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Abstract

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Crowdfunding through the Internet, a new fundraising technique for small business ventures, can benefit fund-seeking companies by helping to overcome funding difficulties, providing value-added involvement, facilitating access to further funding, providing publicity and contacts, and enabling fundraising with only limited or no loss of control and ownership.

Crowdfunding through Internet platforms is a new phenomenon allowing small business ventures to raise capital from a large number of private individuals, the so-called ‘crowdfunders.’

Crowdfunding can offer a variety of financial and non-financial benefits to fund-seeking business ventures.

Financially, it helps small companies to overcome funding difficulties and it facilitates access to further financiers while allowing businesses to raise capital with limited or no loss of ownership and control.

In terms of non-financial benefits, crowdfunders can provide value-added involvement and feedback creating, at the same time, publicity and public awareness of the business, and new potentially useful contacts to the business.

Introduction

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

It is widely known that small businesses are important contributors to the UK economy. It is also established that young and growing businesses need access to finance in order to fulfill this important role. However, especially in recent years, many small businesses have been and are still facing substantial difficulties in raising outside capital — this is true for both debt and equity (Cressy, 2012). There is considerable interest in policy, practice, and academia to explore ways of overcoming these so-called ‘funding gaps’ (Department for Business, Innovation and Skills, 2012).

‘Crowdfunding’ through the Internet is a relatively new fundraising mechanism that can have the potential to help small, young businesses overcome funding gaps (Van Wingerden and Ryan, 2011). Recently, crowdfunding has rapidly gained substantial public exposure, particularly following the launch of an estimated 500 Internet crowdfunding platforms, most of which are located in the USA and the UK (Avery, 2012). These platforms allow small and young businesses to raise capital — for instance, in the form of donations, loans, or equity — from a large number of unrelated individuals (the ‘crowd’) (Belleflamme et al., 2012; Collins and Pierrakis, 2012). Despite this increasing publicity, a recent survey showed that over two-thirds of small businesses in the UK are entirely unaware of the concept of crowdfunding (Moules, 2012).

As will be explained further below, crowdfunding can be used by businesses requiring small to modest amounts of capital. This often, but not exclusively, refers to businesses in their seed, start-up, and early stages, after they have exhausted founders', friends', and family's investments but before being established enough to attract venture capital2 or bank loans.3 There are other funding sources, which invest similar amounts into businesses in their early stages of development; particularly business angels4 come to mind (Ramadani, 2009). However, they are not enough to bridge the funding gap between internal (founders, friends, and family) and formal external (venture capital and banks) investors (Collins and Pierrakis, 2012).

There is much debate about crowdfunding in the media and amongst practitioners, but to date, academic literature in this emerging field is virtually non-existent, consisting of only a very small number of published articles and working papers. Owing to the newness of this funding source, little is known about it and entrepreneurs, who are thinking about using crowdfunding, have only a very limited amount of literature at their disposal on which to base their decisions. On the academic side, the newness of the field results in a plethora of potential research avenues, all of which require exploration and subsequent theorizing and explanation.

It is on this basis that this article explores the current state of literature in the field of crowdfunding in order to describe this funding source and to provide an exploratory summary of its benefits and drawbacks for fund-seeking business ventures. In achieving this purpose, this article aims to serve two main audiences:

  • 1
    Practitioners, especially fund-seeking entrepreneurs. The review of the current knowledge within the field of crowdfunding aims to educate entrepreneurs by providing them with an overview of this new funding source, thus increasing the number of small businesses knowledgeable about crowdfunding. More importantly, this article aims to present a framework of crowdfunding benefits, which helps entrepreneurs understand the advantages (and disadvantages) of this source of capital. This will support their decision making when considering crowdfunding.
  • 2
    Researchers/academics. The review of the current state of knowledge in the field of crowdfunding aims to serve as an exploratory and descriptive basis, upon which researchers can build further explorations of various aspects of this emerging field of study. Moreover, the framework of crowdfunding benefits presented in this article constitutes a very early and tentative attempt at developing a theoretical framework in the field, which can also be used as a starting point for further study.

The remainder of this article proceeds as follows: next, we briefly present the definition and origins of crowdfunding, while also outlining the reasons why it emerged as a new funding source. This is followed by an overview of how crowdfunding works and a more detailed description of what it is. Subsequently, this article uses a framework of investor benefits (Macht and Robinson, 2009) to explore the benefits of crowdfunding for business ventures; we amend the framework in light of the specific benefits of crowdfunding. The article then outlines the drawbacks of crowdfunding, before presenting a summary and conclusion, which illustrates the article's contributions to practice and academia.

Crowdfunding: Origins, definition, and reasons for emergence

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Crowdfunding is a fundraising technique, which allows businesses to obtain capital from a large number of individuals from the general public, the ‘crowd’ (Belleflamme et al., 2012). Crowdfunding is one form of an activity called ‘crowdsourcing.’ In its offline version, crowdsourcing has been in existence for centuries in a variety of different contexts, all of which refer to companies or individuals using a large crowd of people to carry out certain tasks (Aitamurto, 2011). Owing to the interactive nature of the Internet and the emergence of various online social and professional networking platforms, crowdsourcing via the Internet is being widely used by companies of all sizes. Kleemann et al. (2008) described a number of crowdsourcing activities, including the following:

  • companies ask their customers to rate their purchases, for the purpose of feedback to the companies themselves and to other (potential) customers;

  • companies ask their customers to contribute to the design of new products/services; and

  • customer-to-customer support, for instance, through interactive blogs.

All of these crowdsourcing activities require the crowd (mostly customers in the case of crowdsourcing) to use the Internet to interact with the company and one another in order to help the company carry out certain tasks. However, none of these activities refers to fundraising or financial inputs.

A specific form of crowdsourcing, which has a strong financial element, has been introduced in the creative and performing arts sectors (Aitamurto, 2011). In 2006, the pioneer in this context was Sellaband (2012), which allowed individuals to financially support the production of a band's or an artist's CD (Kappel, 2009). In return, the funders would obtain some rewards, such as a free copy of the CD or a small proportion of the sales revenue (Ordanini et al., 2011; Schwienbacher and Larralde, 2010). Over the subsequent years, a number of similar online platforms emerged, which also allow crowds to fund the creative and performing arts. At the same time, the crowd-based fundraising model's applicability to businesses was explored, resulting in the launch of a number of online platforms aimed at raising funds for business ventures, not necessarily within the performing and creative arts (Ordanini et al., 2011). The term ‘crowdfunding’ was coined to describe the application of the Internet crowdsourcing concept to the fundraising activity, for both creative projects and businesses. Lambert and Schwienbacher (2010, p. 6) provided the first academic definition of crowdfunding:

An open call, essentially through the Internet, for the provision of financial resources either in form of donations or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes.

Although this definition explicitly mentions the Internet as the basis for crowdfunding, the fact that crowdsourcing has existed for hundreds of years shows that it is possible to solicit the contribution (including the financial contribution) of large crowds of people on an offline basis. However, due to the recent emergence of online crowdfunding, this article focuses solely on crowdfunding through the Internet. To be more precise, we investigate crowdfunding for business ventures rather than artistic projects and in so doing, we consider any form of investment in said ventures, be it donations, lending, or equity (Collins and Pierrakis, 2012).

Marsden (2011) described online crowdfunding as a legal minefield. In the UK, the regulatory environment in the area of equity investing creates barriers for crowdfunding as businesses are only allowed to use open calls for equity if they address them to sophisticated investors (for example, business angels) or if their offering is approved by a person authorized by the Financial Services Authority (Collins and Pierrakis, 2012). The regulation of open calls for non-equity investments is less stringent, but the Financial Services Authority (2012) nevertheless cautions non-sophisticated crowd investors against providing crowdfunding.

Despite being such a legal minefield, the idea of crowdfunding has extensive potential to support small, young companies because the current financing options available to them are insufficient to overcome the funding difficulties they face. Business angels have previously been mentioned as useful sources of finance for small, young businesses, which have exhausted funds from founders, friends, and family but are unable to obtain capital from institutional investors like venture capitalists or banks (Ramadani, 2009). Although business angels invest similar amounts as can be raised through crowdfunding, there are many and varied reasons why business angels are not sufficient to overcome the funding gap for a majority of small companies. It is not the purpose of this article to review all of these reasons in much detail, so that the following form merely a brief overview of some of the key reasons why crowdfunding emerged as an alternative source of capital to help bridge the funding gap.

  • Business angels require investees to demonstrate high growth potential and therefore high return potential (Sohl, 1999; Wong et al., 2009). This excludes lifestyle ventures, which have very limited growth potential, as well as not-for-profit or some social enterprises, from attracting such funding.

  • Resulting from strict and highly individual investment criteria (including, amongst others, the aforementioned high growth potential and investors' prior experience in the investee's industry, etc.), business angels only invest in very few of the businesses they come across. For instance, Mason and Harrison's (2008a) results showed that business angels only invest in 8% of deals they encounter. This shows that even businesses with high growth potential may not be successful in attracting angel funding if they do not meet the business angels' specific criteria.

  • There are only around 20,000 to 40,000 business angels in the UK and they all tend to favor investing in close geographic proximity to their homes (Mason and Harrison, 2000). Moreover, since business angels like to remain anonymous, it is difficult and time-consuming for entrepreneurs to identify potential angel investors (Mason, 2007).

  • It is even more time-consuming and difficult to locate suitable business angels as it is important that entrepreneurs and investors get along. This is important because business angels tend to expect hands-on involvement in their investee businesses and a lack of chemistry between entrepreneur and angel can lead to friction and conflict (Sweeting and Wong, 1997).

  • Entrepreneurs are frequently unwilling to give up ownership of their ventures, so that it is often their decision to reject funding offers from business angels if they are deemed to request too much equity (Mason and Harrison, 1996). Along a similar line, business angels' desire to become (overly) involved in the business can also be a deal-breaker as entrepreneurs may be concerned about investors interfering in their business (De Noble, 2001).

  • Businesses may lack ‘investment readiness.’ This means that some businesses could have the potential to be attractive to business angels but they are not quite investable yet. Often, such businesses require a bit more time and capital to develop certain areas, before becoming interesting to business angels. Common areas of development refer to, amongst others, the entrepreneur's lack of management skills, unrealistic forecasts, unfocused business ideas, and unclear business models. Through added investment in the deficient areas, this can be remedied but it means that such businesses often need additional capital and time in order to become investment ready (Mason and Harrison, 2004).

Online crowdfunding: How does it work?

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Entrepreneurs sign their business up to a crowdfunding site, which vets the business and decides on whether to allow it to use the site for fundraising (Collins and Pierrakis, 2012). Following a positive outcome of the vetting process, the crowdfunding site publishes information about the business and the investment opportunity it offers. This ‘pitch’ typically includes details about the target amount desired; the time by which the money needs to be raised; the reason(s) why the capital is required; and the rewards to be offered to investors in return for capital investment. Investors — the so-called ‘crowdfunders’ — also sign up to the platform and can subsequently view the investment opportunities. If they decide to invest, they use the platform to pledge however much capital they wish to invest, whereby the amounts invested tend to be rather small, theoretically as little as US$1 per investment (Van Wingerden and Ryan, 2011).

Amounts pledged will show on the online platform, but only if the business manages to raise the full target amount will the investment actually be made (Kappel, 2009). Businesses that are unsuccessful in raising the entire target amount will not be able to benefit from the pledges made so far; in that case, pledges will be returned to investors (Collins and Pierrakis, 2012).

The investments are merely facilitated through the online platform, which means that crowdfunding can be considered a direct investment from the crowd into the business; this is in contrast to indirect investments, which may occur if members of the general public provide capital into banks or funds, which will then in turn make investments into businesses. However, despite this being a direct investment, the contact between investor and investee tends not to be direct as the online platform functions as an intermediary, facilitation, and communication tool (Lambert and Schwienbacher, 2010).

Crowdfunding: A review of the literature

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

This section presents a review of the literature relating to the concept of ‘crowdfunding’ by describing the investors, the investments, and the investees. Entrepreneurs can use this exploratory description to understand this novel type of funding better, while researchers and academics can use it as a basis to investigate crowdfunding further.

Amounts invested

Crowdfunding allows for very small investments, starting theoretically at US$1 per investment. In Van Wingerden and Ryan's (2011) US study, the crowdfunders' investment tended to be between US$6 and US$50. In the UK, there are no detailed statistics relating to all crowdfunding platforms, but investment amounts typically quoted range from £10 (Watkins, 2012) upwards, with some investors providing very large sums, such as Crowdcube's5 largest individual investment of £100,000 (Crowdcube, 2012).

Nature of the investor

Crowdfunding requires investment from a ‘crowd,’ which is a large group of individual members of the general public (Schwienbacher and Larralde, 2010). The investors in these cases are called ‘crowdfunders.’ They are private individuals, who do not have a background as professional investors (with exceptions — it is conceivable that, for instance, high-net-worth individuals or business angels would invest through crowdfunding platforms) (Ordanini et al., 2011).

There is currently no research describing the typical crowdfunder but, given the wide spread of investment amounts indicated above, it is reasonable to assume that any individual can be a potential crowdfunder. The only academic piece of work describing some aspects of a crowdfunder's profile is Van Wingerden and Ryan's (2011) thesis: 52% of crowdfunders are under the age of 35; just over 56% have provided crowdfunding only once or twice over the preceding three months; and just under half rely on the views and decisions of other crowdfunders when choosing their investees.

Geography

Agrawal et al. (2011, p. 1) argued ‘perhaps the most striking characteristic of crowdfunding is the geographic dispersion of investors.’ Their findings stated that on average, entrepreneurs and investors are 3000 miles apart. It is interesting to compare this to business angels, who typically invest within an hour's drive from their home or work place (Harrison et al., 2003). Crowdfunders, in contrast, have less stringent geography-related funding criteria and thus it is conceivable that crowdfunders may even invest across borders.

Crowdfunders' motivation to invest

According to Lambert and Schwienbacher (2010), around 22% of crowdfunders do not obtain any form of reward in return for their capital — the investment is a donation. However, the remaining 78% of crowdfunders obtain rewards of various natures, for instance: equity in the business; cash rewards; free access to the investee's product or service; or an opportunity to have their names associated with the investee. Aitamurto (2011) identified that crowdfunders who provide financial donations to journalistic publications are interested in supporting a specific cause, as opposed to obtaining monetary return on investment.

Lambert and Schwienbacher (2010) suggested two further non-financial motivations: feelings of personal gain, resulting from crowdfunders' contributions to the success of the funded business(es); and social reputation. The latter refers to crowdfunders' desire to be perceived in a positive light by others (Bénabou and Tirole, 2006), which can be achieved through contributing to a worthwhile cause, such as investment in a small business. However, it is reasonable to assume that other motivations, such as philanthropic or altruistic reasons, as sometimes found for business angel investors, may also play a role (Sullivan and Miller, 1996).

Both Ward and Ramachandran (2010) and Van Wingerden and Ryan (2011) researched aspects of the investment motivation and concluded that crowdfunders take into consideration the decisions and actions of other crowdfunders and investors in the same and related/similar ventures; for instance, ventures that have already successfully raised some capital or businesses similar to other successful ventures tend to be preferred. While this does not explain the motivation of the first-mover, it suggests a certain bandwagon effect in the motivation of the followers.

Value-added

Some other investors, including business angels, provide more than just money — they also provide investee businesses with added benefits, such as giving them access to their own network of contacts, becoming actively involved in the business (for instance, as an advisor, mentor, or sounding board), and facilitating access to further financiers. This is called value-added because it can add value beyond the financial investment, either through prior experiences of relevance for their chosen investee businesses or through soft involvement, which refers to people-centered, interpersonal, and emotional support (Macht, 2011).

Owing to crowdfunders being members of the general public, it is reasonable to assume that some crowdfunders have relevant experience and contacts, which can add value to their investee companies; however, at the same time, it is very probable that many crowdfunders do not possess any value-adding attributes. Schwienbacher and Larralde (2012) argued that almost two-thirds of crowdfunders do not become actively involved in their investee companies but, if they do, then such involvement may be limited to providing feedback or being allowed voting rights regarding further development of the products/services. Nevertheless, Collins and Pierrakis (2012, p. 24) argued that crowdfunders can provide the ‘wisdom of the crowd,’ referring to their combined skills and experiences.

A further value-adding capability of crowdfunding refers to much public exposure of the business and an increase in awareness of its products/services as a result of: the large number of investors; the likelihood that they will use word-of-mouth to promote their investee; and the fact that the crowd members may feel like members of a tight-knit community (Belleflamme et al., 2012).

Target amounts sought by businesses

According to Schwienbacher and Larralde (2012), most companies attempting to raise finance through crowdfunding seek small to modest amounts of capital. Statistics from Crowdcube concur, showing that the average target amount is £146,552, while the smallest amount raised to date was £12,000 (Crowdcube, 2012).

Nature of the investee

Schwienbacher and Larralde (2012) showed that companies from any industry are able to use crowdfunding, although they stated that investees need to be somewhat innovative in order to capture interest from the general public — this ‘innovativeness,’ however, is not further specified and it is reasonable to assume that different crowdfunders will have different attitudes to what constitutes interesting and innovative. Crowdcube's (2012) statistics agree with this as they include various diverse industries, including consumer products, financial services, and Internet/technology.

Lambert and Schwienbacher (2010) further identified that businesses with a not-for-profit orientation tend to be substantially more successful in raising capital from crowds than for-profit organizations or businesses seeking funding for specific projects only. Kappel (2009) argued that it is particularly, but not exclusively, businesses without a solid track record that can benefit from crowdfunding.

Overall, there appear to be no specific types of business which are excluded from being successful; it seems that any small business can theoretically raise capital through crowdfunding, independent of its size, stage of development, growth potential, innovativeness, return potential, or age.

Entrepreneurs' motivations to seek crowdfunding

Lambert and Schwienbacher's (2010) survey of crowdfunding-seeking entrepreneurs identified three main motivations to use crowdfunding: to raise finance; to create public exposure for the company or project; and to establish whether the product/service will be accepted into the market once launched. They also suggested that for some entrepreneurs, it may be the inability to raise capital from the more established sources — such as business angels, venture capitalists, or banks — which forces them to use crowdfunding as the only available alternative. This is a rather necessity-driven motivation.

Other entrepreneurs may deliberately select crowdfunding because they can see the benefits this source can deliver over other established funding sources (please see below for a detailed discussion of the advantages and disadvantages of crowdfunding) or because they deliberately choose crowdfunding alongside, before, or after other types of finance to expand or complete a certain fundraising target (Belleflamme et al., 2010).

Benefits of crowdfunding for capital-seeking businesses

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

The benefits from crowdfunding can be viewed in the form of a framework, which supports fund-seeking entrepreneurs with their decision regarding whether to consider crowdfunding while at the same time representing a basis for further research. Macht and Robinson (2009) created a framework of investor benefits in the context of business angels (see Figure 1).

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Figure 1. Framework of business angel benefits. Source: Macht and Robinson (2009, p. 189).

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Since business angels and crowdfunding enable businesses to raise similar amounts, at least one of the benefits — 'Helping to Overcome Funding Difficulties' — appears intuitively logical to have relevance also for crowdfunding. Therefore, we tentatively use this business angel framework as a guide to explore the relevance and applicability of these four benefits in the context of crowdfunding.

Helping to overcome funding difficulties

Since business angels were said to be able to overcome funding difficulties (Macht and Robinson, 2009), the fact that crowdfunding can provide similar amounts suggests that this benefit is applicable also to crowdfunding: crowdfunding is likely to overcome funding gaps between the entrepreneurs' own investments and formal, external financiers. Moreover, any individual with access to the Internet and even just £10 to spare could potentially be a crowdfunder (Belleflamme et al., 2012; Hurley, 2012). Thus, the pool of potential investors in the UK is huge.

Since crowdfunding is also not constrained by investors' desire to invest only in close geographic proximity to their homes, the pool of potential crowdfunders is expanded further, to also include individuals from more distant locations or even other countries (Agrawal et al., 2011).

Moreover online crowdfunding, being an open invite via the Internet, can be considered an effective way of reaching very large numbers of potential crowdfunders (Schwienbacher and Larralde, 2012) and thus removes the time-consuming process of searching for investors. A related benefit refers to crowdfunders' all-encompassing funding criteria — which comprise businesses of any industry, growth potential, profit orientation, size, and age — and even include businesses without a track record and collateral. As such, crowdfunding also seems to be suitable for businesses that do not appeal to other investors like business angels or banks. Crowdfunding may thus be able to overcome funding difficulties for businesses which are not (yet) attractive to other investors (Collins and Pierrakis, 2012).

Given that there are an estimated 500 Internet crowdfunding platforms in the world already (Avery, 2012), fund-seeking businesses have a rather large choice of intermediaries. We propose that this can also be seen as a benefit since it not only further increases the pool of potential investors but also enables them to shop around for the most suitable platform.

Provision of contacts

If a large crowd of people is interested in a business, they are able to create ‘hype’ around it and generate public exposure for the business and its products/services (Belleflamme et al., 2012; Lambert and Schwienbacher, 2010). While this does not mean that crowdfunders introduce the investee directly to members of their own contact networks, by their investment decision they quasi-recommend the business. This may increase its public exposure, or raise awareness of its existence with a wider audience. Increased publicity and public exposure is a benefit for businesses, particularly if they are still young and suffer from a limited marketing budget.

Facilitation of further funding

The added publicity and awareness within the general public may, possibly, result in exposure to more crowdfunders or even other financiers (for example, business angels or venture capitalists). This seems particularly likely given the fact that many crowdfunders take into account other crowdfunders' opinions and actions when making investment decisions (Van Wingerden and Ryan, 2011). We can tentatively propose that there may be a bandwagon effect: if one person invests, others follow. Should this proposition prove to be true, the crowdfunders' investments are able to benefit investee companies by facilitating access to further capital.

A further benefit of crowdfunding may refer to the notion of ‘investment readiness.’ We propose that businesses which are not quite of interest to other investors yet may be able to use the capital obtained through crowdfunding to not only become investment ready (for instance, by paying for management training or further developing the product/service) but also fund the ongoing capital requirements of the business until investment readiness is achieved. Although this benefit has not previously been discussed in the extant literature, we propose its potential existence because Schwienbacher and Larralde (2012) showed that crowdfunding can be used concurrently with or followed by business angels.

Involvement

The use of a large crowd of investors also enables entrepreneurs to benefit from the ‘wisdom of crowds’ (Collins and Pierrakis, 2012, p. 24), which refers to the collective skills and knowledge of the investors. Some of these skills and knowledge may be relevant and useful to the investee business and can thus benefit it if investors became involved. However, Belleflamme et al. (2010) argued that most crowdfunding does not refer to active involvement of crowdfunders.

Lambert and Schwienbacher (2010) showed that crowdfunding can easily be combined with other forms of crowdsourcing. Thus, entrepreneurs can also obtain non-financial feedback from crowds of people (some of whom may be/become customers) to develop or even test new product/service ideas prior to launch. This can be done explicitly by asking the crowd for specific feedback or implicitly by interpreting the crowd's actions: for instance, investment from many individuals suggests that products/services will be accepted in the market (Van Wingerden and Ryan, 2011). Schwienbacher and Larralde (2012) further argued that such feedback can speed up the new product/service development time. Such feedback from a large crowd has a clear potential to benefit businesses.

As the above exploration shows, the four benefits which Macht and Robinson (2009) established in the context of business angel investors seem to be relevant also in the context of crowdfunding. However, it is clear that the reasons why these four factors are in fact beneficial to investee companies differ from business angels. For instance, business angels are able to overcome funding difficulties for high-growth businesses; crowdfunding, in contrast, is able to overcome funding difficulties for any type of business. Moreover, our exploration of the crowdfunding literature showed a further benefit, which is not included in Macht and Robinson's (2009) framework. After presenting this additional fifth benefit, we amend the business angel framework to reflect and explain the benefits of crowdfunding as identified in the current literature (see Figure 2 for the emerging crowdfunding benefits framework).

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Figure 2. Framework of crowdfunding benefits.

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Additional benefit: Limited/no loss of control and ownership

This additional benefit, which emerged from our exploration of the current literature about crowdfunding, refers to crowdfunders' attitudes toward investment contracts, equity, and return on investment. Owing to crowdfunders not being professional or sophisticated investors, they tend to require less information upfront and spend less time (if any at all) negotiating detailed contracts. This may be of benefit for entrepreneurs as it means limited time and effort required for contracting (Schwienbacher and Larralde, 2012).

Many crowdfunders provide capital in the form of donations or are content with obtaining non-financial rewards in return for an investment — entrepreneurs with a fear of giving up ownership and control will especially benefit from this (Mason and Harrison, 1996). Even those crowdfunders investing in equity will typically only provide small amounts of money, which means that each crowdfunder will only be a very small shareholder, leaving the entrepreneur with the majority of shares. Also, due to their small shareholding positions, individual crowdfunders will not have the power or voting rights to interfere substantially with the entrepreneurs' decisions (Schwienbacher and Larralde, 2012). This is again of advantage for entrepreneurs concerned about loss of ownership and control.

As the above summary of the benefits has shown, it appears that Macht and Robinson's (2009) framework of business angel benefits can also be used as a basis for exploring the benefits of crowdfunding for small, young businesses. However, an additional, fifth benefit emerged from our review of the crowdfunding literature, which is not applicable to business angels. We can add this fifth benefit to Macht and Robinson's (2009) display, thus adding to the framework. Figure 2 presents our amended version of the benefits framework, including the fifth benefit (boxes and arrows displayed as dotted lines), while at the same time displaying the reasons why each of these factors is considered a benefit of crowdfunding.

Downsides of crowdfunding for capital-seeking businesses

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Although the objective of this article is to explore the benefits of crowdfunding, any exploration of benefits should be complemented with some reference to the downsides in order to present a balanced picture. This section will therefore briefly summarize these downsides of crowdfunding for small businesses, again based on the current literature.

Before being able to attract crowdfunders, an entrepreneur has to disclose some information about the business and its products/services on the crowdfunding Internet platform. This may raise issues of intellectual property protection and entrepreneurs may be worried that competitors could access the information published on the website (Schwienbacher and Larralde, 2012).

A further downside of most crowdfunding platforms refers to their ‘all or nothing’ approach: the fact that businesses must raise the entire target amount or the deal will not come to fruition. Therefore, businesses may not be able to raise any capital at all if their initial fundraising target is not met. This seems to be a major issue, given that Van Wingerden and Ryan (2011) suggested less than half of ventures seeking crowdfunding actually manage to raise their target amount.

Moreover, even if negotiations, due diligence, and contracts are not sophisticated, the investment of very small amounts by a large number of crowdfunders can result in overly high transaction costs for the venture. The same is true for ventures intending to raise very low target amounts — the costs of publicizing the opportunity on a crowdfunding platform are the same, independent of the amount sought (Lambert and Schwienbacher, 2010).

Related to the potentially large number of investors is the fact that managing many shareholders tends to be time-consuming and challenging (Collins and Pierrakis, 2012). They have an interest in the venture and therefore expect and deserve attention or they may feel unvalued and become disengaged or disinterested. This is further complicated by the fact that crowdfunders are individuals and therefore each crowdfunder is different — they may all have different expectations and requirements (Schwienbacher and Larralde, 2012). These complexities are aggravated further by the fact that the pool of potential investors is not limited geographically — managing investors from various countries, cultures, and languages can be challenging for entrepreneurs (Agrawal et al., 2011).

The large number of online crowdfunding platforms (Avery, 2012) can also be seen as a downside because it may be overly complicated and time-consuming for entrepreneurs to choose a suitable platform.

Despite the possible added-value effects of crowdfunders, there are downsides to that as well: many crowdfunders may not have sufficient or relevant experience and skills to support entrepreneurs in relation to running their business, while at the same time not having the understanding required to support entrepreneurs emotionally. More professional investors (for example, business angels), however, may provide highly useful added value (Mason and Harrison, 2008b) or at least provide emotional, ‘soft’ involvement if they do not have relevant experience (Macht, 2011). Alternatively, it is plausible that many crowdfunders' lack of interest in financial return and reward can have negative implications for their willingness to add value as they may not be sufficiently motivated to help make a business profitable and successful (Schwienbacher and Larralde, 2012).

Finally, there is a key downside to offering products or services in return for investment: by giving away free products/services to investors, businesses effectively reduce their sales opportunities, as these investors could be potential customers who would otherwise have purchased the products/services.

Summary and conclusion

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Crowdfunding allows small businesses to raise small to modest amounts of money — via crowdfunding Internet platforms — from a large ‘crowd’ of individual members of the public. Each investor, or ‘crowdfunder,’ invests usually very small amounts.

Crowdfunding is a sub-activity of crowdsourcing, which has been in existence as an online vehicle for companies and artists since 2006. Because of the newness of the field, the academic literature is very scarce. Our aim was to use this literature to explore the current base of knowledge in the field of crowdfunding and specifically to establish in an exploratory way the benefits that this new funding source can have for capital-seeking business ventures. As such, this article contributes to two main audiences:

  • 1
    Practitioners, especially fund-seeking entrepreneurs. The review of the crowdfunding literature compiled in this article provides entrepreneurs with an explanation of crowdfunding which should enable them to become more aware of and educated in this new funding source. However, and more importantly, this article explores the benefits and drawbacks of crowdfunding, which entrepreneurs can use to inform their decision regarding whether to seek crowdfunding or not. As is clear from our development of the benefits framework, crowdfunding can present many advantages to small fund-seeking business ventures. Not all of these refer to the capital that can be raised through crowdfunding — there are also substantial non-financial benefits and drawbacks, which entrepreneurs should consider carefully to establish whether crowdfunding is a suitable financing option for them.
  • 2
    Researchers/academics. This article not only shows the scarcity of the literature in the newly emerging field of crowdfunding, but more importantly it brings together the current state of knowledge in one place. By drawing upon a framework of business angel benefits, we explored the benefits of crowdfunding in a structured way while at the same time being able to establish, albeit tentatively, the usefulness and applicability of the framework to the field of crowdfunding. Since this can be considered one of the first attempts at theory building in the field, it can be used as a basis for further exploration and theorizing.

Using the benefits framework and the review of the extant literature, we have shown that crowdfunding can help overcome funding difficulties for young, small businesses, especially if they are not (yet) of interest to other types of financiers. Crowdfunding may also facilitate the receipt of further finance as not only can the funding make businesses more investment ready but the online community of crowdfunders can create hype around the business and thus attract the attention of further crowdfunders and other investors. This hype also increases publicity and as such enables businesses to obtain access to more contacts, which can be useful for their future development. Crowdfunders can provide involvement in the businesses in which they invest; for instance, by offering feedback or other forms of crowdsourcing or by providing combined knowledge (‘wisdom of the crowd’), they can support the business post-investment. A further benefit, which was not part of the original benefits framework, emerged from our review of the literature: limited/no loss of control and ownership. This is of particular benefit to entrepreneurs who are concerned about loss of control to investors: crowdfunders tend to be small shareholders or do not require shareholding at all (for instance, by donating rather than investing money); they often prefer non-financial rewards (for example, free use of products/services) over monetary rewards; and they are unlikely to be sophisticated investors, carrying out no or only simple due diligence.

Given the exploratory nature of this study and the overall limited amount of extant research in the field of crowdfunding, there are still vast and diverse opportunities for researchers to explore and the potential to build upon our benefits framework is extensive. Entrepreneurs and researchers should not consider this framework as all-encompassing, but instead should use it as a starting point to explore crowdfunding from both practitioner and academic sides. Ultimately, this framework can be further developed and improved as the amount of knowledge of crowdfunding grows in the future.

  • 2

    Venture capitalists tend not to be interested in small, young businesses. On average, they invest £1m to £2m, whereby their minimum investment tends to be around £100,000 (Pierrakis, 2010).

  • 3

    Banks tend not to be interested in small, young businesses because they are not risk takers; small, young businesses, however, pose much risk to lenders because of their lack of track record, credit and trading history, and collateral (Mittel and Kraus, 2011).

  • 4

    Business angels are high-net-worth, private individuals who invest modest to large amounts (that is, around £25,000 to £200,000) of their own money into small, young, unquoted business ventures (Avdeitchikova et al., 2008; Mason and Harrison, 2011); they do not have any friendship or family relationship with the entrepreneurs they fund (Mason and Harrison, 1996).

  • 5

    Crowdcube is the UK's first equity-based crowdfunding platform and its successes are widely quoted in current research, case studies, and media articles (for example, Collins and Pierrakis, 2012; Williams, 2012).

References

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Biographical Information

  1. Top of page
  2. Abstract
  3. Introduction
  4. Crowdfunding: Origins, definition, and reasons for emergence
  5. Online crowdfunding: How does it work?
  6. Crowdfunding: A review of the literature
  7. Benefits of crowdfunding for capital-seeking businesses
  8. Downsides of crowdfunding for capital-seeking businesses
  9. Summary and conclusion
  10. References
  11. Biographical Information
  12. Biographical Information

Jamie Weatherston is Programme Director for International Development at Newcastle Business School. Following a career in education and the small business sector in various countries, Jamie's research interests now cover various facets of entrepreneurship, with a particular focus on the effects of environment and context on entrepreneurial activity and the study of finance, growth, and exporting of entrepreneurial businesses.