I. Innovation
5. Market-based financing of innovation, a detailed introduction of
5.1. Crowdfunding
Szőcs Árpád
5. Market-based financing of innovation, a
It is important to note, however, that the digital world tends to underestimate the background knowledge required by some professions. Financial institu-tions and venture capital fund managers are typically experts who have learned over the years; for example, what aspects of a business are worth financing. In light of that, despite its advantages, crowdfunding comes with significant risks to the investor. The most significant risks are lending risks and counterparty risks, which can be partly mitigated by the platform152. Be-sides, the typically small amount of investment allows more and more people to try themselves as investors and to obtain financing companies that would not or would be harder to do with traditional tools.
5.1.1. A historical perspective
While some people claim that crowdfunding can be traced back to the 1700s, others cite a campaign by Joseph Pulitzer as the first crowdfunding cam-paign. When the U.S. found itself unable to raise enough money to pay for a base for the Statue of Liberty in 1885, Pulitzer used his newspaper, The New York World, to raise money to cover the cost from more than 160,000 donors in just five months. Crowdfunding as we know it today kickstarted in 1997 when fans donated $60k online to the British rock band Marillion to fund the band’s reunion tour153. Michael Sullivan is credited with coining the term crowdfunding back in 2006 with the launch of fundavlog, a failed attempt at creating an incubator for videoblog-related projects and events, including a simple funding functionality. But the term crowdfunding only really began to be used by the masses a few years later with the advent of the platform Kickstarter154.
Subsequently, the process began, resulting in rapidly growing crowdfunding platforms. It is important to mention Indiegogo created in 2008, and Kick-starter established in 2009. Today, KickKick-starter is almost the same concept for testing new creative ideas and products as Google is for getting information.
Since its launch, 17 million people have backed a project, $4.7 billion has been pledged, and 176,425 projects have been successfully funded155. As-sisted by the widespread adoption and social acceptance of Web 2.0 technol-ogies, crowdfunding expanded on a large scale, providing the infrastructure
152 Bethlendi, A., & Végh, R. (2014): Could it Become a Viable Option for Hungarian Small Busi-nesses? Financial and Economic Review, 100-124.
153 Olawale, D. (2018. November 14.11.2018): www.medium.com. Forrás: https://me-dium.com/@danielolawale6/benefits-and-drawbacks-of-crowdfunding-4cf6f79afd9b
154 Castrataro, D. (2011. december 12.12.2011): www.socialmediaweel.org. Forrás: https://so-cialmediaweek.org/blog/2011/12/a-social-history-of-crowdfunding/
155 (https://www.kickstarter.com/, 2020.01.23.)
to reach millions of investors and supporters online156 157. Employing plat-form mediated approaches to collect many small amounts from a large num-ber of individuals, crowdfunding has diffused from nonprofit projects to en-trepreneurial funding for innovative new ventures. In enen-trepreneurial fund-ing, the prevailing types are reward-based, lendfund-ing, and equity crowdfund-ing158. Not only did this new form of funding offer start-ups an opportunity to seek funding, but it also provided opportunities for nonprofit donations and charitable fundraising.
5.1.2. How does crowdfunding work?
The process of crowdfunding begins with the development of a “pitch” that gives information to potential funders. The pitches are hosted in crowdfund-ing platforms that organise and administrate the whole process and act as a market for fund-seekers to interact with the crowds159. The pitch information can take the form of hard facts such as revenue figures or monthly disposable income, or soft claims such as the entrepreneurs’ backgrounds and aspira-tions or promises. However, only some of the presented facts are validated by the crowdfunding platform (for example, some platforms check basic in-formation like credit score, personal income160. The average amount of suc-cessful campaigns ranged from a few thousand dollars and thus did not com-pete with institutional investors. Although crowdfunding platforms have grown dynamically in recent years, this new form of funding is not expected to replace traditional tools, but rather to complement them.
Crowdfunding types
Recently, different types of crowdfunding and their variations have appeared.
In the following, the four largest, defining types are described.
156 Agrawal, A., Catalini, C., & Goldfarb, A. (2015): Crowdfunding: Geography, social networks, and the timing of investment decisions. Journal of Economics & Management Strategy, 253–274.
157 Allison, T., McKenny, A., & Short, J. (2013): The effect of entrepreneurial rhetoric on micro-lending investment: An examination of the warm-glow effect. . Journal of Business Venturing, 690–
707.
158 Cholakova, M., & Clarysse, B. (2015): Does the possibility to make equity investments in crowdfunding projects crowd out reward-based investments? . Entrepreneurship Theory and Prac-tice, 145–172.
159 Bruton, G., Khavul, S., Siegel, D., & Wright, M. (2015): New financial alternatives in seeding entrepreneurship: Microfinance, crowdfunding, and peer-to-peer innovations. Entrepreneurship Theory and Practice, 9–26.
160 Iyer, R., Khwaja, A., Luttmer, E., & Shue, K. (2015): Screening peers softly: Inferring the quality of small borrowers. Management Science, 1554–1577.
• In donation type crowdfunding, contributors support a project and re-ceive no or only symbolic rewards in return, as motivation is purely intrinsic161.
• In reward-based crowdfunding, crowd funders receive nonpecuniary tangible (prototypes) or intangible (experiences) rewards in exchange for their support, being driven by intrinsic (for example, engagement) and extrinsic benefits (for instance, the reward)162.
• In lending crowdfunding, supporters receive a monetary return in the form of interest, reflecting the risk and duration of the project163164
• In equity crowdfunding, supporters receive a shareholding contract or a revenue-sharing scheme in return for their contribution165.
The most complex type for backers, requiring their highest involvement, is equity crowdfunding, followed by lending crowdfunding and reward crowd-funding. Donation crowdfunding is significantly less complex and crowd funders’ involvement is minimal166
Largest crowdfunding platforms
• Kickstarter: The most popular crowdfunding site on the Internet, Kickstarter has become a household name. However, it is more for funding inventions and creative works and not for helping nonprofit organisations or funding somebody’s endeavors without something in return. Also, participants do not get to keep the money pledged if the Kickstarter goal is not reached.
161 Gerber, E., & Hui, J. (2013): Crowdfunding: Motivations and deterrents for participation. ACM Transactions on Computer-Human Interaction, 34.
162 Cholakova, M., & Clarysse, B. (2015): Does the possibility to make equity investments in crowdfunding projects crowd out reward-based investments? . Entrepreneurship Theory and Prac-tice, 145–172.
163 Allison, T., McKenny, A., & Short, J. (2013): The effect of entrepreneurial rhetoric on micro-lending investment: An examination of the warm-glow effect. . Journal of Business Venturing, 690–
707.
164 Bruton, G., Khavul, S., Siegel, D., & Wright, M. (2015): New financial alternatives in seeding entrepreneurship: Microfinance, crowdfunding, and peer-to-peer innovations. Entrepreneurship Theory and Practice, 9–26.
165 Cholakova, M., & Clarysse, B. (2015): Does the possibility to make equity investments in crowdfunding projects crowd out reward-based investments? . Entrepreneurship Theory and Prac-tice, 145–172.
166 Hornuf, L., & Schwienbacher, A. (2014): Crowdinvesting – Angel Investing For the Masses?
Handbook of Research on Venture Capital.
• Indiegogo: While it tends to play second fiddle to Kickstarter, Indi-egogo has several advantages its counterpart doesn't provide. For in-stance, Indiegogo has flexible funding that lets participants keep the funds they've raised, even when they haven't been able to reach their goal. It also lets them buy funded products in the platform's market-place, so successful projects have another potential source of income.
• Patreon: Another popular crowdfunding platform, Patreon sets itself apart with its subscription model. Instead of being for straight-up campaigns, this is more for providing ongoing financial support for a creative venture or artist. There's also the option to provide content exclusive to patrons who are subscribed to somebody’s Patreon through the site itself.
• GoFundMe: This one is more popular for individuals who need money right away. They may often see people asking for crowdfund-ing for short-term projects and medical emergencies in GoFundMe, which is common practice in this platform.
• Crowdrise: While not as popular as the platforms mentioned above, Crowdrise has garnered attention for its focus on crowdfunding "real-world issues" over funding for-profit ventures. It can also be used to fund college scholarships, weddings, and even birthday parties. Due to this mostly socially-conscious objective, GoFundMe took notice and acquired it in early 2017167
5.1.3. What is the future of crowdfunding?
In less than a decade, crowdfunding has already been recognized as one of the most typical methods of fundraising for innovative products and services.
It has assisted millions of innovators and startups in bringing their ideas into the market. The era of non-regulated crowdfunding platforms had already passed, but with the rise of blockchain technology, many new platforms have been incorporated into exotic tax-haven destinations without complying with their respective regulations. Today crowdfunding is mainly conducted based on national legislation, which means that platforms are subject to rules de-pending on the country where they operate. This makes it difficult for plat-forms to provide their services beyond borders. The European Union (EU) has already established one-stop-shop access to its market, which helps
167 Kim, L. (2018): Top 10 Crowdfunding Platforms of 2018. Forrás: https://www.inc.com/larry-kim/op-10-crowdfunding-platforms-of-2018.html
crowdfunding platforms overcome the barriers they face operating cross-bor-der and gives more opportunities to European investors.168 On the other hand, the regulation of crowdfunding in the United Crowdfunding platforms that are reward-based or for the collection of donations are mostly unregulated, subject only to the prohibitions on fraud and false advertising that apply to all commercial transactions169. Internet penetration and the proliferation of smart devices are expected to attract more and more regions and entrepre-neurial candidates to the online world. Against this background, crowdfund-ing platforms are expected to continue to grow in the future and possibly to specialize by topic.