Crowdfunding still has some growing up to do, but it has major potential as a disrupter to the investment scene. Prof Theo Lynn and Dr Pierangelo Rosati examine the situation.
Entrepreneurs are heralded as the risk-takers, the innovators, the engines for growth in the modern economy. And yet, access to sufficient funding remains the common cry of these newborn ventures.
Traditional providers of finance – banks – are often resistant to the lures of start-up passion and their risk profile, often comprising untested entrepreneurs and untried products, sometimes unattractive markets and, usually, unrealistic returns. It would seem most start-ups just ‘don’t fit the profile’.
But maybe in these days of unicorns and zebras, there is a princess for every frog – or rather, in the case of crowdfunding, princesses.
The power of the crowd
The emergence and widespread adoption of the internet has connected the long tail of consumers and their specialist interests into ‘mega niches’. It has also facilitated the efficient outsourcing of tasks to larger undefined groups of people worldwide: the so-called crowd.
‘Crowdfunding has emerged as a means for a variety of initiatives, other than commercial operations, to seek funding’
At its core, crowdfunding involves sourcing funding through small amounts of money from a large group of typically non-professional individuals (the crowd) instead of larger tranches from one or a small number of professional or sophisticated firms. Furthermore, unlike traditional funding, the motivation for the funding may not be financial or equity-based but rather, early or preferential access to a product or service, or merely to be part of a wider community or cause. As such, crowdfunding has emerged as a means for a variety of initiatives, other than commercial operations, to seek funding, including charitable and social causes as well as artists, musicians and film-makers.
Crowdfunding is a two-sided market of projects and funders enabled by an intermediary: a crowdfunding platform. Kickstarter, Indiegogo and GoFundMe are just three of the many platforms worldwide.
Crowdfunding platforms do not borrow, pool, or lend money on their own account but enable investors to pledge funds, often on an all-or-nothing or keep-it-all basis. In return for enabling the transaction, the platforms receive a commission based on funds raised or donations received.
‘Crowdfunding not only provides early-stage access to much-needed finance but also identifies, at an early stage, a prospective market of customers’
These platforms solve a number of problems for both start-ups and individuals wishing to participate in the start-up economy. For start-ups, crowdfunding not only provides early-stage access to investors and much-needed external finance but also identifies, at an early stage, a prospective market of customers who may purchase, advocate or provide feedback on a product or service. For investors, crowdfunding platforms not only reduce the cost of finding investment opportunities but allow investors of all sizes to participate in a funding round.
What makes a successful crowdfunding campaign?
Studies on the characteristics of successful crowdfunding campaigns suggest a small number of factors influencing success.
- Project quality remains a critical factor. If it looks like a dog and barks like a dog, it’s still probably a dog.
- Who you know and who knows you matter. Investors in crowdfunding platforms use a variety of signals as a proxy for trust, including online and offline social cues and relationships. Early well-known reputable champions and advocates help build momentum.
- Geography matters. Somewhat counterintuitively, most crowdfunding investors are relatively local.
- Friends and family still matter particularly in the early stages of funding campaigns. Crowdfunding has less social risk due to the small amounts that can be pledged. Investments from friends and family, therefore, are important social cues, no matter what the quantum.
- Risk minimisation is still important. Smaller goals and the pledge type – keep it all versus all or nothing – matter. While all-or-nothing campaigns are more popular, research suggests that keep-it-all campaigns are more successful.
Big business does not equal safe business
Crowdfunding is big business. In 2015, Massolution estimated crowdfunding investments worldwide of $34.4bn from more than 1,250 crowdfunding platforms.
Despite the size of the crowdfunding market, crowdfunding can still appear to be a bit like the wild west. There are many examples of both failed and fraudulent projects. Equity investors lose money. Reward investors may not receive their product, or receive less than what they expected, or nothing at all. While the crowdfunding platforms have put in mechanisms to reduce this risk, regulations are emerging, and the interpretation, applicability and desirability of regulation is uncertain.
Crowdfunding platforms are global online entities with projects and investors similarly located throughout the world. Each of these stakeholders may operate under a wide range of laws and regulations for securities markets, consumer protection and tax purposes, depending on the type of investment and the type of reward – thus making interpretation and applicability of regulations complex for non-sophisticated entrepreneurs and investors.
The attraction of crowdfunding for firms and investors is simplicity. Too much regulation might destroy this.
Crowdfunding is still at an early stage of conceptualisation but has great potential to address some of the major challenges in the global start-up economy. It is already disrupting early-stage investment. Can it have an even greater impact? Like all ventures, only time will tell.
Prof Theo Lynn and Dr Pierangelo Rosati are part of the Finance Innovation Group in DCU Business School, a research group comprising researchers with an interest in finance and financial technologies. The group is currently organising the 4th DCU Symposium on Capital Markets and Fintech, which will be held on Friday 8 December in DCU Business School.