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Crowdfunding. An Equity Financing Instrument

Seminar Paper 2014 21 Pages

Business economics - Investment and Finance

Excerpt

Table of Contents

Abstract

List of Abbreviations

List of Tables

List of Figures

1 Introduction

2 Problem Definition

3 Objectives

4 Methodology

5 Theoretical Background
5.1 A Theoretical Approach to the Crowdfunding Model
5.2 Types of Crowdfunding
5.3 Crowdfunding Process

6 Important Success Factors for a Crowdfunding Project

7 Requirements for Equity-Based Crowdfunding in the United States

8 Pros and Cons for Crowdfunding

9 Business Case: Cosmopol

10 Conclusion

Bibliography

Online Sources

Abstract

This work paper occupies with the issue of crowd funding as a financial instrument, by considering all types of crowd funding. The literature differs between a donation-based, a reward-based, a debt-based, and an equity-based type, whereat the law requires different claims. NPO`s usually make use of donation-based crowd funding systems, whereas start-up companies try to use the equity-based or debt-based type to make an investment more attractive to the crowd. The JOBS-act enables start-up companies to collect equity or debt through crowd funding by limiting the requirements for these kind of companies to facilitate them an easier access to the financial market. Up to now, many online intermediaries use a gap in law to provide equity-based crowd funding by building up so called angel groups through the registration of crowd funder. This club enables them investing in crowd funding without respecting the current legal requirements. Summing up, start-up companies are dependent on crowd funding as they will not get equity through the common way by asking banks or investment companies for loans. Crowd funding is an excellent opportunity and way to transform business ideas into real life business.

List of Abbreviations

illustration not visible in this excerpt

List of Tables

Table 1: Multiplier of Crowdfunding Projects

List of Figures

Figure 1: Crowdfunding Projects in Germany

Figure 2: Types of Crowdfunding

Figure 3: Crowdfunding Participants

Figure 4: Key Words of the JOBS-Act

Figure 5: Facts about Seedmatch

1 Introduction

Since several years crowd funding is accepted as a kind of financing instrument, due to borrowers have the opportunity to receive money as a type of equity, dept, reward, or donation, mostly via Internet. As many start-ups or charitable communities do not have the possibility to receive investments from banks or investment companies, they have to look for alternatives to finance their enterprises. And that is the reason why many people are looking for crowd funding; the opportunity to access money from the individual network.[1] In Germany, the crowd funding model is relative new, but almost 4.500 projects where already initiated through online platform providers, until the 3rd quarter 2013. Figure 1 shows the amount of German crowd funding projects, classified into the German online provider. Surprisingly only 30 % of the started projects were also successfully finished. Many projects get quitted because they do not collect enough money to start up their business, which means that they do not have enough followers.[2]

illustration not visible in this excerpt

Figure 1: Crowdfunding Projects in Germany

Source: Own description, Statista (2014)

However, that data shows that collecting money via crowd funding is not that easy and that the conviction of potential non professional money lenders is the main issue during the money collecting process.

2 Problem Definition

Amongst others, crowd funding can be used to raise or establish corporate equity to start a business or finance a project. In Germany, nearly 63 % of the issued crowd funding projects were quitted before maturity as they did not collect enough money. As that type of financing is very new aged, many entrepreneurs or start ups do not know how this financial instrument really works and which challenges have to be considered for a successful initiation, as equity-based crowd funding constitutes a legally challenge.

3 Objectives

The main objectives of this work paper are to analyze the structure and process of crowd funding projects and to show how to initiate an auspicious project to collect money as equity.

4 Methodology

The paper will start with a theoretical part to get an overview of the sophisticated issue. The next step will be the analysis of important success factors for a crowd funding project before generating the legal requirements for an equity-based crowd funding project. A Pro and Cons comparison will round up the theoretical part of the assignment. The business case Cosmopol will deliver a current example of an equity-based crowd funding project and will serve a practical illustration of the task. Last but not least a short conclusion will finish the work paper.

5 Theoretical Background

This chapter should serve an introduction to the crowd funding system and should generate an overview of the sophisticated issue by defining all necessary contents of the topic.

5.1 A Theoretical Approach to the Crowdfunding Model

Crowd funding is not a new aged phenomenon, as the history goes back to 1885 where the statue of liberty was built. When the financial resources for this mega project went out, Josef Pulitzer started a crowd funding project to collect the remaining amount of 102.000 US$ (the equivalent of 2.3 million US$) by donators. He started a campaign, by publishing the project in his newspaper and printing flyers to invite private people donating for the huge and unique project. In less than 6 month the needed money was collected by a crowd of nearly 120.000 donators with an average spending amount of 1 US$ and the project finally got realized.[3] This short story can be named as one of the first crowd funding activities in the newer ages. Additional, the pay in advance model of the early 17th and 18th century in the book financing industry can be enumerated as an ancestor in crowd funding. Book publisher provided additional advantages for early bookers who had ordered a book before it was actually written, to finance the enterprise and the authors promised an enumeration in the book cover or a lower price.[4]

However, a detailed definition of crowd funding could sound like this: “Crowd funding… describes the collective cooperation, attention and trust by people who network and poll their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations.”[5] Some scientists recline crowd funding to a similar business called crowd sourcing, which was firstly introduced by Jeff Howe and Mark Robinson in 2006. Their definition is that companies use a high number of motivated people with different knowledge and skills to cover resources and execute tasks, whereat the communication and knowledge transfer happens via the Internet.[6] The main commonality is that companies harness the crowd of people to reach a goal. But the difference is that crowd sourcing looks for human resources to get a job done and crowd funding on the other hand looks for the money of the crowd. Similar to crowd funding is the micro-patronage system where many private people facilitate the work of others by donating via the Internet. Micro-patronage in contrast to crowd funding is limited by donations and mostly the donators do not receive any advantages out of their investment.[7] Today, many online-platforms like Indiegogo, Kickstarter.com, RocketHub, StartNext, or VisionBakery act as an intermediary between companies and investors and try to realize the financing of prospective and innovative projects.[8] In Germany, the biggest crowd funding-platforms enabled a successful financing of over 1350 projects and the market has just begun to start. A legal framework of crowd funding investments ensures the JOBS act, signed by President Barack Obama in April 2012. “The act requires the SEC to write rules and issue studies on capital formation, disclosure and registration requirements.”[9]

5.2 Types of Crowdfunding

The literature distinguishes between 4 basic types of crowd funding, differing in the form of reward after a successful implementation of the projects. Figure 2 charts the 4 types of crowd funding.

illustration not visible in this excerpt

Figure 2: Types of Crowdfunding

Source: Own description, Thorpe (2013), pp. 4 – 5.

Donations usually do not offer a reward or a backflow of resources after a successful implementation of the project. It is common the NPO`s use that kind of crowd funding to finance their enterprises, due to they are dependent on donators and their goodwill to balance their costs. These campaigns do not offer any accomplishment in exchange for the collected money except the promise to invest the resources for a charitable intention. In 2010, a study by Lambert & Schwienbacher identified that over 22 % of the crowd funding activities were donation-based.[10] The second possibility of doing crowd funding is a rewards-based model similar to the donation model. In this case the money source receives rewards like free entrance in donated movies or a copy of a supported CD-album for giving money into the projects. The initiator tries to solicit the enterprise by promising advantages due to offering rewards for donators similar to the early bird rebates.[11] Crowd funding as a debt financing instrument was not legally cleared until the end of 2013, when the JOBS-act enabled everyone to have an equal opportunity to invest in start-up deals. With that crowd funding-type the companies have the opportunity to get financial access financed by a crowd of people and still keep the managing role in the company, as financial institutes like banks or venture capitalists always try to influence managerial decisions when they lend money. The money source gets a reward in kind of repayment and interest rates after a successful implementation of the project. Similar to the dept-based model, an equity-based model offers a membership to the crowd, by investing a small amount in start-ups or later-staged companies. This possibility enables non-professional private investors to become a part of the improvement and to earn a lot of money if one company catches the big fish like “Facebook” did.[12] Giving crowd funding a legal framework by the JOBS-act, non-professional investors got an additional incentive for investing in new start-ups and enables them to make contributes to the economic growth.

5.3 Crowdfunding Process

The crowd funding process is dominated by 4 main participants and is illustrated in figure 3. Firstly the creative director or entrepreneur has a business idea or a charitable project or any other kind of project which he wants to finance by a crowd. Secondary, the executor is that party who transforms the business idea into reality by economizing the idea. In this case the entrepreneur can take both sides, he can be the creative director who has the idea on the one hand, and be the executer who transforms the idea to a real profitable business on the other hand.

illustration not visible in this excerpt

Figure 3: Crowdfunding Participants

Source: Own description,

The crowd funder at least is the crowd which offers money to finance the project, thereby it is unimportant if he donates the money or eaves the investment as equity with a return. At least the intermediary provider provides the market place where entrepreneur and the crowd funder meet and make business.[13] This intermediary can occur as online platform like Kickstarter.com, a web 2.0 based website where the entrepreneur is able to advertise his business and reach for financial investments. However, the word web 2.0 does not describe a new technology; either it describes the improvement in usability of already available online technology, as online users are able to design their own websites and make use of online platforms by creating accounts.[14] On the entrepreneurial side there exist three main phases of implementing a project or a business idea. The project phase describes the first steps of a business idea where the creative director establishes a plan or a general idea of what he wants to do. If that idea gets fully developed than the entrepreneur should think about how he will organize the business. The foundation of an organization, an association or a charitable organization should be realized in the foundation phase of the project. Last but not least the operating stage comes into place; this phase is also called the “Early-Stage-Phase” where the organization and the team will be built up.[15]

6 Important Success Factors for a Crowdfunding Project

The literature has identified certain success factors influencing the progress of a crowd funding project. As the project idea affects many people it is important to create a special communication strategy via the Internet. A short video-clip on “Youtube” where the entrepreneur introduces the team and the business idea reaches more people than an announcement in a newspaper, but it is important to keep the story short as online surfer might get bored if the introduction takes too long. Additional, a reward in the already named forms can arouse interest. Also a high transparency about the usage of the money is very important as the funder wants to know where his money goes to. Another fact is that the initiator needs good backers who carry his idea into the web and advertise for the mission. A big community and the community of the own community grants for a better support; the more people know about the project the better. Online followings on common social networks like Facebook, Twitter, Youtube, or LinkedIn enables a big audience. A continuous communication with the crowd is necessary to keep the people interested in the project and prevents from loosing supporters and important advertising media.[16] Significant supporters which can act as multiplier are listed in table 1.

illustration not visible in this excerpt

Table 1: Multiplier of Crowdfunding Projects

Source: Hemer et al. (2011), p. 72.

Additional, entrepreneur can make use of traditional advertising media like broadcasting, print media, flyer, etc. But the main important thing is to tell the story to as many people as possible, as like the word “Crowd Funding” tells, everything depends on the crowd and its investment ability.[17]

7 Requirements for Equity-Based Crowdfunding in the United States

As already mentioned, equity-based crowd funding is a new type of crowd funding as it constitutes a financing instrument which is subject to the securities regulations. It is important to make a note of the fact that equity-based crowd funding happens through the emission of securities. With the JOBS-act the US congress enabled small start-ups to get access to the equity-based financing system without strong requirements, as start-ups do not have the possibility or the financial opportunities to get access to the usual equity-financing market as bigger firms might have. The JOBS-act identifies some key words which describes an equity-based crowd funding process. Figure 4 illustrates the key words.

Abbildung in dieser Leseprobe nicht enthalten Figure 4: Key Words of the JOBS-Act

Source: Own description, Thorpe (2013), pp. 92 – 93.

[...]


[1] Thorpe (2013), pp. 4 – 5.

[2] Statista (2014), n/a.

[3] Crowdfunduk (2012), n/a.

[4] Wittmann (2011), pp. 167 – 170.

[5] Roebuck (2011), p. 1.

[6] Bradham (2008), pp. 80 - 90.

[7] Roebuck (2011), p. 2.

[8] Crowdfunding (2014), n/a.

[9] SEC (2014), n/p.

[10] Schwienbacher & Larralde (2010), p. 13.

[11] Thorpe (2013), p. 4.

[12] Spirer (2014), pp. 225 – 227.

[13] Hemer et al. (2011), p. 33.

[14] Behrendt & Zeppenfeld (2008), pp. 11 – 16.

[15] Hemer et al. (2011), pp. 27 – 28.

[16] Spirer (2014), pp. 310 – 313.

[17] Thorpe (2013), pp. 74 – 76.

Details

Pages
21
Year
2014
ISBN (eBook)
9783656749561
ISBN (Book)
9783656749417
File size
700 KB
Language
English
Catalog Number
v280938
Institution / College
University of applied sciences, Nürnberg – IOM
Grade
1,3
Tags
crowdfunding equity financing instrument

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Title: Crowdfunding. An Equity Financing Instrument