Crowdfunding. The way to finance early-stage ventures?

Scientific Essay, 2015

39 Pages, Grade: 1,3


Table of Contents
1 Introduction ... 3
1.1 Context ... 3
1.2 State of the art ... 3
1.3 Problem Statement and Objective of the Paper ... 4
1.4 Methodology and Structure of the Paper ... 5
Crowdfunding ... 6
2.1 Forms and Characteristics ... 6
Equity-based crowdfunding ... 6
Reward-based crowdfunding ... 6
Credit-based crowdfunding ... 7
Donation-based crowdfunding ... 7
2.2 Mechanism and Key Players ... 7
The Entrepreneur ... 8
Backers ... 9
The Platform ... 11
3 Expert Interviews ... 12
3.1 Study Design ... 12
3.2 Analysis ... 13
4 Results ... 18
5 Discussion ... 20
6 Conclusion ... 22
Bibliographical References ... IV
List of Figures and Tables ... V
List of Abbreviations ... VI

1.1 Context
Crowdfunding is an increasingly popular, new way to the initial ("seed")
financing of early-stage ventures. Starting in 2006, the crowdfunding market
represented by internet-based platforms, such as Kickstarter, Indiegogo or Kiva,
has grown exponentially being expected to reach a volume of USD 10.9 billion
in 2015 (cp. Barnett, 2014). Kickstarter alone, the largest of all crowdfunding
platforms, has funded 22,000 projects with the help of 3.3 million people
worldwide, amounting to a volume of USD 529 million in 2014 - equivalent to
USD 1,000 per minute. By 2025, the global crowdfunding market's value is
estimated to rise to USD 96 billion -- roughly 1.8 times the size of the global
venture capital industry today (cp. World Bank 2013).
1.2 State of the art
Due to crowdfunding, there is nothing (legal) that cannot be funded, it seems.
One best practice example comes from the German-based crowdfunding
platform Companisto, which we are going to deal with in the following chapters.
One of its 37 hosted projects is the molecular ice cream Kyl 21 - "the world's
most futuristic popsicle" (Companisto 2015), which recently raised EUR 940,000
supported by 2,000 backers, and was shortlisted by the TV channel Arte as the
,,Idea of the year" (cp. Lehmann, 2015; see Figure 1).
According to the scientific community, crowdfunding can be defined as an open,
internet-based call for the collective allocation of financial resources, either in
the form of donations or in exchange for a financial or non-financial reward, in
order to support an entrepreneurial venture at an early stage or in expansion
(cp. Lambert and Schwienbacher, 2010; cp. Schwienbacher and Larralde, 2012;
cp. Bradford, 2012). Without the presence of financial intermediaries, each
individual contributes with a typically small amount to the money pool (cp.
Kuppuswamy and Bayus, 2013). Crowdfunding "fills a void left between
Figure 1. Kyl 21 Molecular Ice Cream. (Source: Companisto 2015)

microfinance and professional/institutional investors" (World Bank 2013: 22), by
linking to it the concept of crowdsourcing, as a process of outsourcing tasks to a
greater number of anonymous individuals, the so-called ,,crowd", by using their
assets and competences (cp. Bradford, 2012; see Giudici et al., 2013).
Crowdfunding is considered as a financial innovation, democratizing and,
therefore, revolutionizing the funding of new ideas globally (see Kuti and
Madarász, 2014). Its emergence has been promoted by, firstly, drying out
capital flows for entrepreneurial projects, particularly connected to the economic
crisis of late 2008, and, secondly, by the use of digital technology - mainly the
World Wide Web, allowing to match capital supply and demand by overcoming
geographical distance (see Agrawal et al., 2011).
While the mechanism of crowdfunding is well understood, its dynamics are not
(see Kuppuswamy and Bayus, 2013; see also Mollick, 2013). The literature has
just began to explain why certain ventures get funded and others (the majority)
not, putting in an effort to analyze the impact and motivation of key drivers,
namely project movers, backers and the platform. Although, crowdfunding
seems to reduce the geographic gap between entrepreneurs and backers, there
is evidence for phenomena like rational herding, and home bias, emphasizing
the importance of the entrepreneurs' social network in running a successful
campaign (cp. Ordanini et al., 2011).
1.3 Problem Statement and Objective of the Paper
In addition to crowdfunding, early-stage ventures may use other sources of
financing, notably banks, government subsidies, equity tenderers, donors,
sponsors, lenders, venture capitalists or, angel investors (see Belleflamme et
al., 2012). Yet, the scientific literature dealing with crowdfunding as an
alternative to ordinary means of finance is rather limited. In this paper, we would
like to address the role of crowdfunding by answering the question: Could
crowdfunding become a substantial instrument to finance entrepreneurial early-
stage ventures, and if so, under which condition(s)? In this respect, we are
going to analyze, whether crowdfunding could and would substitute or
complement traditional forms of financing for early-stage businesses.
Our contribution to the existing scientific literature consists of bringing in an
existential input about the role of crowdfunding as one or the one tool for
financing start-up initiatives in the international context. The work will have
several implications for managers: It will facilitate their decision-making-process
about using crowdfunding as a financial tool, by providing them with a realistic
view on its chances and challenges in the light of certain conditions to be
developed throughout the paper. Furthermore, it will help managers select the
appropriate crowdfunding platform that serves their purposes best. As we will
see throughout the paper, the collection of funding is not a trivial process. It is
linked to questions of regulation, tangible and intangible exchange (intellectual
property, information) and, finally, with social relationships including questions
of trust and credibility.

As the present paper will outline, crowdfunding can serve for various ideas and
objectives. The literature distinguishes project initiators according to their
location (urban/rural), their organizational constitution (individual/group/firm) and
their aim of activity (for-profit/not-for-profit). The intention of this paper is to give
a reflective and prospective view on the role of crowdfunding for early-stage
ventures, based on opinions from stakeholders within the crowdfunding system,
the scientific literature and our personal assessment as future managers.
In the light of international business studies, we would like to limit the scope of
the current paper to for-profit ventures at an early stage. Also, we will deal with
projects hosted by crowdfunding platforms online, as opposed to individual
crowdfunding projects promoted offline, or those launched on private or
company websites. Crowdfunding outside the platform can enable the
entrepreneur to tailor his campaigns according to his needs (cp. Belleflamme et
al., 2012); however, it implies a higher risk for, both, entrepreneurs and
contributors due to the absence of a standardized framework (cp. Belleflamme
et al., 2012). Finally, we would like to limit the extent of our empirical research
to a qualitative one.
1.4 Methodology and Structure of the Paper
With respect to the methodology of this paper, we screened about 50 relevant
scientific articles about crowdfunding and selected half of them for our literature
review. After describing the theoretical background of this work (see Chapter 2),
id est (i.e). the types of crowdfunding (see Section 2.1), and introducing relevant
models explaining the crowdfunding mechanism and key players (see Section
2.2), we continued with a qualitative-empirical study in the form of expert
interviews with three stakeholders from the German, French and US-American
crowdfunding system (see Chapter 3), explaining the study design (see Section
3.1) and presenting the analysis of the interviews (see Section 3.2). As a result,
we are going to present the key findings of the empirical research; the results
will enable us to identify critical factors of crowdfunding's success and serve as
a basis for answering our research question (see Chapter 4). The results are
followed by a comparative analysis, interpreting the results and linking the
existing work to our contribution by discussing similarities and differences,
supported by a SWOT table including the strengths and weaknesses of
crowdfunding as a single instrument, as well as its opportunities and threats
(see Chapter 5). Chapter 6 will conclude the work by summarizing the results of
this paper (see Section 6.1), commenting on the scope of our results (see
Section 6.2), and suggesting elements for future research (see Section 6.3).

The current chapter presents the state of the art research about crowdfunding.
Section 2.1 gives an overview about the different forms of crowdfunding and its
characteristics; section 2.2 deals with the mechanism of crowdfunding,
explaining the role of each actor involved.
2.1 Forms and Characteristics
As mentioned above, crowdfunding serves for diverse entrepreneurial ideas,
motivations and objectives of, both, project initiators and backers. Therefore,
the instrument takes different shapes, which are categorized by the scientific
literature according to the relation between project movers and contributors.
The most significant distinction is made between the financial and non-financial
return given to project backers, leading to the four main categories, which are
the equity-based, the reward-based, the credit-based (also lending-based), and
the donation-based crowdfunding (see Kuti and Madarász, 2014; cp.
Belleflamme et al., 2012). Besides the general characteristics that they share,
each of the forms has its specificities and, therefore, requires a further definition
based on the one provided in the introduction.
2.1.1 Equity-based crowdfunding
Equity-based crowdfunding consists of a share issuance of the company,
whereby funders, as a return on their contribution (here investment), receive a
share in the form of equity, or similar arrangements (cp. Kuti and Madarász,
2014; cp. Ahlers et al., 2012). This type of crowdfunding is typically used by
entrepreneurs, requiring a relatively large amount of capital (cp. Belleflamme et
al., 2012). The financial gain, for both, investors and entrepreneurs, is the main
motivation behind the use of this particular type (cp. Kuti and Madarász, 2014).
As the profit-sharing model involves the sale of a security, it holds a relatively
high risk for contributors and is, thus, subject to binding regulations in many
countries (see Ahlers et al., 2012). In the US, president Obama passed the
JOBS act legislation of 2012 for "Jumpstart our Business Startups" offering the
possibility to the general public (e.g. non-accredited investors) to receive
company equity in exchange for funding (see Ahlers et al., 2012). Also in
Germany and in France, equity-based crowdfunding is currently permitted,
although, the issuance of voting shares through crowdfunding is not (see
Bessière and Stephany, 2014; see Lehmann, 2015).
2.1.2 Reward-based crowdfunding
Reward-based crowdfunding is the most common and widespread form. It
involves a non-financial return, such as credit or pre-ordering of products, in
exchange for funding (cp. Belleflamme and Lambert, 2014). Thus, the main
motivation for contributors is of non-monetary nature and can be linked to

patronage and social benefits, personal status and, in our context to a lesser
extent, to altruism (see Kuti and Madarász, 2014). Reward-based crowdfunding
places funders in the position of early adopter consumers, revealing their taste
preferences for a specific product or service before this one entered the market.
Its biggest ambassador is the US-based platform Kickstarter, which we are
going to deal with throughout this paper.
2.1.3 Credit-based crowdfunding
Credit-based crowdfunding or peer-to-peer (P2P) lending refers to funding,
whereby entrepreneurs (here borrowers) receive loans from other individuals
(here lenders) without financial intermediation (cp. Ahlers et al., 2012; cp.
Belleflamme and Lambert, 2014). The funder is retributed through interests.
Also, this form will be dealt with in this paper, represented by the French
platform Lumo (see Chapter 3).
2.1.4 Donation-based crowdfunding
Donation-based crowdfunding, a form where contributors do not get any return,
takes a rather small share in the crowdfunding universe, contributing only 9
percent to the total amount of crowdfunding platforms, according to a study by
Belleflamme et al. (2012). As mentioned earlier, donation-based crowdfunding
will not be part of our analysis, as ventures hosted on donation-based platforms
are usually not profit-driven, aimed at funding charity, research or personal
projects. In this respect, the funder acts as a philanthropist, driven by sympathy
and social concerns (cp. Kuti and Madarász, 2014; cp. Ordanini et al., 2011).
In order to tackle the research question, the following section will give an
overview about the actors involved in the mechanism of crowdfunding, by
analyzing their motivations, behaviors as well as their challenges.
2.2 Mechanism and Key Players
Crowdfunding can be described as a value-co-creation system, in which each
actor adds to the outcome of the crowdfunding campaign through direct
interaction (cp. Belleflamme and Lambert, 2014; cp. Ordanini et al., 2011). It is
characterized by geographically dispersed project initiators seeking for capital,
and funders responding to a capital request. In most cases, the supply of and
demand for capital are matched by an interconnecting online platform, hosting
projects for a limited amount of time (cp. Agrawal et al., 2011; cp. Belleflamme
and Lambert, 2014).
Despite of the crowdfunding type, the process of value co-creation can be
mapped as following: On one side, the fundraiser is signaling a request for
funding by describing the project as well as the function of and return on the
financial contribution (see Ahlers et al., 2012). On the other side, the potential
backer can select and contribute financially to a project, s/he is attracted by
(see Ahlers et al., 2012). Assuming the presence of an interconnecting platform,

the majority of crowdfunding campaigns is subject to the principle of ,all or
nothing'. Here, a campaign is successful, if the target capital is accumulated by
the end of the deadline; vice versa, the campaign is a failure, if the targeted
sum has not been accumulated before the end of the deadline - the initiator
comes away empty-handed and the funders will be refunded (cp. Giudici et al.,
2013; cp. Kuti and Madarász, 2014).
2.2.1 The Entrepreneur
The reasons behind the use of crowdfunding vary amongst project movers,
including the creation of a new business, and the realization of a project or
product within an existing business (cp. Mollick and Kuppuswamy, 2014).
Moreover, there are diverse incentives for project initiators for using
crowdfunding. The instrument involves a lower cost of capital, enabling the
entrepreneur to get in touch with a high number of potential funders, by
bundling the sale of equity with the early access to products (cp. Kuti and
Madarász, 2014). Besides raising a substantial amount of capital, crowdfunding
platforms serve as a cost-efficient way for validating the market potential of a
product or service through early-stage market research and testing (cp.
Belleflamme et al., 2012). The ,,petri-dish" of user demand enables project
initiators to create an ecosystem around the product, which consists of potential
users and supporters, giving collective input about their preferences and
evaluating the project or service quality (cp. Kuti and Madarász, 2014; cp.
Ordanini et al., 2011). Furthermore, crowdfunding serves as a promotional
device helping to increase public awareness and supporting custom-made en
masse production at lower costs (cp. Kuti and Madarász, 2014; cp. Belleflamme
and Lambert, 2014). Also, crowdfunding platforms enable entrepreneurs to
receive legitimacy, to compare different projects and to get inspiration from the
success of others (cp. Gerber et al., 2011).
In contrast with traditional ways of financing, crowdfunding can, to a large
extent, overcome the barrier of geographical distance and, as a consequence,
widen the entrepreneur's access to capital (cp. Agrawal et al., 2011).
Nevertheless, there is a strong and consistent evidence for the importance of
localized social capital in activating a network of supporters. Local backers,
namely friends and family (F&F), are a particularly relevant source in the early
stage of the funding request (cp. Agrawal et al., 2011; cp. Kuti and Madarász,
2014). They constitute the offline network of the entrepreneur and trigger a sort
of ,,snow-ball" effect of online-funding activities by signaling the quality of a
project through their investment, thus, creating credibility early in the cycle (see
Kuppuswamy and Bayus, 2013; see also Giudici et al., 2013). This explains why
a majority of entrepreneurs uses social media tools that facilitate social
networking (see Belleflamme et al., 2012); moreover, this might be one reason
why individual and rural-based ventures are more likely to fail in reaching the
targeted capital, than group and metropolitan initiatives (see Kuti and Madarász,
However, project initiators have to face a trade-off between the incentives
mentioned above and the disincentives connected to crowdfunding. The

boundary between describing the idea of a product or service enough to make
the crowd contribute, and disclosing its recipe of success, can become blurred.
In the frame of early-stage ventures, the risk of revealing relevant information
about the venture, its key resources and profit potential, might counteract the
effort to protect his intellectual property and , in addition, have a negative impact
on the entrepreneur's position in future negotiations with suppliers or customers
(see Kuti and Madarász, 2014). Furthermore, the individuals' diverse
expectations towards the venture and their own impact of contribution, can
require a resource-intense crowd management (cp. Agrawal et al., 2013).
Unlike the "who's who" in the traditional financing scene of business angels or
venture capitalists (VCs), there are no long-term relationships with the crowd.
According to Mollick and Kuppuswamy and Bayus (2013), the majority of
contributors, at any point of the funding cycle, consists of one-time backers that
likely come from the creator's own social circle. This could pose a risk in terms
of ex-post financing (cp. Kuti and Madarász, 2014).
2.2.2 Backers
With a view to the backers, there is a discrepancy between their role(s) and the
role of traditional funders, such as VCs. Backers are contributors (investors,
donors, lenders), consumers and guinea pigs at the same time (see section
2.1). They act as agents for, select, promote, donate to or take a share in
projects, and, finally, contribute to the venture's maturation (cp. Ordanini et al.,
2011). Unlike business angels, backers are present in high numbers with each
contributing a relatively small part of the requested target capital of a project,
receiving an equally small monetary or non-monetary return (cp. Belleflamme et
al., 2012).
According to Ordanini et al. (2011), contributors need to have specific traits in
varying intensities, among these are an orientation towards innovation, a social
identification with the content and cause of the crowdfunding campaign, as well
as the pursuit of certain benefits through the investment in the project. Lin et al.
(2014) identified four archetypes of crowdfunders on the largest platform
Kickstarter, namely active backers, trend followers, the altruistic and, the
majority, the crowd. In the context of for-profit initiatives, it might be unlikely that
contributors own altruism as a trait for investing in projects (see Lin et al. 2014).
Being supported by active backers may indicate quality of the venture (cp. Lin et
al., 2014) - a relevant aspect for project managers. This leads us to the
question: What makes individuals contribute to a crowdfunding campaign?
Beyond the motivation of personal payoff or reward, backers might seek for
social benefits, such as community involvement, related to the experience to
being part of a project or social group (cp. Belleflamme et al., 2013; cp. Lin et al,
2014). Or, it might motivate consumers to get an early access to new products
(cp. Kuti and Madarász, 2014). Moreover, linked to the contribution might be the
desire for patronage, thus, being partly responsible for the project's success
(see Kuti and Madarász, 2014; cp. Ordanini et al. 2011); this might be seen as a
way of self expression and gaining personal status in public (cp. Kuti and
Madarász, 2014). These aspects being said, it is not a surprise that backers
prefer to contribute to ventures that are located in the geographical area of the
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Florence Klement (Author), 2015, Crowdfunding. The way to finance early-stage ventures?, Munich, GRIN Verlag,


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