Crowdfunding is the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet. Crowdfunding is a form of crowdsourcing and of alternative finance. In 2015, it was estimated that worldwide over US$34 billion was raised this way.
Although similar concepts can also be executed through mail-order subscriptions, benefit events, and other methods, the term crowdfunding refers to Internet-mediated registries. This modern crowdfunding model is generally based on three types of actors: the project initiator who proposes the idea and/or project to be funded, individuals or groups who support the idea, and a moderating organization (the "platform") that brings the parties together to launch the idea.
Crowdfunding has been used to fund a wide range of for-profit entrepreneurial ventures such as artistic and creative projects, medical expenses, travel, or community-oriented social entrepreneurship projects.
Crowdfunding has a long history with several roots. Books have been crowdfunded for centuries: authors and publishers would advertise book projects in praenumeration or subscription schemes. The book would be written and published if enough subscribers signaled their readiness to buy the book once it was out. The subscription business model is not exactly crowdfunding, since the actual flow of money only begins with the arrival of the product. The list of subscribers has, though, the power to create the necessary confidence among investors that is needed to risk the publication.
War bonds are theoretically a form of crowdfunding military conflicts. London's mercantile community saved the Bank of England in the 1730s when customers demanded their pounds to be converted into gold - they supported the currency until confidence in the pound was restored, thus crowdfunded their own money. A clearer case of modern crowdfunding is Auguste Comte's scheme to issue notes for the public support of his further work as a philosopher. The "Première Circulaire Annuelle adressée par l’auteur du Système de Philosophie Positive" was published on 14 March 1850, and several of these notes, blank and with sums have survived. The cooperative movement of the 19th and 20th centuries is a broader precursor. It generated collective groups, such as community or interest-based groups, pooling subscribed funds to develop new concepts, products, and means of distribution and production, particularly in rural areas of Western Europe and North America. In 1885, when government sources failed to provide funding to build a monumental base for the Statue of Liberty, a newspaper-led campaign attracted small donations from 160,000 donors.
Crowdfunding on the internet first gained popular and mainstream use in the arts and music communities. The first noteworthy instance of online crowdfunding in the music industry was in 1997, when fans underwrote an entire U.S. tour for the British rock band Marillion, raising US$60,000 in donations by means of a fan-based Internet campaign. They subsequently used this method to fund their studio albums. In the film industry, independent writer/director Mark Tapio Kines designed a website in 1997 for his then-unfinished first feature film Foreign Correspondents. By early 1999, he had raised more than US$125,000 on the Internet from at least 25 fans, providing him with the funds to complete his film. In 2002, the "Free Blender" campaign was an early software crowdfunding precursor. The campaign aimed for open-sourcing the Blender 3D computer graphics software by collecting $100,000 from the community while offering additional benefits for donating members.
Crowdfunding started to gain mainstream traction with the launch of ArtistShare (2003). As the model matured, more crowdfunding sites started to appear on the web such as Kiva (2005), IndieGoGo (2008), Kickstarter (2009), GoFundMe (2010) and Microventures (2010).
The phenomenon of crowdfunding is older than the term "crowdfunding". According to wordspy.com, the earliest recorded use of the word was in August 2006.
The Crowdfunding Centre's May 2014 report identified two primary types of crowdfunding:
- Rewards crowdfunding: entrepreneurs presell a product or service to launch a business concept without incurring debt or sacrificing equity/shares.
- Equity crowdfunding: the backer receives shares of a company, usually in its early stages, in exchange for the money pledged.
Reward-based crowdfunding has been used for a wide range of purposes, including motion picture promotion, free software development, inventions development, scientific research, and civic projects.
Many characteristics of rewards-based crowdfunding, also called non-equity crowdfunding, have been identified by research studies. In rewards-based crowdfunding, funding does not rely on location. The distance between creators and investors on Sellaband was about 3,000 miles when the platform introduced royalty sharing. The funding for these projects is distributed unevenly, with a few projects accounting for the majority of overall funding. Additionally, funding increases as a project nears its goal, encouraging what is called "herding behavior". Research also shows that friends and family account for a large, or even majority, portion of early fundraising. This capital may encourage subsequent funders to invest in the project. While funding does not depend on location, observation shows that funding is largely tied to the locations of traditional financing options. In reward-based crowdfunding, funders are often too hopeful about project returns and must revise expectations when returns are not met.
Equity crowdfunding is the collective effort of individuals to support efforts initiated by other people or organizations through the provision of finance in the form of equity. In the United States, legislation that is mentioned in the 2012 JOBS Act will allow for a wider pool of small investors with fewer restrictions following the implementation of the act. Unlike nonequity crowdfunding, equity crowdfunding contains heightened "information asymmetries". The creator must not only produce the product for which they are raising capital, but also create equity through the construction of a company. Equity crowdfunding, unlike donation and rewards-based crowdfunding, involves the offer of securities which include the potential for a return on investment. Syndicates, which involve many investors following the strategy of a single lead investor, can be effective in reducing information asymmetry and in avoiding the outcome of market failure associated with equity crowdfunding.
Software value token
Another kind of crowdfunding is to raise funds for a project where a digital or software-based value token is offered as a reward to funders which is known as Initial coin offering (abbreviated to ICO). Value tokens are endogenously created by particular open decentralized networks that are used to incentivize client computers of the network to expend scarce computer resources on maintaining the protocol network. These value tokens may or may not exist at the time of the crowdsale, and may require substantial development effort and eventual software release before the token is live and establishes a market value. Although funds may be raised simply for the value token itself, funds raised on blockchain-based crowdfunding can also represent equity, bonds, or even "market-maker seats of governance" for the entity being funded. Examples of such crowdsales are Augur decentralized, distributed prediction market software which raised US$4 million from more than 3500 participants; Ethereum blockchain; Digix/DigixDAO; and "The DAO." Some of the largest token crowdsales in 2017 were Tezos which raised US$232 million, Bancor which raised US$153 million and Status which raised US$102 million.
Debt-based crowdfunding (also known as "peer to peer", "P2P", "marketplace lending", or "crowdlending") arose with the founding of Zopa in the UK in 2005 and in the US in 2006, with the launches of Lending Club and Prosper.com. Borrowers apply online, generally for free, and their application is reviewed and verified by an automated system, which also determines the borrower's credit risk and interest rate. Investors buy securities in a fund which makes the loans to individual borrowers or bundles of borrowers. Investors make money from interest on the unsecured loans; the system operators make money by taking a percentage of the loan and a loan servicing fee. In 2009, institutional investors entered the P2P lending arena; for example in 2013, Google invested $125 million in Lending Club. In 2014 in the US, P2P lending totalled about $5 billion. In 2014 in the UK, P2P platforms lent businesses £749 million, a growth of 250% from 2012 to 2014, and lent retail customers £547 million, a growth of 108% from 2012 to 2014. In both countries in 2014, about 75% of all the money transferred through crowdfunding went through P2P platforms. Lending Club went public in December 2014 at a valuation around $9 billion. Debt crowdfunding in the U.S. further evolved with the 2016 enactment of Title III of the JOBS Act, which allows unaccredited investors to invest directly in private businesses through regulated Funding Portals or Broker-Dealers.
Litigation crowdfunding allows plaintiffs or defendants to reach out to hundreds of their peers simultaneously in a semiprivate and confidential manner to obtain funding, either seeking donations or providing a reward in return for funding. It also allows investors to purchase a stake in a claim they have funded, which may allow them to get back more than their investment if the case succeeds (the reward is based on the compensation received by the litigant at the end of his or her case, known as a contingent fee in the United States, a success fee in the United Kingdom, or a pactum de quota litis in many civil law systems). LexShares is a platform that allows accredited investors to invest in lawsuits.
Charity donation-based crowdfunding is the collective effort of individuals to help charitable causes. In charity crowdfunding, funds are raised for pro-social or pro-environmental purposes.
The inputs of the individuals in the crowd trigger the crowdfunding process and influence the ultimate value of the offerings or outcomes of the process. Each individual acts as an agent of the offering, selecting and promoting the projects in which they believe. They sometimes play a donor role oriented towards providing help on social projects. In some cases, they become shareholders and contribute to the development and growth of the offering. Individuals disseminate information about projects they support in their online communities, generating further support (promoters). Motivation for consumer participation stems from the feeling of being at least partly responsible for the success of others’ initiatives (desire for patronage), striving to be a part of a communal social initiative (desire for social participation), and seeking a payoff from monetary contributions (desire for investment). Additionally, individuals participate in crowdfunding to see new and innovative products before the public. Early access often allows funders to participate more directly in the development of the product. Crowdfunding is also particularly attractive to funders who are family and friends of a creator. It helps to mediate the terms of their financial agreement and manage each group’s expectations for the project.
An individual who takes part in crowdfunding initiatives tends to reveal several distinct traits: innovative orientation, which stimulates the desire to try new modes of interacting with firms and other consumers; social identification with the content, cause or project selected for funding, which sparks the desire to be a part of the initiative; (monetary) exploitation, which motivates the individual to participate by expecting a payoff. Crowdfunding platforms are motivated to generate income by drawing worthwhile projects and generous funders. These sites also seek widespread public attention for their projects and platform.
Crowdfunding websites helped companies and individuals worldwide raise US$89 million from members of the public in 2010, $1.47 billion in 2011, and $2.66 billion in 2012 — $1.6 billion of the 2012 amount was raised in North America. In 2012, more than one million individual campaigns were established globally and the industry was projected to grow to US$5.1 billion in 2013. and to reach US$1 trillion in 2025. A May 2014 report, released by the United Kingdom-based The Crowdfunding Centre and titled "The State of the Crowdfunding Nation", presented data showing that during March 2014, more than US$60,000 were raised on an hourly basis via global crowdfunding initiatives. Also during this period, 442 crowdfunding campaigns were launched globally on a daily basis.
In 2012, there were over 450 crowdfunding platforms operating. In 2015 it was predicted that there would be over 2,000 crowdfunding sites to choose from in 2016. Project creators need to exercise their own due diligence to understand which platform is the best to use depending on the type of project that they want to launch. Fundamental differences exist in the services provided by many crowdfunding platforms. For instance, CrowdCube and Seedrs are Internet platforms which enable small companies to issue shares over the Internet and receive small investments from registered users in return. While CrowdCube is meant for users to invest small amounts and acquire shares directly in start-up companies, Seedrs pools the funds to invest in new businesses, as a nominated agent.
Curated crowdfunding platforms serve as "network orchestrators" by curating the offerings that are allowed on the platform. They create the necessary organizational systems and conditions for resource integration among other players to take place. Relational mediators act as an intermediary between supply and demand. They replace traditional intermediaries (such as traditional record companies, venture capitalists). These platforms link new artists, designers, project initiators with committed supporters who believe in the persons behind the projects strongly enough to provide monetary support. Growth engines focus on the strong inclusion of investors. They "disintermediate" by eliminating the activity of a service provider previously involved in the network. The platforms that use crowdfunding to seek stakes from a community of high net-worth private investors and match them directly with project initiators.
The Professional Contractors Group, a trade body representing freelancers in the UK, raised £100,000 over a two-week period in 1999 from some 2000 freelancers threatened by a Government measure known as IR35. In 2004, Electric Eel Shock, a Japanese rock band, raised £10,000 from 100 fans (the Samurai 100) by offering them a lifetime membership on the band's guestlist. Two years later, they became the fastest band to raise a US$50,000 budget on SellaBand. Franny Armstrong later created a donation system for her feature film The Age of Stupid. Over five years, from June 2004 to June 2009 (release date), she raised £1,500,000. In December 2004, French entrepreneurs and producers Benjamin Pommeraud and Guillaume Colboc, launched a public Internet donation campaign to fund their short science fiction film, Demain la Veille (Waiting for Yesterday). Within a month, they managed to raise €17,000 online, allowing them to shoot their film.
As of 2015 the highest reported funding by a crowdfunded project to date was Star Citizen, an online space trading and combat video game being developed by Chris Roberts and Cloud Imperium Games; it had raised $77M by that time, and while it had a devoted fan base it was also criticized for being a potential scam.
Brave’s $35 million Basic Attention Token (BAT) sale sold out in less than 30 seconds.
On April 17, 2014, the Guardian media outlet published a list of "20 of the most significant projects" launched on the Kickstarter platform prior to the date of publication:
- Musician Amanda Palmer raised US$1.2 million from 24,883 backers in June 2012 to make a new album and art book.
- The "Coolest Cooler" raised a total of $13,285,226 from 62,642 backers. The cooler features a blender, waterproof Bluetooth speakers and an LED light.
- Zack Brown raised $55,000 from over 6900 backers in September 2014 to make a bowl of potato salad. Noteworthy is that his initial goal was only $10, but his campaign went viral and got a lot of attention. Brown ended up throwing a potato salad party with over 3,000 pounds of potatoes.
Although musician Palmer raised over $1 million through the Kickstarter crowdfunding process, she received criticism afterward, some of which was published in prominent media outlets. Writing for the New Yorker, Joshua Clover initially focused upon issues specific to Palmer, but then broadened the scope of his examination to include financial conduct in the Internet era. ("you can’t spell Internet without intern.") According to Clover, Palmer initially invited local musicians to play on stage with her band and her on the stops of her U.S. tour, but offered to "feed you beer, hug/high-five you up and down (pick your poison), give you merch, and thank you mightily," instead of monetary compensation, as the money raised on Kickstarter was allocated to the production of the next studio album—in accordance with the campaign—as well as other financial commitments. This decision was then overturned a week later, as Palmer explained on her blog:
Clover also made reference to the British political situation at the time, writing "that even newly minted haves, like Amanda Palmer, really need to treat have-nots, such as local musicians, a whole lot better." In a September 12, 2012 New York Times article, American Federation of Musicians President Raymond M. Hair Jr. explained, "If there's a need for the musician to be on the stage, then there ought to be compensation for it." The following day, prominent sound engineer and musician Steve Albini was also vocal and, after initially referring to Palmer as an "idiot," apologized, writing that he had not met her or heard her music. Following his apology, in which he admits "it's my fault," Albini asserted: "It should be obvious also that having gotten over a million dollars from such an effort that it is just plain rude to ask for further indulgences from your audience, like playing in your backing band for free."
Controversy arose in the crowdfunding sector in May 2014 when an adult entertainer was blocked by platform GiveForward. Following an allergy reaction, Eden Alexander required intensive medical treatment, but doctors, aware of her occupation, associated her health issue with drug use and did not provide the necessary care to a sufficient extent; as a consequence, Alexander's condition worsened. Alexander then launched a GiveForward crowdfunding campaign to cover her medical bills, but the campaign was removed from the platform after a social media exchange, whereby a potential donor requested nude pictures as reciprocation and Alexander agreed to the offer—this was noticed within a brief time frame and WePay, the payment service used by GiveForward, deemed the negotiation a violation of WePay's terms of service, considering it the offer of "Adult or adult-related services ... Adult or adult-related content ... and Obscene or pornographic items." Alexander restarted her crowdfunding campaign by using the services of Tilt.com. The campaign ended on June 13, 2014 with $10,550 raised.
Following the Alexander incident of May 2014, WePay CEO Bill Clerico wrote an explanation of their terms in relation to adult services to the TechCrunch media outlet:
Clerico further stated that such practice is "a relatively common requirement in the industry" and assured the TechCrunch writer that WePay agreed to cease Alexander's campaign "because we are contractually required to."
Crowdfunding is being explored as a potential funding mechanism for creative work such as blogging and journalism, music, independent film (see crowdfunded film), and for funding startup companies. Community music labels are usually for-profit organizations where "fans assume the traditional financier role of a record label for artists they believe in by funding the recording process". Since pioneering crowdfunding in the film industry, Spanner Films has published a "how to" guide. A Financialist article published in mid-September 2013 stated that "the niche for crowdfunding exists in financing films with budgets in the [US]$1 to $10 million range" and crowdfunding campaigns are "much more likely to be successful if they tap into a significant pre-existing fan base and fulfill an existing gap in the market." Innovative new platforms, such as RocketHub, have emerged that combine traditional funding for creative work with branded crowdsourcing—helping artists and entrepreneurs unite with brands "without the need for a middle man."
Food and agriculture
Several crowdfunding platforms have emerged that allow people to donate or invest in food- and agriculture-related opportunities. AgFunder is one global platform that gives both individual and institutional investors access to venture capital investments, both in agriculture technology and food technology companies. Cropital has developed a platform to allow investors to invest in small-holder farmers, and rewards-based platforms like Barnraiser allow users to support farmers and food startups.
The crowdfunding platform PieShell was launched in 2016 to focus exclusively on food and beverage campaigns.
Philanthropy and civic projects
A variety of crowdfunding platforms have emerged to allow ordinary web users to support specific philanthropic projects without the need for large amounts of money. GlobalGiving allows individuals to browse through a selection of small projects proposed by nonprofit organizations worldwide, donating funds to projects of their choice. Microcredit crowdfunding platforms such as Kiva (organization) facilitate crowdfunding of loans managed by microcredit organizations in developing countries. The US-based nonprofit Zidisha applies a direct person-to-person lending model to microcredit lending for low-income small business owners in developing countries.
DonorsChoose.org, founded in 2000, allows public school teachers in the United States to request materials for their classrooms. Individuals can lend money to teacher-proposed projects, and the organization fulfills and delivers supplies to schools. There are also a number of own-branded university crowdfunding websites, which enable students and staff to create projects and receive funding from alumni of the university or the general public. Several dedicated civic crowdfunding platforms have emerged in the US and the UK, some of which have led to the first direct involvement of governments in crowdfunding. In the UK, Spacehive is used by the Mayor of London and Manchester City Council to co-fund civic projects created by citizens. Similarly, dedicated humanitarian crowdfunding initiatives are emerging, involving humanitarian organizations, volunteers and supports in solving and modeling how to build innovative crowdfunding solutions for the humanitarian community. Likewise, international organizations like the Office for the Coordination of Humanitarian Affairs (OCHA) have been researching and publishing about the topic.
One crowdfunding project, iCancer, was used to support a Phase 1 trial of AdVince, an anti-cancer drug in 2016.
Real estate crowdfunding is the online pooling of capital from investors to fund mortgages secured by real estate, such as "fix and flip" redevelopment of distressed or abandoned properties, equity for commercial and residential projects, acquisition of pools of distressed mortgages, home buyer downpayments and similar real estate related outlets. Investment, via specialised online platforms in the US, is generally completed under Title II of the JOBS Act and is limited to accredited investors. The platforms offer low minimum investments, often $100 – $10,000. There are over 75 real estate crowdfunding platforms in the United States. The growth of real estate crowdfunding is a global tendency. During 2014 and 2015, more than 150 platforms have been created throughout the world, such as in China, the Middle East, or France. In Europe, some compare this growing industry to that of e-commerce ten years ago.
In Europe the requirements towards investors are not as high as in the United States, lowering the entry barrier into the real estate investments in general. Real estate crowdfunding can include various project types from commercial to residential developments, planning gain opportunities, build to hold (such as social housing) and many more. The report from Cambridge Centre for Alternative Finance addresses both real estate crowdfunding and peer 2 peer lending (property) in the UK.
Intellectual property exposure
One of the challenges of posting new ideas on crowdfunding sites is there may be little or no intellectual property (IP) protection provided by the sites themselves. Once an idea is posted, it can be copied. As Slava Rubin, founder of IndieGoGo, said: "We get asked that all the time, ‘How do you protect me from someone stealing my idea?’ We’re not liable for any of that stuff." Inventor advocates, such as Simon Brown, founder of the UK-based United Innovation Association, counsel that ideas can be protected on crowdfunding sites through early filing of patent applications, use of copyright and trademark protection as well as a new form of idea protection supported by the World Intellectual Property Organization called Creative Barcode.
A number of platforms have also emerged that specialize in the crowdfunding of scientific projects, such as experiment.com, and The Open Source Science Project. In the scientific community, these new options for research funding are seen ambivalently. Advocates of crowdfunding for science emphasize that it allows early-career scientists to apply for their own projects early on, that it forces scientists to communicate clearly and comprehensively to a broader public, that it may alleviate problems of the established funding systems which are seen to fund conventional, mainstream projects, and that it gives the public a say in science funding. In turn, critics are worried about quality control on crowdfunding platforms. If non-scientists were allowed to make funding decisions, it would be more likely that "panda bear science" is funded, i.e. research with broad appeal but lacking scientific substance. Initial studies found that crowdfunding is used within science, mostly by young researchers to fund small parts of their projects, and with high success rates. At the same time, funding success seems to be strongly influenced by non-scientific factors like humor, visualizations, or the ease and security of payment.
In order to fund online and print publications, journalists are enlisting the help of crowdfunding. Crowdfunding allows for small start-ups and individual journalists to fund their work without the institutional help of major public broadcasters. Stories are publicly pitched using crowdfunding platforms such as Kickstarter, Indiegogo, or Spot.us. The funds collected from crowdsourcing may be put toward travel expenses or purchasing equipment. Crowdfunding in journalism may also be viewed as a way to allow audiences to participate in news production and in creating a participatory culture. Though deciding which stories are published is a role that traditionally belongs to editors at more established publications, crowdfunding can give the public an opportunity to provide input in deciding which stories are reported. This is done by funding certain reporters and their pitches. Donating can be seen as an act that "bonds" reporters and their readers. This is because readers are expressing interest for their work, which can be "personally motivating" or "gratifying" for reporters.
Spot.us, which was closed in February 2015, was a crowdfunding platform that was specifically meant for journalism. The website allowed for readers, individual donors, registered Spot.us reporters, or news organizations to fund or donate talent toward a pitch of their choosing. While funders are not normally involved in editorial control, Spot.us allowed for donors or "community members" to become involved with the co-creation of a story. This gave them the ability to edit articles, submit photographs, or share leads and information. According to an analysis by Public Insight Network, Spot.us was not sustainable for various reasons. Many contributors were not returning donors and often, projects were funded by family and friends. The overall market for crowdfunding journalism may also be a factor; donations for journalism projects accounted for .13 percent of the $2.8 billion that was raised in 2013.
Larger crowdfunding platforms such as Indiegogo or Kickstarter, both of which are not journalism-specific, may garner more success for projects. This is because these large-scale platforms can allow journalists to reach new audiences. In 2017, 2.3 million out of Kickstarter's 7.9 million users had donated toward more than one project.
Traditionally, journalists are not involved in advertising and marketing. Crowdfunding means that journalists are attracting funders while trying to remain independent, which may pose a conflict. Therefore, being directly involved with financial aspects can call journalistic integrity and journalistic objectivity into question. This is also due to the fact that journalists may feel some pressure or "a sense of responsibility" toward funders who support a particular project. Crowdfunding can also allow for a blurred line between professional and non-professional journalism because if enough interest is generated, anyone may have their work published.
There is some hope that crowdfunding has potential as a tool open for use by groups of people traditionally more marginalized. The World Bank published a report titled “Crowdfunding’s potential for the Developing World” which states that “While crowdfunding is still largely a developed world phenomenon, with the support of governments and development organizations it could become a useful tool in the developing world as well. Substantial reservoirs of entrepreneurial talent, activity, and capital lay dormant in many emerging economies...Crowdfunding and crowdfund investing have several important roles to play in the developing world’s entrepreneurial and venture finance ecosystem.”
As the popularity of crowdfunding expanded, the SEC, state governments, and Congress responded by enacting and refining many capital-raising exemptions to allow easier access to alternative funding sources. Initially, the Securities Act of 1933 banned companies from soliciting capital from the general public for private offerings. However, “President Obama signed the Jumpstart Our Small Businesses Act (“JOBS Act”) into law on April 5, 2012, which removed the ban on general solicitation activities for issuers qualifying under a new exemption called ‘Rule 506(c).’” A company can now broadly solicit and generally advertise an offering and still be compliant with the exemption’s requirements if:
- The investors in the offering are all accredited investors; and
- The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.
Another change was the amendment of SEC Rule 147. Section 3(a)(11) of the Securities Act allows for unlimited capital raising from investors in a single state through an intrastate exemption. However, the SEC created Rule 147 with a number of requirements to ensure compliance. For example, intrastate solicitation was allowed, but a single out-of-state offer could destroy the exemption. Additionally, the issuer was required to be incorporated and do business in the same state of the intrastate offering. With the expansion of interstate business activities because of the internet, it became difficult for businesses to comply with the exemption. Therefore, on October 26, 2016 the SEC adopted Rule 147(a) which removed many of the restrictions to modernize the Rules. For example, companies would have to do business and have its principal place of business in the state where the offering is sold, and not necessarily where offered per the prior rule.
Benefits and risks
Benefits for the creator
Crowdfunding campaigns provide producers with a number of benefits, beyond the strict financial gains. The following are non financial benefits of crowdfunding.
- Profile – a compelling project can raise a producer's profile and provide a boost to their reputation.
- Marketing – project initiators can show there is an audience and market for their project. In the case of an unsuccessful campaign, it provides good market feedback.
- Audience engagement – crowdfunding creates a forum where project initiators can engage with their audiences. Audience can engage in the production process by following progress through updates from the creators and sharing feedback via comment features on the project's crowdfunding page.
- Feedback – offering pre-release access to content or the opportunity to beta-test content to project backers as a part of the funding incentives provides the project initiators with instant access to good market testing feedback.
There are also financial benefits to the creator. For one, crowdfunding allows creators to attain low-cost capital. Traditionally, a creator would need to look to "personal savings, home equity loans, personal credit cards, friends and family members, angel investors, and venture capitalists." With crowdfunding, creators can find funders from around the world, sell both their product and equity, and benefit from increased information flow. Additionally, crowdfunding that supports pre-buying allows creators to obtain early feedback on the product. Proponents of the crowdfunding approach argue that it allows good ideas which do not fit the pattern required by conventional financiers to break through and attract cash through the wisdom of the crowd. If it does achieve "traction" in this way, not only can the enterprise secure seed funding to begin its project, but it may also secure evidence of backing from potential customers and benefit from word of mouth promotion in order to reach the fundraising goal. Another potential positive effect is the propensity of groups to "produce an accurate aggregate prediction" about market outcomes as identified by author James Surowiecki in his book The Wisdom of Crowds, thereby placing financial backing behind ventures likely to succeed.
Proponents also identify a potential outcome of crowdfunding as an exponential increase in available venture capital. One report claims that If every American family gave one percent of their investable assets to crowdfunding, $300 billion (a 10X increase) would come into venture capital. Proponents also cite that a benefit for companies receiving crowdfunding support is that they retain control of their operations, as voting rights are not conveyed along with ownership when crowdfunding. As part of his response to the Amanda Palmer Kickstarter controversy, Albini expressed his supportive views of crowdfunding for musicians, explaining: "I've said many times that I think they're part of the new way bands and their audience interact and they can be a fantastic resource, enabling bands to do things essentially in cooperation with their audience." Albini described the concept of crowdfunding as "pretty amazing."
Risks and barriers for the creator
Crowdfunding also comes with a number of potential risks or barriers. For the creator, as well as the investor, studies show that crowdfunding contains "high levels of risk, uncertainty, and information asymmetry."
- Reputation – failure to meet campaign goals or to generate interest results in a public failure. Reaching financial goals and successfully gathering substantial public support but being unable to deliver on a project for some reason can severely negatively impact one's reputation.
- IP protection – many Interactive Digital Media developers and content producers are reluctant to publicly announce the details of a project before production due to concerns about idea theft and protecting their IP from plagiarism. Creators who engage in crowdfunding are required to release their product to the public in early stages of funding and development, exposing themselves to the risk of copy by competitors.
- Donor exhaustion – there is a risk that if the same network of supporters is reached out to multiple times, that network will eventually cease to supply necessary support.
- Public fear of abuse – concern among supporters that without a regulatory framework, the likelihood of a scam or an abuse of funds is high. The concern may become a barrier to public engagement.
For crowdfunding of equity stock purchases, there is some research in social psychology that indicates that, like in all investments, people don't always do their due diligence to determine if it's a sound investment before investing, which leads to making investment decisions based on emotion rather than financial logic. By using crowdfunding, creators also forgo potential support and value that a single angel investor or venture capitalist might offer. Likewise, crowdfunding requires that creators manage their investors. This can be time-consuming and financially burdensome as the number of investors in the crowd rises. Crowdfunding draws a crowd: investors and other interested observers who follow the progress, or lack of progress, of a project. Sometimes it proves easier to raise the money for a project than to make the project a success. Managing communications with a large number of possibly disappointed investors and supporters can be a substantial, and potentially diverting, task.
Some of the most popular fundraisings are for commercial companies which use the process to reach customers and at the same time market their products and services. This favors companies like microbreweries and specialist restaurants – in effect creating a "club" of people who are customers as well as investors. In the USA in 2015, new rules from the SEC to regulate equity crowdfunding will mean that larger businesses with more than 500 investors and more than $25 million in assets will have to file reports like a public company. The Wall Street Journal commented "It is all the pain of an IPO without the benefits of the IPO." These two trends may mean crowdfunding is most suited to small consumer-facing companies rather than tech start-ups.
Benefits for the investor
There are several ways in which a well-regulated crowdfunding platform can provide attractive returns for investors:
- Crowdfunding Reduces Costs – The platforms reduce search and transaction costs, which allows a higher participation in the market. Many individual investors would otherwise have a hard time to invest in early-stage companies because of the difficulty of identifying a company directly and the high costs of joining an Angel Group or doing it through a professional venture firm.
- Current Early Stage Investing Isn’t Efficient – Venture capital firms often neglect the consumer sector and focus mainly on high-tech companies. Crowdfunding opens up some of these neglected markets to individual investors. Crowdfunding doesn’t make sense in every industry, but for some, like retail and consumer, it does.
- Value of New Investors – Another reason why crowdfunding is attractive is that the investors add value to companies. They act as brand advocates and can even be used as a focus group. Crowdfunding allows individual investors to be a valuable part of the company they invest in.
Risks for the investor
On crowdfunding platforms, the problem of information asymmetry is exacerbated due to the reduced ability of the investor to conduct due diligence. Early stage investing is typically localized, as the costs of conducting due diligence before making investment decisions and the costs of monitoring after investing both rise with distance. However, this trend is not observed on crowdfunding platforms - these platforms are not geographically constrained and bring in investors from near and far. On non-equity or reward-based platforms, investors try to mitigate this risk by using the amount of capital raised as a signal of performance or quality. On equity-based platforms, crowdfunding syndicates reduce information asymmetry through dual channels – through portfolio diversification and better due diligence as in the case of offline early-stage investing, but also by allowing lead investors with more information and better networks to lead crowds of backers to make investment decisions.
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Studies and Papers
- Crowdfunding and Civic Society in Europe: A Profitable Partnership? Open Citizenship, vol. 4, no. 1. (2013).
- Dynamics of Crowdfunding: Determinants of Success and Failure by Ethan Mollick, examines what causes individual projects to succeed or fail.
- An Empirical Examination of the Antecedents and Consequences of Contribution Patterns in Crowd-funded Markets examines the patterns of crowdfunding in journalism
- Is There an eBay for Ideas? European Management Review, 2011
- Herding Behavior as a Network Externality, Proceedings of the International Conference on Information Systems, Shanghai, December 2011
- The Geography of Crowdfunding, NET Institute Working Paper No. 10-08, Oct 2010
- Ex Ante Crowdfunding and the Recording Industry: A Model for the U.S.?
- Crowdfunding and the Federal Securities Laws by C. Steven Bradford