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Crowdfunding as a financial instrument for startups

by Steven Wolf (Author) Eugen Kraemer (Author)

Term Paper 2015 28 Pages

Business economics - Investment and Finance

Excerpt

Table of Content

List of Figures

1 Introduction
1.1 Problem
1.2 Aim
1.3 Procedural method

2 Crowdfunding
2.1 Definitions: crowd, funding, crowdfunding, crowdinvesting
2.2 Forms of crowdfunding
2.3 Crowdfunding and Crowdinvesting
2.4 Functionality
2.5 Historical Development

3 Actors of crowdfunding
3.1 Capital-seeking companies (startups)
3.1.1 Reasons and aims
3.1.2 Selection of the form and conditions
3.1.3 Selection criteria of crowdfunding from the view of capital seeking companies (startups)
3.2 Investors
3.2.1 Who are the investors?
3.2.2 Reasons and aims – intrinsic
3.2.3 Participation in the profit and accretion – monetary
3.3 Financial intermediary (platforms)
3.3.1 Aims
3.3.2 Remuneration model

4 Advantages and risks
4.1 Overview
4.2 Startups – advantages
4.3 Startups – disadvantages and risks
4.4 Investors – advantages
4.5 Investors – disadvantages and risks

5 Current examples of successful Crowdfunding projects (practice examples)
5.1 Reward based
5.2 Equity based
5.3 Lending based
5.4 Donation based

6 Conclusion

References

Internet References

List of Figures

1. Source: Forms of crowdfunding

2. Source: Worldwide funding volumes; geographical distribution

3. Source: Conditions of six representative crowdfunding platforms

4. Source: Advantages and Disadvantages for startups and investors

5. Source: Coolest Cooler

6. Source: Pebble e-paper watch for IOS and Android

7. Source: Exploding Kittens on Kickstarter

8. Source: Protonet 2 on Seedmatch

9. Source: 86,402 Seconds in Haiti – Donation project on Crowdrise

1 Introduction

1.1 Problem

In the past years the number of startups increased continuously. Often it is the case that a startup doesn’t have the financial power to realize a business and if an investor or a financial institute refuses to support the startup many good ideas can fail already at the beginning.

Therefore it is necessary for startups to find new ways for financing the business ideas. Crowdfunding is one method for financing and investing which nowadays reaches a high popularity and growth among innovative people, groups and companies.

1.2 Aim

To get a better understanding of the whole context this term paper investigates the different perspectives and actors of crowdfunding to give an answer to the actual aim. The aim is to analyze whether crowdfunding is an appropriate way of gaining funds for startups or not.

1.3 Procedural method

In the first part the theoretical information is provided. This includes definitions and differentiations of used basic terms like crowdfunding and crowdinvesting as well as the different forms of crowdfunding. Also in the same part the functionality and the historical development of crowdfunding will be shown.

In chapter 3 the actors of crowdfunding – the startups, the investors and the platforms – will be described. This part will focus on the different reasons, aims and other important aspects for each of the actors.

An overview of advantages and risks for startups and investors will be given in the fourth chapter.

To have a better impression about the different crowdfunding forms, levels and scales, the fifth chapter will show some examples of successful crowdfunding campaigns.

Based on all researched and derived information, the last chapter will give a summary and conclusion to the aim of this term paper.

2 Crowdfunding

2.1 Definitions: crowd, funding, crowdfunding, crowdinvesting

For the term crowdfunding the literature shows different approaches of defining it. First of all the word can be derived from the separate words crowd and funding. According to Kozinets a crowd is defined as a big organized group who gets together online to plan, organize and carry out projects.[1] The term funding is a synonym of financing.

Both statements can be found bundled in Ordaninis definition: „Crowdfunding is a collective effort by people who network and pool their money together, usually via the Internet, in order to invest in and support efforts initiated by other people or organizations.“[2]

2.2 Forms of crowdfunding

Depending on the type of rewards or service returns for the investors there are four different types of crowdfunding. As showed in source 1 these four forms can be sorted according to the complexity of the investment decision (y-axis) and the level of security of the investment decision (x-axis).

Abbildung in dieser Leseprobe nicht enthalten

1. Source: Forms of crowdfunding:[3]

The donation based crowdfunding shows a low risk of investment as the investors don’t expect any reward or return on their investment. The investors are mainly driven by social thought and goodwill.

A still low investment risk can be seen in the form called reward-based crowdfunding. The investors receive a non-monetary reward for their investments linked to the funded projects. The rewards can be e.g. copies of CD’s, books, games or participations in events with the creators of the projects. The investors are mainly affectively connected to the idea and benefit by receiving the goods or services produced by the project before they are distributed on the open market to everyone.

More complex and insecure for the investors is the form of lending-based crowdfunding. The invested capital has to be paid back with an additional interest no matter whether the project was successful or not. This crowdfunding type shows characteristics of debt financing.

Similar to the lending-based is the equity-based crowdfunding. In this case the investors also expect a return on their investment. The major difference is that the investors have the opportunity to receive shares or at least to benefit from the profits and value increases of the company. In the literature this form of crowdfunding is separated to the term crowdinvesting.[4]

2.3 Crowdfunding and Crowdinvesting

In some cases also the wording crowdinvesting is used. The convergence between the term crowdfunding and crowdinvesting can be found in different sources.

Beck separates these two terms by using the word crowdfunding for donation-based and reward-based projects. Crowdinvesting is used for equity-based projects. Beck is also aware of different understandings of the terminology.[5]

According to Schramm and Carstens the original term crowdfunding comes from the USA and could be globally solidified through the success of the strongest platform Kickstarter. The term crowdinvesting achieves more and more popularity in the German market but is usually directly linked to the equity-based crowdfunding. Crowdinvesting focuses on the point of view of the investors and is only used in connection to the equity-based crowdfunding which means that crowdinvesting is one special form of crowdfunding.[6] This is also similarly seen by lexica.[7]

2.4 Functionality

According to Beck there are four basic steps how a crowdfunding campaign is ideally carried out:[8]

1. Application: The potential founder creates convincing documents about the project (e.g. business plan).
2. Selection: The platform checks the documents. In case of an agreement the conditions are fixed and a contract is set up.
3. Presentation, realization: The project is released and presented on the platform. The potential investors have access to the project and the opportunity to invest – all within a defined time frame.
4. Payment, start: The startup receives the fund and starts the project. Furthermore the investors are informed about the progress of the project and depending on the agreement the investors are paid out or rewarded.

These steps have been further specified by Schramm and Carstens. Before step 1 (application), the founders have to choose the appropriate platform for their project carefully. As described in 2.2 there are different forms of crowdfunding and according to those also the platforms are adapted. For instance, the platforms have different target groups, investment priorities and conditions which have to be taken into consideration.[9]

Furthermore the third step (presentation, realization) is divided into two steps. Firstly, there is a short term preview phase where potential investors can discover the project and remove uncertainties. Secondly, after the start it is the aim to achieve at least the minimum amount of the fund up to the funding limit. Therefore the project has to remain attractive for potential investors.[10]

2.5 Historical Development

The original idea for crowdfunding as it is known today came from the USA. In 2000 the first crowdfunding platform ArtistShare was founded, but in that time the term crowdfunding was not in use yet. Only in 2003 ArtistShare started the first funding project. Shortly thereafter more crowdfunding platforms began to emerge, not only in the USA but also in Europe.

The crowdfunding industry has quickly emerged as a popular option for entrepreneurs to validate their ideas.[11] The worldwide crowdfunding revenue increased from 1.5 billion $ in 2011[12] to 2.7 billion $ in 2012. The revenue in 2013 reached 5.1 billion $.[13] The following charts show the worldwide distribution of funding volumes.

Abbildung in dieser Leseprobe nicht enthalten

2. Source: Worldwide funding volumes (left); geographical distribution (right)[14]

According to Beck and as it can be seen in source 1, North America is the most important market, followed by Europe. The other markets play a minor part.

The most known crowdfunding platforms are Kickstarter (founded 2009 in USA) and Indiegogo (founded 2008 in USA).[15]

Kickstarter could successfully finance 54,400 projects with a total volume of 930 millions $ in the years 2009 – 2013.[16] Indiegogo has reached a sixth of the volume of Kickstarter.[17] Until 15th February 2015 Kickstarter increased the successfully funded projects to a total number of 78,513 projects with an amount of 1.526 billion $.The support was achieved by the investment of 7.9 million investors or as it is called the “backers”.[18]

The first crowdfunding company in Europe was the Dutch platform SellaBand in 2006 and in Germany the first platform Startnext was launched in September 2010.[19]

In contrast to the popularity of crowdfunding platforms in the US, the German platform Startnext successfully funded 960 projects with a volume of 16 million Euro (End of 2014). Compared to the year 2013 the amount nearly doubled. It is considered as the biggest crowdfunding platform in Germany.[20]

In the direct comparison of the top players the German crowdfunding market seems to be not noticeable to the US market but shows high potential and growth rates.[21]

3 Actors of crowdfunding

3.1 Capital-seeking companies (startups)

3.1.1 Reasons and aims

After giving the definition of crowdfunding and showing the historical development this chapter focuses on reasons and aims as well as on the conditions for crowdfunding – starting from startup`s point of view.

A Startup is a young, innovative not yet established company searching for a sustainable and scalable business model.[22]

There are many reasons why a start up chooses crowdfunding as financial method. One possible reason is that there might be a lack of other options of funding for the startup. Even though there are other possibilities to finance the start up those could have a negative impact on the founders.

One example is the funding by a business angel. Often the business angel demands a very high share of the company. A second example is the financing through a private person who requires a major say. In both examples it would be possible for the start up to be financed but with a negative impact in the view of the founders. The crowdfunding method doesn’t require an involvement of the investors. This means the start up can decide about the own plans themselves.

This leads to the following aims of the start up:

- Low involvement as well as low rights of control and information for investors
- Low payoffs to investors
- Low administration effort

If the capital acquirer offers too low incentives (e.g. too low payoffs), this can lead to not achieving the financial aim. Therefore it is important to create a balance between the interests of the capital acquirers and investors.

In the equity based crowdfunding it is usual that the investor gets a share of the annual profit plus a share of accretion of the startup. Certainly the share of accretion will be only paid by an exit at the end of the financial minimum life. It is a kind of commutation.[23]

The equity based platform Seedmatch compares the Startup´s EBIT (earnings before interest and taxes) and turnover of the last year. The investor receives a commutation on the basis of the higher of these two amounts.[24] In the case of another approach the investor could be forced to finance the startup for a extended period to achieve the planed return.

3.1.2 Selection of the form and conditions

The startup has to analyze if crowdfunding is the best method for financing. As written in the definition of a startup, it is an innovative company. Innovation is a must-be criterion when choosing crowdfunding as financial method. Innovation means developing something new and therefore existing business models have almost no chance to get financed by the crowd e.g. fitness center or a kiosk.[25]

Venture capital is another funding method. Venture capital is a temporary equity investment in young, innovative, privately hold enterprises which have an average above growth potential.[26] Venture capital associations require a high share of the startup`s equity capital to finance them. The risk is one reason why a high share needed. Another one is that the startups don’t have an alternative possibility of financing. Furthermore the investors often require rights to a say which mostly founders don’t want.[27] The advantage of venture capital is the knowledge and contacts of the investors which can lead to more success.

If the startup is not innovative enough but doesn’t want to involve investors in the business, the bank credit could be an alternative method. The advantage is that the bank doesn’t have rights to a say, but the disadvantage is that the startup has to pay back the credit also in the case the enterprise has crashed.

Which financial method is the best for a company depends on many factors e.g. innovation power, amount of funding, type of products etc.

3.1.3 Selection criteria of crowdfunding from the view of capital seeking companies (startups)

When a company thinks about crowdfunding there are 10 criteria to take into account:

1. Are there topics or regional restrictions on the crowdfunding platform e.g. only startups from Berlin or only green products?
2. How much capital does the startup need and is it possible to reach this amount via the platform? In case of a small platform and a required amount of 1,000,000 € by the startup the achievement of this amount could be difficult. Otherwise only the bigger platforms are qualified for the project. Another reason could be a funding restriction. The platform investment has a funding restriction up to 100,000 €.
3. Is there enough commercial support for the project like access to social networks e.g. Facebook as well as to the print media?
4. What experience does the platform have? Platforms with longer experience usually offer better marketing solutions for the project. Furthermore a more established platform creates more stability and reliability.
5. How high is the fee of the platform? For a startup it is also important to take the fees into account which have to be paid to the platform plus the costs of producing videos or pictures about the product.[28] The total fees for a project on Kickstarter amount to 8 – 10 %.[29]
6. How are the regulations for an exit and for the duration? An exit of a startup after a short time in the case of an equity base crowdfunding could lead to issues e.g. to liquidity problems if the startup hasn’t generated enough profit. Therefore the startup has to decide if a long or short term funding is necessary.
7. How high are the conditions and shares for the investors? The startup aims an own high rating due to the fact that in many cases the rating influences the value of the shares. If the startup is rated too high the investors don’t expect a high return and could lose interest.
8. Which kind of investors reaches the startup on the different platforms? For a startup it could be success-related on which platform the project is presented. The platform SellaBand focuses on music projects and e.g. an innovative robot would be the wrong platform for it.
9. How are the reporting requirements regulated? The startup should know what is necessary to communicate to the crowd and platform. This can be different from platform to platform.
10. Which rights and possibilities do the platforms and investors have to decide about the project or startup? A startup could change the original business objective.[30] In the case the investors would have a high right to say they could prevent it.

3.2 Investors

3.2.1 Who are the investors?

As this funding method is in a growing phase, a fundamental information or overview about the investors is not given yet.[31] It can be said, that the investors or the crowd consists of private investors without any or a low stock experience or professionals on stock markets.

No matter whether it is about crowdfunding or crowdinvesting, the essential word here is the crowd. The initiator of a project needs this crowd to fund the project. This crowd supports the idea for different reasons, as described in the following parts.

3.2.2 Reasons and aims – intrinsic

The investors usually have different reasons to invest into a project. Those reasons aren’t strictly based on financial return but also might have intrinsic motivations.[32] One of the first and largest crowdfunding platforms Indiegogo describes the following reasons for funding:

1. People
2. Passion
3. Participation
4. Perks

People are supporting other people like e.g. a friend, a team or another person who inspires the funder. The contribution to a campaign is based on being personally affected to the project runners – simply by liking them.

Another motivation can be that the investors are passionate about the project. They like the idea and want to support it. For instance, the investors want to support elementary education.

Others contribute to be part of something bigger than they are. This can be for instance a project to build up a community center.

Perks are advantages and rewards which the investor can get by contributing to the project. This can be things or experiences which are made by the project. The investor has the advantage of being ahead of the mass. A practical example can be a deck of cards of a new invented game.[33]

The four mentioned intrinsic motivation aspects can be found in the form of donation based or reward based crowdfunding.

3.2.3 Participation in the profit and accretion – monetary

Besides the above mentioned intrinsic driven reasons to fund projects there are certain monetary reasons. The participation on the profit is one major reason for investors. Among many others, two general types can be chosen:

1. The participation on the annual result of the entity
2. The participation on the accretion of the entity

The level of return on investment depends on fundamental components, such as the success of the startup, the mechanism of profit-sharing, the proportion of share and the enforceability of the interest. The framework for these components is usually delivered by the crowdfunding platforms in the form of a contract between the founders and investors. A common method is participation on the ongoing profit as well as a share on the value of the entity in the case of an exit.

Beck sees the monetary or financial aspect as the core aims for investors and distinguishes the reasons with different priorities.

The highest priority for investors is to achieve as high return on their investment as possible, followed by the slightly lower priority by having low administrative expenses. A semi-high priority is characterized to receive extensive information about the project and to have certain control rights about it. Less important is the right to say for the investors.[34]

These monetary reasons are typical for the form of the equity based crowdfunding, which is also called the crowdinvesting.

[...]


[1] Cf. Kozinets, Hemetsberger, Schau (2008), p. 345.

[2] See Ordanini, Miceli, Pizzetti, Parasuraman (2011), p. 2.

[3] See Schramm, Carstens (2014), p. 8.

[4] Cf. Schramm, Carstens (2014), p. 7.

[5] Cf. Beck (2014), pp. 25-29.

[6] Cf. Schramm, Carstens (2014), p. 21.

[7] Cf. Unternehmerlexikon (2015).

[8] Cf. Beck (2014), p.19.

[9] Cf. Schramm, Carstens (2014), p. 20.

[10] Ibid.

[11] Cf. Beck (2014), p.34.

[12] Cf. Massoution (2012).

[13] Cf. Statista (2013).

[14] See Wilson, Testoni (2014), on the basis of Crowdfunding Industry Report 2013, p. 3.

[15] Cf. Beck (2014), p. 35.

[16] Cf. Kickstarter (2014).

[17] Cf. Beck (2014), p. 35.

[18] Cf. Kickstarter (2015), Stats.

[19] Cf. Beck (2014), p. 34.

[20] Cf. Startnext (2014).

[21] Cf. Beck (2014), p. 36.

[22] Cf. Schramm, Carstens (2014), p. 11.

[23] Cf. Beck (2014), pp. 69-71.

[24] Cf. Seedmatch (2015), Exitbeteiligung.

[25] Cf. Schramm, Carstens (2014), p. 12.

[26] Cf. Gabler Wirtschaftslexikon (2015).

[27] Cf. Beck (2014), p. 72.

[28] Cf. Beck (2014), pp. 85-86.

[29] Cf. Kickstarter (2015), Fees.

[30] Cf. Beck (2014), pp. 86-87.

[31] Cf. Schramm, Carstens (2014), pp. 53-54.

[32] Cf. Dresner (2014), pp. 120-121.

[33] Cf. Indiegogo (2015), Basics.

[34] Cf. Beck (2014), pp. 89-90.

Details

Pages
28
Year
2015
ISBN (eBook)
9783668040601
ISBN (Book)
9783668040618
File size
572 KB
Language
English
Catalog Number
v305910
Institution / College
The FOM University of Applied Sciences, Hamburg
Grade
1,3
Tags
Crowdfunding Crowdinvesting Finance and Accounting Startup Finanzierung Investment Investition Financial instrument Finanzierungsinstrument Crowdfunding forms

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Title: Crowdfunding as a financial instrument for startups