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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
21
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.
25
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.
27
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).
28
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
38
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
39
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
41
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.
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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
54
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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