kickstarter even

prohibits some contents to be raised on the site, such as the charity or cause project, which are

available on other crowdfunding platform. Since the crowdfunding website plays a role of

platform, the author regards a blog as an active communication tool between crowdfunders

and the platform as well as project creators and the platform. Therefore, the author believes

that the website without a blog is not as effective as the website with a blog and data release.

From the point of partner, the author reckons IndieGoGo that and SellaBand have a more

complicated framework than Kickstarter. Firstly, the cooperation with partners widens the

crowdfunding field. For example, IndieGoGo launched the entrepreneurial as new category

since it cooperated with Startup America initiative, so that small business projects could

raise funds through IndieGoGo. Secondly, the partnership upgrades the crowdfunding

framework through incorporating other services into initial model. For example, SellaBand

offers other solution services (like promotion, CD printing) provided by a third party at lower

prices. Thirdly, the partnership strengthens the impact of crowdfunding and may avoid some

conflicts. Through the partnership, more projects can collect initiatives through

crowdfunding while more potential funders can be attracted to crowdfunding activities. More

importantly, it could avoid some conflicts when relevant regulation is absent. For example,

raising business projects directly on the crowdfunding website may cause conflicts due to the

absence of microfinance regulation, while the cooperation with business initiative gives the

crowdfunding platform a legal validity.

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8.3 Analysis of Crowdfunders

As illustrate in the fifth section, the first three motivators including (1) the opportunity

to support an attractive idea or the producer they know; (2) the altruistic intentions for

funding the project; (3) the opportunity to help others realize dreams. As far as I am

concerned, the above three motivators are all non-profitable to funders. Besides the intrinsic

motivators, being part of the project is also an important factor some crowdfunders

emphasized in the interview. Although the amounts of money that most of funders

contributed are tiny, they still spent proper time and energy to surf the website and browse

their interesting projects. Therefore, the interaction between the crowdfunders and the

project creators is a kind of benefit-based relationship. However, the fast development of

crowdfunding testified the experience innovation theory. According to Prahalad and

Ramaswamy (2003), the experience innovation focus on the experience environments

and the value is co-created by companies and consumers and their networks. From this

point, the crowdfunding really fulfilled the characteristics of experience innovation, because

the funders ranked the satisfaction of their non-profitable experiences and feelings as their

main motivators.

Moreover, the fourth motivator “Reward-oriented intention” reveals that the reward plays

an indispensable role in the application of crowdfunding. Generally speaking, any

crowdfunding project will provide different rewards for different contribution levels, such

putting on the name in the acknowledgement list or a limited version CD. With the

prevalence of crowdfunding and more projects succeed through crowdfunding, especially

after more successful projects broke the target price record again and again, the contributors’

attitude to rewards may also change at some extent. And it is sure that the perspective of

reward could reveal variable motivators of funders.

But there are some crowdfunders mentioned that they paid more attentions on the project

itself than reward. As far as I am concerned, there are possible reasons as following. Firstly,

the reward is not accessible for them, such as Sheilagh said, or the cost of delivering the

reward is overwhelming the money donated due to the geographic dispersion of

crowdfunding. For those funders who care about rewards, the accessibility of rewards is

one of the factors influencing their contribution decisions, either tangible reward or virtual

reward. Then they might prefer to back up local projects which could easily deliver

rewards or large projects which have perfect rewards unit. On the other hand, the author

considers that what the crowdfunders really care about is whether the project creator

expressed or had gratitude to the contributors rather than rewards. The reward is one kind of

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acknowledgment in its nature. Therefore, no matter whether the reward is expensive or not,

it still impacts significantly on the crowdfunding. If a project provides an empty promise,

then what it ruined profoundly is the crowdfunders infinite confidence.

Concerning to the motivator of cross investment, it is an emerging trend. Due to the

regulation of microfinance, the crowdfunding was used as donations for the creative and

art work. With more projects succeeding through crowdfunding, it triggered more potential

producers’ attentions to raise money for their own projects through crowdfunding. Thus,

this emergent motivator turned up. The reciprocity and cross investment shows that great

potentialities of crowdfunding could move to an entrepreneurial direction. It is easily

observed that this emergent feature came out among the same kind of projects, such as movie

or video, while project creators and most of people who keep following and updating the

specific kind of projects are from the same circle in reality. Then they could easily collect

together and also build external networks outside the crowdfunding website. For example,

it is noticed that several interviewees the author contacted individually are doing the same

job and also Facebook friends. From this point, the author believes that crowdfunding is

successful especially in film field not only due to the positive attributes of the nature of

crowdfunding, but also largely due to the momentum that has been created by the movie

producers over the years. Based on the answers refer to evaluation, it is evident that most

of issues relevant to how to evaluate conform to the above motivators. But another four

new issues added to the evaluation: (1) the worth of project; (2) personal

experiences relevant to projects; (3) the project creator’s talents and competency and (4) the

cost of crowdfunding. And the fourth one reveals that the crowdfunding has large

potentials in applied for the business arena or is moving on the entrepreneurial direction.

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Chapter IX - Conclusion & Platform Launch This chapter attempts to summarize a conclusion and proposes some untouched areas for future research.

9.1 Conclusion

First of all, it is found that there are some developments of crowdfunding websites in terms

of business model. And in the thesis, it is easy to find that IndieGoGo and SellaBand have

already expanded its crowdfunding circle and upgraded its crowdfunding business model

through adding more functions on the website and incorporating the external partnership

into initial model. Moreover, the partnership is an important tool in the promotion of

crowdfunding because it not only strengthens the impact of crowdfunding but also avoid

some existing conflicts.

Secondly, the structured interviews with crowdfunders reveal that there are five motivations

of crowdfunders which including (1) the opportunity to support an attractive idea or the

producer they know; (2) the altruistic intentions for funding the project; (3) the opportunity

to help others realize dreams; (4) the reward-oriented intentions of crowdfunders; and (5)

the reciprocity and cross investment between project creators and crowdfunders.

9.2 Platform Launch

Since the crowdfunding is developing at a rapid pace, all aspects of the crowdfunding are

worthy to pay attentions on. More specifically, the author considers the following contents

are interested to focus on in the future.

Considering the crowdfunding potential and market scope after the research, we have plans

to launch a platform called Orenda Network to bridge the gap between creators and

contributors.

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Figure 9.1: Orenda Network (Source: www.orendanetwork.com)

Currently Orenda Network is in pre-launch stage and is a hybrid platform. Initially it will have donations and rewards model and once we have rules and regulation set by concerned governing body, we will enable equity crowdfunding as well. Orenda network is a group of people/community who believes in betterment of society by empowering themselves or others to change. Crowd funding mechanism will be used to make it happen. i.e. people create campaigns -social cause, creative, innovative, etc which will help community at large and people who believes in it will be financially backing up the creator. We are not just any other platform. We have best Transparency mechanism and provides option for equity on later stages. Social cause campaigns are on no profit basis. Thus we will help various NGO's to raise funds and provide the step by step updates to the contributors In terms of Orenda Network crowdfunding website, the author states the website design is an important factor does provide efficiency to crowdfunding. As all well known, there are a large amount of projects covering various themes and many forums in a crowdfunding website, how to balance different information and allocate resources is worthy to further study. In terms of project creator, the future research can focus on how to improve the successful rate involving self-investment as well as how to design better crowdfunding plan. In terms of crowdfunding project, the author considers that how to borrow experience of those successful and popular projects and use it in other less popular projects.

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