What is crowdfunding?
Crowdfunding is a method of collecting a large amount of small grants, which together can finance or capitalise a popular company, product or idea.
They are the biggest in crowdfunding
The biggest crowdfunding sites in the world are Kickstarter (started in 2009) and Indigogo (started in 2008). For example from its inception until September 2014 Kickstarter has organised 180,000 crowdfunding campaigns, of which about 40% were successful. The approximately 71,000 successful campaigns received USD 1.33 billion in support from 7.1 million people. Approximately 44% of the Kickstarter campaigns mentioned above successfully reached their target financing goals.
One of the most successful crowdfunding campaigns is Pebble smartwatch, which in 2012 sought USD 100,000 for their smartwatch and managed to obtain USD 10.3 million. The biggest crowdfund is Coolest Cooler, which in 2014 pulled in USD 13.3 million after seeking USD 50,000 on Kickstarter.
Few companies with crowdfunding live up to their goals.
Studies have just started arriving on compliance with reward-based crowdfunding (i.e., donors receiving their goods after having backed the company) and the above campaigns are examples. The studies conclude that in 70% of cases companies do not meet the promised commitment. However we find that the proportion of fraud is very low, which is believed to be due to “the crowd’s” significance in a social context (Mollick 2013).
Different types of crowdfunding
There are different types of crowdfunding, but here we focus primarily on Equity-based crowdfunding (also called crowdfunding toward partnership) which is when donors/investors receive shares/ownership interest in the companies that seek financing through crowdfunding. The types of crowdfunding available today are:
- reward-based crowdfunding
- debt-based crowdfunding
- donation-based crowdfunding
- equity-based crowdfunding
We focus primarily on Equity-based crowdfunding (also called crowdfunding toward partnership) which is when donors/investors receive shares/ownership interest in the companies that seek financing through crowdfunding.
Advantages of equity crowdfunding
There are numerous advantages to seeking financing through crowdfunding. For example Crowdfunding gives a company vital capital when it is in a very early stage and when everyone else says no. A successful crowdfunding campaign can also contribute to the company/contractor’s acquisition of a larger network, but also the company or product acquires a large number of dedicated ambassadors. These ambassadors must be continually updated on the company’s development, but if this is successful they become a loyal and strong sales force.
Other benefits most often mentioned are that the process is often less time consuming and faster than seeking capital from. e.g. a venture capital company. Also the unilateral conditions set forth by the company for crowdfunding facilitate the process of raising capital for the company.
In summary, the biggest advantages of a crowdfunding campaign include the possibility of capital injection as well as marketing channels.
Disadvantages of crowdfunding
Disadvantages most often mentioned in this context are the difficulty to control who comes into the company as a partner, as well as the administrative work that occurs after a successful campaign. Instead of calling a new owner to a general meeting, everyone, sometimes up to a hundred, must be called and have the right to participate. Even a simple task like setting up the voting list for the meeting becomes very time consuming. Or for that matter, maintaining an accurate and updated share register.
The dialogue and exchange of expertise with all shareholders can also be a challenge after successful financing through crowdfunding. The information requirement and request for information become more unidirectional in a crowdfunded company, which can be a disadvantage.
Most often it is mentioned that a crowdfunded company more easily takes in venture capital at a later stage when the business model or product receives acceptance by the Crowd, i.e. it is treated as “proof of concept”. Our view is, unfortunately, the exact opposite and with a sprawling and huge crowd of shareholders, companies are often over a barrel when negotiating with venture capital companies or venture capitalists. And this disadvantage outweighs the acceptance the Crowd has given the company/product. The general opinion is also that equity crowdfunding is an inexpensive way to bring capital into the company. From what we have seen, we do not share that view, but pricing seems to be in line with what small companies are paying in fees for competing alternative players.