Crowdfunding, the future of Startup Financing?

Importantly, the profiles and motivations of the funders are also very different compared to debt and equity financiers. With certain arguable exceptions such as equity-backed crowdfunding, the crowd is typically comprised of lay consumers who are incentivised by the general desire to see the materialisation of certain products or services and/or the associated rewards. Furthermore, according to a recent study, 50% of crowdfunders surveyed indicated that they had funded projects simply because “they liked the project and wanted to support the idea.” Their risk profiles are fundamentally different, as they are only required to commit a comparatively smaller amount, usually from a range of $10 to $100. Hence, crowdfunders are more willing to fund ventures and ideas that traditional debt and equity financiers may not. This has resulted in many to believe that crowdfunding has democratized funding. Undoubtedly, it has risen as a powerful alternative and source of financing for growing ventures.

Indeed, there have been many instances and numerous examples of growing ventures successfully raising and even surpassing their funding objectives via crowdfunding. The most prominent and promising example is the Pebble Smartwatch which was conceived by a largely unknown founder with sparse track record who had set an original funding objective of $ 100,000 on Kickstarter. He would end up raising over $10.3 million, bringing his concept to market. He would later rely on crowdfunding again to bring a subsequent iteration of the product and again raised $20.3 million.

Crowdfunding Benefits for Growing Ventures

The benefits that crowdfunding reaps to growing ventures transcends the mere democratisation of funding. There are also other values that are particularly beneficial to growing ventures, when carefully considered:

i. Market Validation

Given that crowdfunding platforms possess immense reach, engaging in crowdfunding actually provides a means for growing ventures to pre-sell their products and services to a sizeable crowd. This exercise provides an effective and cost-efficient method for growing ventures to assess potential market feedback to some extent. This is particularly important for growing ventures as they generally may not have gone to market yet or may be within the product development phase. The feedback gained can be further analysed and used to verify any performance assumptions held by such ventures. This may certainly be employed to complement any other market validation or research exercises that may be pursued by growing ventures. The value of this exercise has been appreciated by many crowdfunding applicants; such as the founder of RingSafe, who noted:

“To me, market validation is one of the most compelling reasons to try crowdfunding over alternative methods of raising seed money. When John and I invented RingSafe, we got good feedback from family and friends on our idea and prototype…What we really needed to learn was whether total strangers would be willing to part with their hard-earned money to buy our product. Through crowdfunding, you can set up pre-orders for a concept and reduce the risk of building your first batch. Your success will also tell you whether people care about your idea at all.”

As a result, crowdfunding enables growing ventures to hedge risks and develop better market understanding to some extent. This may become useful for ventures in later rounds of financing, as the results here can be utilized as a potential way to demonstrate proof of concept.

ii. Marketing Channel

For very much the same reasons discussed above, crowdfunding provides a great channel for growing ventures to engage in marketing their brand and ideas. Crowdfunding allows growing ventures to introduce their ideas and brand on platforms are highly frequented by users. The marketing effect is further enhanced by the fact that most crowdfunding platforms are directly integrated with social media platforms and sharing features, allowing ventures to easily reach multiple platforms and gain organic and referral traffic. In addition, many well executed crowdfunding campaigns also receive media attention as the crowdfunding scene has been experiencing increasing media coverage. On the other hand, many researchers have also noted that the funders are also a source of viral marketing as well, it is believed that funders tend to promote the projects they have funded. They can generate considerable awareness and public exposure for these ventures.

iii. Wisdom of the Crowd

One of the common challenges that growing ventures face is the lack of business acumen and foresight, particularly when they pursuing innovative ideas. Within this aspect, crowdfunding provides a viable solution in the form of what has been commonly dubbed ‘wisdom of the crowd’. Specifically, crowdfunders may also offer their own experiences and skills in the form of comments and feedback on the ideas of the fundraisers, they encounter on the platforms. Such comments may range from pointing out existing flaws with an idea, market viability or even suggestions for improvement. On an aggregate level, the combined feedback received can be valuable for growing ventures in allowing them to build a better understanding of their own ventures, its shortfalls and assist in improving the idea. Naturally this has led many to believe that this ‘wisdom’ can speed up the product development process.

Drawbacks of Crowdfunding for Growing Ventures

Our assessment highlights that crowdfunding can provide a very effective source of financing for growing ventures in not only meeting the existing funding gap but also in directly providing value-added benefits that cater to the nature of growing ventures. However, crowdfunding also possesses certain drawbacks that growing ventures should take into account:

i. Hidden Costs of Crowdfunding

Although it is largely true that crowdfunding is generally open to all with no upfront costs. There can be underlying costs that may arise for disorganised and over- optimistic fundraisers. On reward-based crowdfunding platforms, the implementation of miscalculated rewards may translate as significant obligations to meet once the funding objective is achieved. Over-optimistic or negligent projections may result in the inability to meet the obligations on time or even at all; it may also transfer to affect the cash-flow of the very venture itself, stunting its growth as the founders focus on meeting obligations as the main priority. Unfortunately, this has happened to many fundraisers. Most recently, Schuley Towne successfully raised over $86,000 via crowdfunding for a lock-pick set. He had planned to start his venture revolving around this product but after receiving the funds, he was unable to realize his company as he had been over-optimistic about production and meeting deadlines. Towne is now struggling to meet the product obligations he has assumed via crowdfunding. Simultaneously, failure in crowdfunding also carries with it significant hidden costs as well. As exemplified by Towne’s case, the public nature of crowdfunding means that any substantial failure can be publicised. This could translate into significant negative publicity and reputational damage to growing ventures which may affect their ability to go to market or even raise further funds later in its lifecycle.

ii. Intellectual Property Rights

Compared to traditional funding methods, a major challenge that fundraisers meet with crowdfunding is the issue of secrecy. As already identified, crowdfunding is by nature a very public process of raising funds. Generally, successful campaigns involve the disclosure of comprehensive and detailed information about the venture and its products and services. This may of course work against growing ventures which are relying on secrecy in going to market as a competitive strategy. Vitally, what is more concerning is that there is actually no legal guarantee from these platforms that pitches are protected from intellectual property (IP) theft. Unless, ventures pursuing crowdfunding have taken prior IP precautions, they may be out of legal recourse in the unfortunate event of these incidents occurring. This has created the reluctance of many growing ventures which choose to opt out of crowdfunding.

iii. Efficacy of Funding

There is also a question of whether crowdfunding provides effective funding for the needs of certain growing ventures. Specifically, the all-or-nothing approach means that if fundraisers do not meet their funding objectives and raise the entire amount, they are left with nothing. Thus, for certain growing ventures crowdfunding provides little assurance that their funding needs will be met.