Crowdfunding. Overview of the industry, regulation and role of crowdfunding in the venture startup

Master's Thesis, 2014

98 Pages, Grade: 5.00/5

I. M. (Author)



Structured Abstract



Part 1
What is crowdfunding?
Position of crowdfunding inside the entrepreneurial equity “food” chain and how crowdfunding differs from angel/VC funding
Main actors in crowdfunding space
Crowdfunding taxonomy and crowdfund investing ecosystem
Literature review and principal research streams
General exploratory research
Who gets crowdfunded?
Regulation and policy
Dynamics of the crowdfunding process
The geography of crowdfunding
Common points and research gaps
Five forces that shape the crowdfunding industry
Market overview and SWOT analysis of crowdfunding
Part II
Is the Italian approach truly in line with expectations of market participants and the general public?
Other European countries and the future of Paneuropean regulation
Policymaker suggestions on crowdfunding issues

Part III
Theoretical framework and grounding
Research questions
Research method and design
Data collection and empirical setting
Quantitative Findings
Descriptive results
Empirical patterns and relationships
Evidence in consensus analysis
Qualitative findings
Qualitative findings obtained from questionnaires
Expert interviews
Business angels and equity crowdfunding (cases)
Managerial and policymaker implications
Limitations and suggestions for future research


Appendix 1: Matrix of key provisions of SEC regulations promulgated or proposed
Appendix 2: Cases of crowdfunding platforms supported by business angels
Appendix 3: Survey 1
Appendix 4: Survey 2
Appendix 5: Cross-tabulation between the fear factors (i.e. disadvantages) of crowdfunding and funding sources employed so far during the seed/startup stage (Survey 2)
Appendix 6: Cross-tabulation between funding sources used in the past and those projected to be used in the future (Survey 2)
Appendix 7: Variable dictionary for Survey 2 dataset
Appendix 8: Correlation matrix related to Survey 2 dataset
Appendix 9: Regression analysis models (Survey 2)

Structured Abstract

(Purpose) This thesis aims to take stock and systemize existing knowledge on crowdfunding while providing overview of the industry, its regulatory environment and advancing the insight into the role of crowdfunding in the startup lifecycle.

(Design/metodology/approach) It is adopting an exploratory and phenomenon-based approach which is deemed appropriate when investigating rather new phenomena. Furthermore, the work combines survey and interview methodologies to assess the opinion and real-world behavior of different stakeholders in crowdfunding marketplace and identify gaps requiring further academic consideration.

(Theoretical Perspective) Grounded in limited theories surrounding crowdfunding as well as adjacent fields such as early stage, informal and angel investment.

(Metodology) Empirical data was gathered using multiple interactive web-based questionnaires distributed to different stakeholders and “informed general public” mainly through the social networks (Linkedin, Facebook and Twitter) and di rect solicitation of entrepreneurial associations, networks and online communities. The study relies on bot h qualitative and qu antitative analysis in attempt to find data patterns useful in future research and establish some managerial and policymaker recommendations based on limited evidence collected.

(Originality and practical implications) The work adds value to this field through a 3­fold contribution: Taking a look at crowdfunding through the prism of SWOT analysis of the practice itself and Porter’s 5 forces analysis of crowdfunding platforms industry. Providing evidence in favor of implementing various degrees of regulation based on different crowdfunding categories, using the Italian case of equity-based crowdfunding regulation as a model. Finally, it yields some interesting findings on relevance of crowdfunding in the venture startup while pointing out key motivators which make entrepreneurs consider this fundraising option. In addition, related policymaker/managerial implications are exposed and academic literature updated with reference to contemporary developments in this dynamic field.

Keywords: crowdfunding, industry overview, regulation, role, dynamics Paper type: MSc thesis


The last few decades have been filled with technological advances and persistent innovation. Advent of new communications channels, such as Internet, has revolutionized the way how people interact and conduct business. Naturally, some sectors of the economy have seen more change than others. Private equity and business lending institutions remained mostly unchanged during this period, resisting any significant adjustments in their business models. However, their role might soon be complemented, if not even challenged, by potentially disruptive advancements in the Web space populated by globalized collaborative communities.

Web 2.0 made it possible for internet users to be more than just passive recipients of the content; it enabled active participation and interaction, thus laying foundation for the emergence of many recent phenomena, such as social media, crowdsourcing and crowdfunding. The role of Web 2.0 as a marketing, communicational and educational tool has been analyzed and extensively explained (Jones and Iredale, 2009), however little less is known about how Web 2.0 facilitates formation of new ventures by assisting in pooling ideas and overcoming difficulties in acquiring sufficient funding. In this work we will focus on the role of crowdfunding in a venture startup, always having in mind that Web 2.0 is a critical ingredient which actually facilitates the access to the “crowd” (Belleflamme et al., 2010).

Through crowdfunding an entrepreneur rises external financing by leveraging a large group of people (hereafter referred to as simply the “crowd”), where each individual provides a relatively small amount of money (Belleflamme et al., 2013). This is done as an alternative to soliciting one or more sophisticated investors and the internet is almost exclusively being used as a channel of communication instead of face-to-face presentations or “pitches”. Crowdfunding derives from a broader concept of crowdsourcing, which is simply pooling ideas or solutions from the crowd in order to meet some private or corporate need (Belleflamme et al., 2013).

After the financial crises of 2007-08, acquiring traditional funding, such as startup loans, angel or venture capital (VC) became increasingly harder for young firms. Crowdfunding emerged, roughly at that time, as an answer to difficulties faced by early stage entrepreneurs. In the last 6years this new form of capital origination gained traction in most developed economies (Netherlands, UK, USA, Italy and Australia among others). Shiller (2008) views crowdfunding as an important financial innovation which essentially democratizes finance and brings in light the “knowledge dispersed over millions of people”. So crowdfunding can be viewed as more than just a form of financing; it is an important point of reference when estimating the market for future products or services, a source of collective wisdom and feedback during venture development and a f oundation for future community of lead users. The phenomenon is increasingly attracting attention in developing economies as well, where according to The World Bank (2013) it should play a major role in support of innovation, jobs and growth in the future.

Crowdfunding takes many forms (Hemer, 2011) which will bediscussed in more depth in subsequent chapters and caters to many different projects, especially those in creative industries, charity and ent repreneurial startups. This work will focus mostly on startups and the role of crowdfunding in promoting, nurturing and sustaining entrepreneurial activities as an engine of economic growth. The research conducted here is mostly of exploratory and descriptive nature, seeking to help understand better this new phenomenon and fill some of the gaps in a rather scarce academic knowledge on this topic. Additionally, it should contribute to the debate on whether crowdfunding is suitable as an addition to or as substitution of more traditional funding channels, such as business angels or VCs. Analysis of recent policy actions by governments and further recommendations provided in this work shall also have significant managerial implications, guiding entrepreneurs about how to set up and manage their crowdfunding campaigns.

This manuscript is organized in a following way: In the first part I offer a more extensive definition of crowdfunding, its place in equity “food” chain and an overview of the key elements of the crowdfunding ecosystem. Various models of crowdfunding are presented in detail together with a comprehensive literature review on existing academic work in this field. Intermediaries such as crowdfunding portals are briefly analyzed together with preliminary observations on biases, conflicts of interest and liability issues. Furthermore, I provide some recent data on the size of crowdfunding market and its major players accompanied by a SWOT and Porter analysis of the industry. Second part discusses the risks of crowdfunding and current regulatory framework in major economies, such as USA, EEA and Italy. The aim is to critically analyze current legislation and come up with conclusions which will serve as a foundation for policymaker recommendations presented in Part III. The third part opens with some general observations about the VC industry and traditional sources of funding while putting crowdfunding in this perspective and arguing how and why crowdfunding can be either complementary or substitute for more traditional investors. Main research question, whether crowdfunding can serve as a pillar in venture startup, is introduced together with the description and reasoning behind the methodologies used. Case studies are presented together with the results of a custom-made survey and expert interviews. Results are then discussed together with policymaker suggestions and managerial implications which emerged during the research. The manuscript concludes with some ideas for further work and a list of appendices and resources discussed in the text.

Part I

What is crowdfunding?

Crowdfunding (also known as crowdfinance) is a term used to describe a form of fundraising, usually conducted over the internet, in which a large number of people pool relatively small individual contributions in order to support a specific goal (Ahlers et al., 2012). Review of a rather modest literature on the topic uncovers a number of nuances in how crowdfunding is defined; confirming that substantial academic knowledge in this field is yet to be developed in order for consensus to emerge. Definition by Schwienbacher and Larralde (2010) explicitly states that crowdfunding is financing of a project or a venture by a group of individuals instead of professional investors such as business angels, VCs or banks. This definition stresses the point that there is no intermediary, since entrepreneurs raise money directly from individuals. In theory, majority of individuals already invest albeit indirectly through their savings which are being managed by intermediary institutions such as banks or mutual funds, so crowdfunding implies some sort of more direct interaction between funders and entrepreneurs. Definition by Rubinton (2011) acknowledges “parties” exchanging contributions in exchange for a form of value, without specifying who or what a “party” might be.

Belleflamme et al. (2013) extended upon the definition of a more general concept of crowdsourcing provided by Kleemann et al. (2008) in order to define crowdfunding as “an open call, essentially through the Internet, for the provision of financial resources either in form of donation or in exchange for a form of reward and/or voting rights in order to support initiatives for specific purposes”. Mollick (2014) and Bradford (2012) acknowledge that crowdfunding essentially draws inspiration from concepts like microfinance and crowdsourcing, but still represents a unique category of fundraising enabled by the proliferation of internet sites dedicated to the concept. The former also acknowledges a state of “evolutionary flux” in this domain, pointing out that even an expansive definition such as that of Belleflamme et al. (2013) leaves out examples such as peer-to-peer lending and fundraising initiatives by music or movie fans, among others. However, one might argue that crowdfunding is still fundamentally different from microfinance or social lending given that both funding objectives and targets are different, so it would be justifiable to treat it as a separate class in contemporary private capital markets.

Some authors labeled it as “community funding” (Kleverlaan, 2013), stressing out the potential of crowdfunding “community” to fill smaller investment gaps (< € 1 million) routinely faced by SMEs (small and medium enterprises) in their earliest stages. Since in this work the focus is on the role of crowdfunding in a venture startup, the most appropriate working definition seems that of Mollick (2013):

“Crowdfunding refers to a variety of different efforts by entrepreneurs - cultural, social and for profit to fund their efforts by drawing on relatively small contributions from a r elatively large number of individuals using the internet, without standard financial intermediaries”

It is interesting to notice that virtually all definitions mention internet as a necessary medium to facilitate crowdfunding. Though some might argue that the concept has been around for along time in different forms during history, internet indeed has made it a much easier, more scalable, and cost-efficient endeavor. Crowdfunding heavily exploits the capabilities of Web 2.0, such as social marketing and viral networking. However, the body of academic knowledge in this field is yet to be extended in order to further develop crowdfunding as a new form of finance and help shape its best practices. In addition to academic relevance, the crowdfunding research is interesting also from a managerial perspective, given that financing business growth during different stages of venture development is a task routinely faced by SMEs’ managers.

Position of crowdfunding inside the entrepreneurial equity “food” chain and how crowdfunding differs from angel/VC funding

Obtaining financing is perhaps the most critical step in the entrepreneurial process. In the early stages (Janssen, 2013) the financing mostly comes in form of equity rather than debt, since banks routinely loan money only to companies who can demonstrate sufficient collateral or cash flows (Smith et al., 2011). Primary sources of capital for SMEs are thus limited to 4Fs (friends, family, fools and foundations), angel investors and VCs.

Fig. 1 shows where crowdfunding might fit in the equity “food” chain, considering the investment size and the stage of development of the firm.

Fig. 1 - Equity “food” chain in a startup lifecycle

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At the earliest stage of venture development an entrepreneur almost always puts his own “skin in the game”, i.e. the business is self-funded by the entrepreneur’s own savings or personal lines of credit. As prototype is developed, friends and family might step in to support the venture and help transition it to a commercial business. At this stage angels and syndicates of angels might be a viable source of additional growth capital until the venture reaches further milestones and qualifies for a VC investment or debt capital (Smith et al., 2011). Crowdfunding targets the earliest stages in a business lifecycle (pre-seed to start-up), aiming to increase availability and reduce cost of capital while also increasing venture’s visibility among angels and VCs. Recently some companies started experimenting with crowdfunding even in growth or subsequent stages, though in such cases the principal motivators tend to be less of a financial nature and more related to product marketing or pre-selling, which will be expatiated on later.

Funding entrepreneurial ventures by crowdfunding in many aspects differs substantially from the VC or angel funding (Mollick, 2013). First, crowdfunding is more democratic (Kim and Hann, 2014); anyone can participate even with very small amounts of capital. On the contrary, sophisticated investors are usually clustered in smaller groups and barriers to enter in terms of capital and industry connections are much higher. Crowdfunding backers are weakly organized and one usually does not have to be a part of some form of community in order to invest. Communication channels are open (public) in crowdfunding, while traditional VCs or angels rely more on confidentiality and proprietary information. Lastly, in most cases crowdfunding backers have little further influence over firms they backed, while financing by VCs by default means giving up a part of ownership and many other caveats attached. However, the last point might over time get different shapes in different legislations, given that regulation on so called “equity-crowdfunding” is still pending in many countries.

Main actors in crowdfunding space

Crowdfunding process involves different actors with distinct roles and responsibilities depending on the model being used (full taxonomy of crowdfunding models will be subsequently introduced). In this manuscript we will befocusing on equity-based crowdfunding as the most relevant for our research, though the general flow of operation can be e asily extended to all models. Inside so called “indirect crowdfunding” (Belleflamme, 2013), which implies an intermediary is present, we can distinguish between the crowd, campaign initiators, platforms, consultancy firms and regulators.

The crowd represents a large, usually anonymous, group of people addressed by an open call for the provision of funds. Entrepreneurs’ friends and family can also be considered part of the crowd as long as they invest through the intermediary (i.e. crowdfunding platform). A fine distinction is made between crowd as a group of all potential contributors and campaign supporters who actually pledge money toward a pitched project. Agrawal et al. (2010) consider all crowdfunders as investors without distinction between different models, though more commonly term “crowd investor” is used to describe a contributor who invests directly in exchange for equity. Hence some experts prefer the use of term crowdinvesting, as opposed to crowdfunding, when it is necessary to stress that funding is provided in exchange for equity. According to Hemer (2011), equity capital provision has the highest process complexity, especially when a large number of backers and micro-transactions have to be managed. In addition, it also represents a highly regulated activity.

The platforms act as intermediaries who facilitate transactions by channeling financial resources from contributors to campaign initiators. Virtually all platforms operate by the same underlying principle of pooling relatively modest contributions from a large number of crowd participants in order to finance a big ticket project. Platforms make money by charging a percentage-based commission on the amount raised or sometimes they might also charge fixed fees. Often platforms may also play the role of gatekeeper, actively filtering out which kind of campaigns should be promoted on a particular site (Lawton and Marom, 2013). Many platforms as well provide additional value-added services, such as certification, due diligence or valuation. The regulator in aparticular legislation may limit certain activities or impose additional duties and responsibilities that a platform has to carry out. As per Agrawal et al. (2010) crowdfunding platforms are intended to overcome distance- related frictions and the majority of them have some properties in common. First, they enable campaign creator to present his entrepreneurial project in a comprehensive way. Second, they enable participation by managing small scale financial transactions between crowd investors and project initiator. And lastly, they provide some basic investment information such as fundraising statistics as well as a communication interface for crowd investors. Platforms have been recently putting a lot of effort in attempt to distinguish themselves, build credibility and capture a share of growing crowdfunding market. This is per se a good development which should help the proper function of this new market (Hemer, 2011).

A campaign initiator is anyone who has an entrepreneurial idea but lacks adequate capital to bring it into practice and thus decides to pitch the idea to a wider audience in hope of receiving financial support for the realization of the venture. It is a common belief that entrepreneurs resort to this method of fundraising since they are unable to secure funding in any other way, be it from angels, VCs, banks or through government grants and foundations. However, recently conducted research (Gerber et al., 2012; Lawton and Marom, 2013; Niederer, 2013) suggests many entrepreneurs resort to crowdfunding (especially reward-based crowdfunding) also for other reasons, such as marketing, validation of project concepts or formation of user communities. Sometimes these can even take precedence to financial goals. Another benefit of crowdfunding is that founders are supposed to spend less time fundraising and retain more control over their business which should have a strong positive impact on business development overall. Yet still, there are researchers (Hui et al., 2012) who point out that time and effort required for a successful crowdfunding campaign are considerable and that the overall process might even prove to be slower than traditional fundraising.

Campaign initiators use a platform to pitch their venture to the public, offering perks, rewards or in case of equity-based model equity in the firm. Fig. 2 illustrates main actors in the crowdfunding space and the way how they interact. Crowdfunding platform channels multiple contributions from participating crowd and passes them on to campaign initiators, after deducing for commissions and fees. Regulator sets the rules on who can participate in this process, what kind of disclosure is necessary and what are the limitations imposed regarding number of investors and capital committed. Role of the regulator differs from one country to another and will be further discussed in Part II.

Fig. 2 — Main actors in the crowdfunding space

Abbildung in dieser Leseprobe nicht enthalten

Source: own interpretation

Crowdfunding taxonomy and crowdfund investing ecosystem

Scholars have long attempted to provide taxonomy for the diverse crowdfunding forms (Giudici, 2012). Kappel (2009) distinguished between ex post (e.g. when a product is offered after financing has been provided) and ex ante crowdfunding (e.g. financial support for political activities or similar). Belleflamme et al. (2010) differentiated between active and passive investments. Active investments imply also an active involvement in the decision making process inside the company, while passive investments receive only a c ompensation resulting from the financed activity. In this sense crowdfunding blurs the line between the role of customer and the investor.

Hemer (2011) focused on project substance when providing taxonomy for crowdfunding. According to commercial objectives and background of the initiative, he differentiates between non-profit, for profit and intermediate crowdfunding. Intermediate crowdfunding is in this sense a catch-all term describing projects which start without a clear commercial goal but over time develop into a for-profit business (for example, social networks or music festivals). Another line of differentiation is according to place of origination of the idea and its eventual affiliation to an organization. In this sense, we can differentiate between completely independent one-off initiatives, embedded projects (initiated and managed by a private or public organization) or startups which naturally lead to a foundation of a company.

Lambert and Schwienbacher (2010) classified crowdfunding typologies according to the nature of the reward for funders. Over time different crowdfunding models emerged and majority of platforms (explained in more detail infra) do specialize in providing services related to the model(s) they advocate. Up to date, most widely used and most frequently researched (Giudici, 2012; Hemer, 2011) capital provision forms are:

1) Reward-based: funders receive non-monetary benefits in exchange for their contribution. Some examples include receiving a pr oduct once it is finished, complementary gifts such as T-shirts or accessories, credit in artistic work (such as movies or music), opportunity to spend time with the founders and “shadow” them, etc.
2) Donation-based: funders contribute for altruistic reasons through a sponsorship or charity donations. No compensation of any kind is received.
3) Equity-based: funders claim a share of future income generated by the project or the company. A share that each crowdfunder receives is most likely proportional to the amount contributed.
4) Lending-based: funders receive back the amount they lent out together with any eventual interest as contractually agreed.
5) Royalty-based: a sub-form of equity crowdfunding targeted mostly to media content creators. Funders should receive royalties from copyright, proportionally to their contribution, for a certain period of time, without actually being stockholders in a company.

Castrataro (2012) proposed extending further this classification to sub-models according to specificities of how each model is being implemented on a particular platform. Consequently reward-based model could be further split into ‘all or nothing’ model, where the funding goal of the campaign must be reached in full and in due time in order for any financial transaction to be generated, versus ‘keep it all’ model where any funding collected is paid immediately to the project owner regardless of whether the initial goal of the campaign is met or not. Equity-based model can be implemented as ‘the club’ model, where each member of the crowd is treated as a member of closed investment club, thus circumventing limitations on public offerings or as a ‘cooperative’ model where a cooperative vehicle is used to pool the funds of individual contributors into a single legal entity which further invests in single businesses. Lastly, lending-based model is realized as either ‘microfinance’ model where the money of the lenders is being managed by an intermediary reassembling a bank for low-income clientele or as a ‘peer-to-peer’ lending where transactions happen directly between the lender and the borrower without any intermediation.

Active experimentation with different combinations of crowdfunding models is increasingly gaining traction in practice, suggesting that there still might be a lot of spur and innovation in the field before stable paradigms emerge. Various studies have shown that not all investment decisions are economically motivated, which might explain the existence and relative success of donation-based crowdfunding so far. Probably the most prominent example is the US President Barack Obama who rose over $137 million dollars for his 2008 election campaign using a donation-based crowdfunding platform. In Columbia as kyscraper (“BD Bacata”) was entirely crowdfunded by locals, proving that the concept works also for real estate. How different investment drivers in the crowdfunding space will evolve in the future and which models will be the most successful, remains an interesting question for both academia and practitioners.

The World Bank (2013) proposed a universal model of crowdfund ecosystem containing four basic elements: community engagement, technology, entrepreneurial culture and economic regulation. Fig. 3 outlines key enablers in the model on which policymakers have to focus in order to promote crowdfund investing.

Fig. 3- Key enablers in the crowdfunding ecosystem

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Source: The World Bank, 2013

Although the research by The World Bank (2013) focuses on these enablers only in terms in which they relate to government policies, it is possible to extend upon that reasoning and argue that the factors presented actually constitute a part of a more universal model describing crowdfunding ecosystem in a holistic way. Community engagement campaigns may be used by the governments in order to strengthen the entrepreneurial culture and encourage future startups to participate in events such as startup weekends, meet-ups and business plan competitions sponsored by government. However, community engagement is also needed in a broader sense in order for the “crowd” to participate. Subsequent research has shown that masses participate in crowdfunding for different reasons, many of them not under direct control or influence by governments (Hemer, 2011; Schwienbacher and Larralde, 2010). People who belong to a certain community are more likely to invest in projects related to that community, the most prominent example being probably computer games fans or movie fans who routinely participate in reward-based crowdfunding on platforms such as Kickstarter. Still the government policies address directly only a small subset of ‘community engagement’ activities, leaving most of them to market forces, creative leadership and personal preferences. Technology is understandably an essential part of the crowdfund ecosystem since it facilitates oversight of the businesses and helps governments derive more accurate numbers for profits, hiring and taxes. But technology is also an enabler in a wider sense, given the internet and technologies facilitating online pitching, communication, transactions and securitization are a necessary requisite for the crowdfunding to happen. Entrepreneurial culture is another important factor in crowdfunding, extensively shaped by the regulatory bodies which directly promote or hinder formation of new ventures through policies affecting “ease of doing business” (The World Bank, 2012). However, also this factor can be v iewed in a much broader spectrum when we consider other aspects such as country’s history and whether being a small business owner is generally profitable and reputable career path in a gi ven social environment. Economic regulations define conditions for entering into, conducting and dissolving business operations. In this sense they should create astimulating environment for venture inception and growth with minimal risk. This is achieved not just through laws directly focusing on entrepreneurship, but also through a broad set of regulations ensuring efficient markets, free competition and reduced systemic risk.

Literature review and principal research streams

Existing scholarly knowledge in this field is relatively scarce and the research has been just recently moving from an embryonic to a growth phase (von Krogh et al., 2012; Giudici, 2012). Most academic work so far has been of exploratory nature due to limited access to data, absence of widely recognized theoretical frameworks and persistent fluidness in the domain. The aim of this section is to offer an overview and critical evaluation of selected research papers and data points. As this thesis focuses more on financial aspects of crowdfunding and its propensity to serve as aviable source of early-stage capital, literature about equity-based crowdfunding is considered more relevant. Nevertheless, research about other types of crowdfunding has been mentioned as well when it seemed pertinent for answering the main question. By exploring the literature, following research streams have been identified: who gets crowdfunded, regulation and policy, dynamics in the crowdfunding space, geography of crowdfunding and various case study analyses. The streams are described and discussed further on, jointly with suggestions regarding new research questions and general hypotheses to be tested, which concludes this chapter.

General exploratory research

Schwienbacher and Larralde (2010) were among the first scholars to put crowdfunding into perspective of entrepreneurial finance and discuss factors affecting entrepreneurial preference for this alternative form of financing. Different business models with respect to the structure of the crowdfunding process have been discussed together with practical recommendations for entrepreneurs seeking funds derived from a case study described in the paper. The authors conclude that small ventures should leverage crowdfunding only if they are raising a reasonably small amount, have an innovative project and are versatile and skilled in Web 2.0 technologies. Some issues are also raised, such as whether intellectual property related risks might deter entrepreneurs from disclosing their ideas and what incentives and remuneration scheme makes the crowdfunding most optimal. These early exploratory findings have set a foundation for subsequent work by other researchers as per von Krogh et al. (2012) model.

Who gets crowdfunded?

Mollick (2013) explored whether the amateurs who casually invest in crowdfunding projects respond to same signals of quality as professional investors (VCs) and whether they are subject to the same biases. VCs are experts in assessing quality of ventures, constantly looking for signals such as background of the startup team, endorsements and demonstrated preparedness in order to determine if a project is worth funding or not. However, this process is also prone to biases which stem from the method itself being too ignorant of some signals due to geographical or gender constraints. For instance, most VCs prefer to fund companies in their geographical proximity with preference generally skewed toward male founders (Chen et al., 2009; Canning et al., 2012). Crowdfunding offers an al ternative selection environment which eliminates some of these biases, even if crowdfunding backers still look for the same indications of venture quality as the experts (Mollick, 2013). The work suggests that entrepreneurs who demonstrate preparedness with a high quality product and team are more likely to be funded, since their venture is perceived as having a higher potential. In this sense “the wisdom of the crowd”, although decentralized, exhibits similar characteristics to one of more institutional structures. The quality signals of high-potential ventures are further magnified through a Matthew Effect, multiplying the impact of project quality and i ncreasing the draw. However, the research does not track the future of companies who received equity­crowdfunding and whether those reached a successful exit in the subsequent period.

It would be interesting to analyze the speed with which those ventures developed, how did they obtain subsequent rounds of financing (either through crowdfunding or angel/VC rounds) and whether they were lacking some of intangible assets and competencies professional investors usually bring to the table (such as networks and industrial know-how). Limitations mentioned by the author hint at possible need to repeat similar research in the future in order to increase robustness of the findings, especially in light of other researchers debating extent to which biases, such as gender bias, are being remedied in crowdfunding space (Marom et al., 2013).

Ahlers et al. (2012) focus specifically on equity crowdfunding context, providing an empirical study onstartup signals that induce small investors to commit financial resources to a specific venture. Previous literature extensively dealt with signaling of startups toward VCs or business angels, however little research has been done having small (retail) investors in mind. Advent of crowdfunding came as an ideal playground for this type of study, where empirical data from one of the largest Australian crowdfunding platform have been analyzed in order to pinpoint common drivers for offerings’ success. The results emphasize the importance of financial roadmaps (such as a pre-planned acquisition or IPO strategy), education level of entrepreneurial team (measured as a number of members with MBA degrees) and perceived risk factors (amount of equity offered and availability of financial forecasts) in increasing the likelihood of attracting investors and the speed of capital rising. The study also highlights once again the fact that equity crowdfunding operates in a mostly rational manner, despite the participation of less sophisticated (retail) investors. Another interesting point is that spatial distance between investors and entrepreneurs remained a significant factor in investor decision making, particularly in early-stage ventures where long distances create barriers to obtaining information and tend to increase monitoring costs. One limitation of the study the authors did not mention is related to ever increasing participation of sophisticated investors in this field. It is questionable how many investors labeled “retail” are actually quite sophisticated, at least in terms of knowledge and experience, if not for their net worth. Ex facto during this year we have seen quite a lot of interest in crowdfunding coming from institutional investors, with business angels investing extensively in crowdfunding platforms (AngelsDen, SyndicateRoom), a development which will be detailed further in subsequent sections. Thus it would be desirable to collect more extensive data on the background and habits of “the crowd”, which is at the moment almost impossible given that very few platforms actually collect this kind of data from investors due to privacy issues. However, upcoming regulation changes (discussed later) and talk of introducing specific investor certifications might reshape this roadblock in the near future.

Younking (2013) concludes that legitimacy of founders is likely to substantially increase possibility of success, especially when it comes to having a famous affiliate on team and (to a lesser extent) a high quality presentation. Strong support is also found for the hypothesis that users who are more “embedded” in the community, i.e.

who participate actively and fund other peoples’ projects, are more likely to be funded. In this sense, a strong role of reciprocity is implied, totally in line with recent works on social psychology (Kuppuswamy and Bayus, 2013). Data for this research have been obtained from Kickstarter, which is a reward-based CFP, so further repeat research would be useful to discover whether these conclusions hold also for platforms utilizing different models like equity-based model. The same applies also to research conducted by Ward (2010) and Burtch (2011), which both focused on reward-based platforms intended for predominately artistic ventures, such as music or digital journalism. Ward (2010) ascertains that it is essential for a crowdfunding project to maintain momentum; otherwise it quickly falls out of favor with the investment community, possibly due to peer effects rooted and driven by an information overload. However, he does not elaborate on ways how projects acquire that initial momentum necessary for success. Likewise, he also argues that investors are strongly influenced by success or failure of related projects, actively using actions of other investors as a guide in the decision process. These findings are in line with subsequent claims by Burtch (2011) who argues that indicators of popularity, such as timing or nature of other investments, are deeply rooted in crowdfunding marketplace where herding and other forms of social influence are likely to occur.

Regulation and policy

Bradford (2012) was one of the first scholars to analyze the legal framework and legislative barriers to crowdfunding in US, even before the JOBS (Jumpstarting Our Business Startups) Act was enacted by President Obama. To facilitate crowdfunded offerings, the SEC (Securities and Exchange Commission) needed to adopt an exception which would strike balance between investor protection and seamless capital formation. Bradford’s paper outlines a number of considerations and practical proposals, many of them ex post adopted by the SEC, which brought the securities regulation more in line with the modern world of internet and social web. Another academic to examine these proposals and the recent JOBS Act was Hazen (2012) who stressed out that a crowdfunding exception conditioned on a meaningful disclosure about the company and the terms of securities offering is the only suitable compromise which would not unduly expose investors to a risk of abuses. Similar stance has been taken also by Martin (2012), who emphasized the need for balance between stifling regulations and necessity to protect integrity and stability of financial markets. Exact rules as implemented by the SEC will be subsequently discussed in Part II. There is currently fear (especially in the US) that the securities laws have become too deregulated, which could potentially trigger fraudulent behavior and loss of confidence in secondary markets for unlisted securities. Crowdfunded securities still remain an unchartered territory and substantial research on this topic is warranted once raising money from the crowd becomes a widespread practice.

In a descriptive study Heminway (2013) analyzed funding portals (CFPs) from a theoretical point of view, by positioning them in existing taxonomical constructs and providing vital preliminary observations on potential issues these intermediaries might face in the future. Depending on the context, portals can be treated as either informational, collectivizing or reputational liaisons, which means they are likely to face typical intermediary-related issues such as conflicting interests, fiduciary duties, biases and gatekeeper liability. The CROWDFUND (Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure) Act, a part of the JOBS Act, introduced what seems like arather burdensome regulatory context which might deter formation of new portals and increase transaction costs. The author concludes that only when the SEC’s rulemaking is fully in place and that enough crowdfunding offerings have been conducted under those rules; it will be possible to judge overall efficiency and benefits of these intermediaries as well as inherent legal issues. Given the current progress on SEC’s rulemaking, this should not be expected before the middle of this year while generating a meaningful time series and collecting empirical research data will probably take a couple more years before welfare effects become evident.

Vitale (2013) from the Monash University in Melbourne built upon the work of Wong (2013) in order to provide an assessment of the Australian regulatory framework and give recommendations how it could be adapted to the post-crowdfunding world, as to obtain full benefits of this new mechanism for raising funds without unduly compromising protective regulatory aims. The Australian regulator ASIC (Australian Securities and Investments Commission) and the facilitatorASSOB (Australian Small Scale Offerings Board) are encouraged to liaise with interested parties and the public in order to identify key issues and c raft regulations conductive to effective and concurrent local crowdfunding space. The most up to date developments regarding these aims are further discussed in the context of similar efforts in the European Union and the USA in the Part II of the research.

Recent study by infoDev, a gl obal partnership program within The World Bank, emphasizes the uprising of crowdfunding and its emergence in developed and developing countries as an important catalyst in the global innovation ecosystem. Closed nature of investing in small businesses is to change rapidly as the social web affects both the flow of information and capital to these startups. However, existing securities regulations were not designed for today’s environment and policymakers worldwide still have to craft new regulations, empower new technologies and educate entrepreneurs about this new vehicle (The World Bank, 2013). So an overall enabling policy, including both “light touch” regulation on crowdfunding and enhanced “easiness of doing business” is a pre-requisite for successful implementation of this funding concept which should lead to more innovation and creation of jobs in a relatively stagnant economy. Similar opinion was voiced also by Alberg et al. (2013) from Kauffman foundation who acknowledged that many young firms continue to face hurdles due to lack of capital and that “the SEC should approve rules under the JOBS Act that encourage experimentation without excessive regulation”.

Dynamics of the crowdfunding process

Hildebrand et al. (2013) criticize the lending-based model, claiming existence of perverse incentives which are not being fully recognized in the social lending marketplace and which lead to some bids being (wrongly) perceived as good quality loans when in fact they are quite the opposite. Empirical evidence from Prosper, one of the most prominent lending-based CFPs, suggests that the rewards received by some group leaders for promoting specific deals introduce adverse incentives in deals selection. Group leaders act as a form of endogenous intermediary in order to facilitate vetting and moderate activities on the platform. In presence of rewards group leaders’ bids result in substantially lower interest rates but higher default rates, this suggests that they behave strategically and m aximize their own financial interest. It is only once that these actors have sufficient skin in the game that the agency problem subsides. These findings provide a valuable input in ongoing debate about the regulatory framework for consumer protection and how to achieve proper incentives for all participants in the crowdfunding market.

Ghose et al. (2013) conducted ani nteresting study onpr ivacy andi nformation control mechanism on crowdfunding platforms. They found evidence that individuals are more likely to conceal private information when investing if the campaign they are supporting has received a great deal of public exposure and if their contribution amount is substantial. Secondly, average amount of prior contributions tend to influence future pledges by other contributors through an anchoring effect. So if prior contributions are rather small, concealing this information from the eyes of the public is likely to be preferred by the campaign organizer and vice versa. This certainly has interesting implications for the design of online information handling mechanisms.

Rubinton (2011) describes crowdfunding as disintermediated investment banking, given that users directly interact without any private network or middleman in between. A simulation model is created where debt and equity are modelled as passive and active investment in order to generate theoretical insights about how certain factors affect the dynamics of financing. Crowdfunding is praised as an important evolution which should modernize obsolete banking processes and commoditize access to capital markets. The model author provides is mostly theoretical and could be still expanded and findings improved by fitting to real life investment opportunities; however access to raw CFP data remains still an issue for empirical research.

Reasons why entrepreneurs might want to take advantage of this new financing tool have been somewhat discussed. Belt et al. (2012) mentions factors like frustrations with costs and burdens of traditional fundraising, lack of access to angel or venture capital, onerous bank lending procedures and a need for gap funding. Collins and Pierrakis (2012) point to a larger outreach of crowdfunding to justify its potential in entrepreneurial world, while also affirming that a combination of intrinsic social and financial motivation is what drives funders to “take the other side” of the transaction.

Mollick (2014) seeks to describe the underlying dynamics of success and failure among crowdfunded ventures by analyzing a dat aset of over 48.500 Kickstarter projects. Crowdfunding success appears to be related to (perceived) project quality and participation of entrepreneurs in social networks (where the “social capital” is estimated by the number of Facebook friends as a proxy). Further, the study finds a significant local component in the nature of projects themselves, which tend to be connected to entrepreneur’s geographic area. Crowdfunding projects onaverage either succeed by a narrow margin or fail by large amounts. Since most CFPs operate on all-or-nothing basis, there could be an incentive for owners of smaller projects to try and m ake up the slack by self-funding the project. However, the findings reveal that smaller projects actually fail by larger margin than bigger ones, despite the fact that self-dealing would be theoretically easier for smaller projects due to lax logistical and financial constraints. This fact raises confidence that the results are not being confounded by self-funding and suggests that the nature of projects and a r ational assessment process, similar to the one of professional investors, dictate whether they will be backed or not. Finally, data from the sample used indicate that almost all founders seek to fulfill obligations assumed during the project pitch, through majority of overfunded and complex projects are likely to be delayed. An empirical setting, enabled by crowdfunding, makes it possible to study both successful and failed nascent ventures, thus overcoming a left-censoring bias (Mollick, 2014). This new environment also has a potential to affect the kind of ideas being forged into entrepreneurial ventures, in a similar way in which Web 2.0 caused a subsequent proliferation of internet startups.

Similarly, Marom and Sade (2013) drew upon a unique sample of around 20,000 Kickstarter campaigns to gauge whether entrepreneurs should place more weight on pitching their personage and background or the business itself. Among some investors there is a mantra that it is better to invest in people, rather than ideas. This “horse versus jockey dilemma” is well known in entrepreneurial finance, though up till now it has not been tackled in the crowdfunding space or in the context of the very early stage financing. The findings, obtained through a data mining technique and verified by human coding, suggest that successful projects tend to focus more on the business idea if they belong to a technology domain and on the entrepreneur if they are of an artistic nature. Furthermore, a deeper understanding of entrepreneurial pitches as a basis of almost all fundraising manners warrants that the results are likely to be relevant also for other crowdfunding mechanisms and beyond.

The geography of crowdfunding

Agrawal et al. (2011) analyzed the broad geographic dispersion of crowdfunding investors. Data collected from aCFP specializing in early-stage musicians’ creative projects (named Sellaband) reveal a mean distance between artists and investors of approx. 3000 miles. Although this number is not uncommon for publicly traded companies, early-stage ventures tend to stay closely clustered in areas near investors since the costs of activities such as gathering information, monitoring progress and providing input to entrepreneurs have been historically sensitive to distance. This trend might have had reversed somewhat in recent years due to new communication technologies, though probably not to the extremes seen in case of crowdfunding (a repeated research on spatial proximity in angel and VC investment would bewarranted in order to definitely confirm this claim). Although the role of geography appears to be greatly diminished in crowdfunding, there is an important distinction between distant and local investors when it comes to investment timing, with distant investors being more responsive to investment decisions of others. The finance literature (Schwienbacher, 2010) justifies this by acknowledging the role of family and friends in early-stage ventures who are likely to be local and face less information asymmetries than other investors. General implication is that CFPs eliminate most distance-related economic frictions but do not eliminate frictions associated with information asymmetries where individuals personally connected to the entrepreneur are likely to be favored. One potential limitation of this study could be questionable extendibility of its results on other types of CFPs and project categories. Creative projects, such as music or video games, mostly reside in a digital space and might very well require different type of monitoring and investor interaction compared to, for example, hospitality or food industry projects. It would be also interesting to verify to what extent this effect remains prominent in a pure equity- based model similar to that used by angels or VCs.

Lin and Viswanathan (2013) performed asimilar research to that conducted by Agrawal et al. (2011), seeking to further explore whether investors on online investment platforms exhibit a home bias similar to one present in an offline context. Agents in offline environment, such as businesses and fund providers, are more likely to conduct transactions with parties residing in a close geographical proximity (Lewis, 1999), which is generally considered sub-optimal. After a number of tests using data obtained from debt-based CFP called Prosper, initial findings suggest that home bias persists also in the crowdfunding space. Existence of home bias in online investment is being justified by Lin and Viswanathan (2013) as due to emotional, rather than social or economic reasons. It is worthwhile to note that these results are at odds with those obtained by Mollick (2013), whose claim is that crowdfunding might be less subject to geographic biases compared to traditional investments. The latter researcher used data obtained from Kickstarter, a CFP which operates a reward-based model instead of a debt-based model used by Prosper, which could explain the anomaly. However this raises some doubts about robustness of generalized findings and re-states the necessity for further research in this domain using more comprehensive datasets. Any additional findings would certainly provide a valuable input for design of future regulatory framework and policies.

The most recent research by Kim and Hann (2014) provided clear evidence in favor of crowdfunding’s potential to democratize access to capital for entrepreneurs who have difficulty accessing traditional sources of funding. Their analysis showed that small cities seem to reap proportionally bigger benefits from crowdfunding since limited access to bank loans in these areas pushes entrepreneurs to rely even further on crowdfunding. It is worthwhile to note that all these findings relate to reward-based model and that it would be necessary to repeat a similar research considering only equity-based platforms in order to check whether the same geography dynamics apply.

Common points and research gaps

Albeit scarce, existing academic literature still covers some very interesting aspects of crowdfunding. However, an important gap which applies to most of the studies is that virtually all focus on reward or donation based models, with equity model hardly represented. Given the novelty of the concept, this is most likely dueto alack of available data. Even where data is present, future studies could go a step further and analyze for instance different revenue sharing models in the context of equity crowdfunding (Mitra, 2013). Another area which is barely touched upon is the question of strategic and product development decisions, mainly to what extent the crowd should have voting rights in enterprise it funds (Belleflamme, 2013). CFPs themselves have been scarcely researched, with most papers focusing on projects listed therein and related dynamics and little regard to how exactly platforms facilitate transactions in those two sided markets (Hildebrand, 2013), how information asymmetry issues are being managed and to what extent success of otherwise comparable projects depends on particular CFP which is being used.

An additional topic for research could be the relevance of pecking order theory in this space and impact crowdfunding might have on the equity food chain of new ventures. Effects on the economic system as a whole should also be examined as well as positioning of this concept in relation to conventional sources of finance (as either complementary or opposing) and dynamics of any interplay which might arise. Some of these gaps should be hopefully filled, at least partially, in this work which aims to lay down the first bricks on a path of understanding equity based crowdfunding and the far-reaching impact it might have in the years to come.

Furthermore, an analysis of motivators for participation in crowdfunding ecosystem and the consequences of having “lean intermediaries” such as CFPs instead of traditional intermediaries would help answer questions such as what are the incentives of entrepreneurs for using this fundraising method or whether sophisticated investors are taking advantage of retail investors in this space and to what extent. One could also study the level to which a crowdfunding demand is predictive of future demand for a product or service and t o what extent are intellectual property rights protected in such a context where entrepreneur basically discloses his product idea in front of a large population. Crowdfunding offers a path through which user innovators, a frequent source of radical innovation, can transition to entrepreneurship (Shah and Tripsas, 2007). In this sense, the role of online communities inside a future venture and to what extent they could replace the know­how and networks of traditional investors is definitely a stimulating question for future research.

Five forces that shape the crowdfunding industry

Porter’s five forces model encompasses a generation of business practice and academic work. The basic premise is that even industries which appear different on the surface have similar underlying factors which drive their profitability. Following this framework, strategists are encouraged to move beyond direct competitive analysis and look into forces surrounding and shaping the target industry. The latest work by Porter (2008) himself goes a step further to stress the importance of subtle factors such as mutual interplay between seemingly unrelated industries and strategic decisions which tend to benefit the industry as a whole, rather than maximize profits of individual participants. Having this in mind, five forces analysis of the crowdfunding industry is conducted following the “Typical Steps in Industry Analysis” outlined in Porter (2008).

Crowdfunding is currently in an early stage of development and growing at a very fast pace. Between 2011 and 2012 the industry grew by around 80%, measured by the amount of money raised by the biggest crowdfunding platforms worldwide surveyed by Massolution (2013). The same consultancy forecasts an even faster growth for 2013, estimating value of the market at around 5 billion USD at the end of 2013. Crowdfunding, narrowly defined, is an intangible goods industry. The final aim is to “produce” funding for successful startups or realize specific projects and goals. From a different perspective, the goal could be t o “produce” successful crowd investors and boost economic activity for whole regions. Most often though, crowdfunding industry is viewed from the angle of crowdfunding platforms (CFPs) which act as an intermediary connecting all the parties involved in the ecosystem. In this sense the industry can be v iewed as a l iaison, facilitator and pr ovider of transaction services for participants. Consequently entrepreneurs or project initiators can be viewed as “suppliers” since they supply ideas and projects and the investors can be viewed as “buyers” who “buy” the ideas and ventures pitched to them. Starting from this basic setup, substitutes can be explored and new entrants identified by looking both inside the industry as well as beyond it. The task of crowdfunding intermediaries is thus two-fold, first to create value in a two-sided market and second to capture a part of that value. The intermediary is dependent on participants for the provision of its services, since if there are no subjects interested in a deal the CFP cannot charge commissions or fees. So while the service provided per se is not highly dependent on other industries (if we omit non-core competencies such as legal, accounting or banking services), its ability to actually generate service flows depends strongly on dynamics inside and between respective industries of the participants. The geographic scope of competition is generally global, though many platforms do specialize in serving particular local markets.

The participants of the crowdfunding ecosystem are identified and segmented into strategic groups as presented in Fig. 4. Overall rivalry resulting from these five forces shapes the industry’s structure and the nature of interaction between CFPs as well as profitability.


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Crowdfunding. Overview of the industry, regulation and role of crowdfunding in the venture startup
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I. M. (Author), 2014, Crowdfunding. Overview of the industry, regulation and role of crowdfunding in the venture startup, Munich, GRIN Verlag,


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