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Under Entrepreneurial Microscope: Crowdfunding



Kirjoittanut: Mikhail Filippov - tiimistä Sointu.

Esseen tyyppi: Akateeminen essee / 3 esseepistettä.
Esseen arvioitu lukuaika on 6 minuuttia.

Introduction

The world will never be the same, as they say, and same is applicable to the business too. Over a long period of time, we’ve faced the growth in popularity of various small businesses and startups as an alternative to a white-collar position under the full control of employer, usually a big and influential companies. However, that’s only one of many benefits these small companies possess. Modern day entrepreneurship today holds some kind of innovation, no matter what the service or the product is, and a lot of people, who might be considered big freaks by the managers of respectable enterprises with their ideas, now received a place to challenge this opinion by proving their generosity with innovating something humanity never knew before, or at least, in a new format. Thank to this storm of creativity, entrepreneurship was quickly noticed by big investors and governments of the countries, which did not let the trend to die down. Matter of fact, they contributed to it substantially – Governments are highly interested in keeping talented entrepreneurs on their territories, and willingly sponsor any initiatives considered innovative and worthy, and sponsors are like bidders, putting their cash into newly-formed companies with a bright future, in hope to raise a potential substitute of a big enterprise or a new big competitor to the market.

Nonetheless, despite this bright scenario and seemingly flawless cooperation between the beginners and the money givers, not all the entrepreneurs end up with cases full of  money in their hands, and so their existence falls under a threat of an end of the business. It goes without saying that there can be other problems, which lead to a bad ending of a startup or small company, which may include something from bad management of the company to being completely alienated and ignored on the market due to absence of competitive benefits. Or in worst case scenario, this can become a scam. But the reality is a tricky thing, and the financial situation is the most common reason why around 20% of newly formed companies cease to exist in the very few years since their establishment, as statistics shows (US Bureau of Labor Statistics. 1997-2023).  Such position speeds up the ones in control to look for alternative ways of financing their business, and that’s where our today’s hero steps in – Crowdfunding.

The roots and types of Crowdfunding

 

As with many things in the world, origins of crowdfunding can be traced to the days when no such term even existed. First recorded evidence of this process being used goes back to 1700s. Most commonly, it was used for the book prints. Book purchasers could basically order the book of their wish to be printed by paying for it in advance. Another story is strongly tied to the legendary Austrian composer Mozart, who wanted to organize a set of concerts in Vienna and was offering manuscripts oof his music for sale to save money, which took him around two years (Schroter 2014). Another notorious example took place in 1885 when publisher of New York’s newspaper “World” Joseph Pulitzer asked the citizens of New York for a contribution to the pedestal of the statue. In return, offering to print the name of each contributor in his newspaper. Five months later, the newspaper reported that they managed to collect in this manner a bit over 100,000$ (Gierczak et al. 2015, 8).

 

Modern day crowdfunding, however, came to us with the internet era in the late 1990s and 2000s. One noticeable example is a British rock band Marillion, which collected money for the 1997 tour through the digital donations (Wilson, 2016). As the time went, in 2001, the world saw creation of the first ever online platform for music artists to collect money with their fans – ArtistShare. Later, now very recognizable names joined – KickStarter, IndieGoGo and others. Funnily enough, to around this time crowdfunding didn’t have its current name, receiving one only in 2006, after a blog post on the Internet(Crowdfunding.de, 2015). And only around 2015, according to Ennico (2016), the Crowdfunding was legally recognized, and allowed as a method of capital acquisition.

Such deep connection to the Internet had also an effect on how the crowdfunding is defined by some. To name some, Lambert and Schwienbacher (2010, 4) define it as an open call, essentially through the Internet for the provision of financial resources either in form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes.

As for types of crowdfunding, researchers are lost in numbers and names for different types they defined in their works. However, the most common types are reward-based, donation-based, equity-based and debt-based crowdfunding. Let’s look at them a bit closer.

 

Reward-based crowdfunding

 

Reward-based crowdfunding is considered to be the most popular type of the company’s funds raising in our days. The studies show that it takes around 62,5% of public sector (Lenart-Gansiniec & Chen 2021, 30). Usually, it works in a manner that funders don’t get their investment back, but instead get some kind of a physical reward instead. According to Mollick (2014, 3), such reward can be an inclusion into credits of a movie, having creative input into a product under development, or being given an opportunity to meet the creators of a project. Other benefits may include having early access to the product of the company funders donated on, or getting a lower price etc.  It is a common feature for many software products, like programs or computer games, book writing, or consumer products.

 

Donation-based crowdfunding

 

This type of money collecting heavily resembles the charity donations. In DBC, Funders are willingly giving money on the development of some kind of product or service without any promised direct return of such investment. Mollick (2014, 3) mentions art or humanitarian projects as examples of possible donations. Zhao et al.(2019, 4) highlight that DBC is highly dependent on the personal connections, since almost fifty percent of funders referred to their relatives or friends as a primal source of information about such money-raising campaigns.

 

Equity-based crowdfunding

 

EBC is said to work in a way that the company pleads for the investment, and instead of a product/service as an expected outcome, it offers a certain part of the ownership over it. It is generally recognized to serve a role of a very quick way for a startup or enterprise to raise the sufficient funds, but at the same time, it is a much riskier way. As Aggrawal et al. (2021) show, the difference between debt-based funding and equity-based funding is same as the difference between a bank and a venture capitalist. What makes it risky is that instead of a fixed interest, there is a fixed return. From the total comparison of types of crowdfunding, it is fourth by size, and has 9,37%(Lenart-Gansiniec & Chen 2021).

 

Debt-based crowdfunding

          

           This type of crowdfunding is also known as “Peer-to-peer lending” or “P2P Lending”, and it is very close to traditional loan, but instead of a usual bank, who provides the loan, it’s a group of investors providing a loan to the company, with a responsibility of a company to return it with percents in a timely matter (Aggrawal et al. 2021). This type offers substantial benefits for both the lender and borrower. For lenders, there has been a growth in the size of returns of their investments, and borrowers are connected to the lenders without interest margins. It is also reported that it is comparatively easier to get financing through the debt-based crowdfunding than through usual financial institutions, as the entrance level and requirements to the borrowers are less strict (Milne & Parboteeah, 2016, 4).

 

Conclusion

In conclusion, as we saw, with the time, crowdfunding has emerged as a powerful tool of alternative financing, offering a variety of options of how the borrowed money returns to the lender. Its path, however, was not easy, as in some countries, crowdfunding was a banned way of raising capital for a company. However, while crowdfunding offers numerous opportunities, it also presents some challenges such as competition for attention, or the potential for fraud and scams. Therefore, as crowdfunding continues to evolve, government policymakers, crowdfunding platforms, and loaners should take these dangers into account, and work together on the development of frameworks that foster innovation while safeguarding against risk.

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REFERENCES

United States Bureau of Labor Statistics. Survival of private sector establishments by opening year chart. 1997-2023.  https://www.bls.gov/bdm/us_age_naics_00_table7.txt

Schroter, W. (2014). “Crowdfunding Around the World.” Forbes. (http://www.forbes.com/sites/wilschroter/2014/07/09/crowdfunding-around-the-world/#254d673b7d09)

Gierczak, M. M.; Bretschneider, U.; Haas, P.; Blohm, I. & Leimeister, J. M. (2015): Crowdfunding – Outlining the New Era of Fundraising. In: Gajda, O. & Brüntje, D. (Eds.), Crowdfunding in Europe – State of  The Art in Theory And Practice; FGF Studies in Small Business and Entrepreneurship (pp. 7-23). Cham: Springer Science + Business Media. 7-23.

 

Wilson R., 2016. Pledge Pioneers: How Marillion invented crowdfunding. Louder. (https://www.loudersound.com/features/pledge-pioneers-how-marillion-invented-crowdfunding)

 

Crowdfunding.de, 2015. Crowdfunding-Wortschöpfer Michael Sullivan im Interview(https://www.crowdfunding.de/magazin/crowdfunding-wortschoepfer-michael-sullivan-im-interview/)

 

Ennico, Clifford R. 2016. 1.288 The crowdfunding handbook: Raise money for your small business or start-up with equity funding portals. 4-114.

 

Lenart-Gansiniec, R, Chen, J (eds) 2021, Crowdfunding in the Public Sector: Theory and Best Practices, Springer International Publishing AG, Cham. 1-12

 

Mollick, E. 2014. The dynamics of crowdfunding: An exploratory study. Journal of Business Venturing,29(1), 1–16

 

Aggarwal, R. et al. 2021. Improving Funding Operations of Equity‐based Crowdfunding Platforms. Production and operations management. [Online] 30 (11), 4121–4139.

 

Milne A., Parboteeah P. 2016. The Business Models and Economics of Peer-to-Peer Lending. ECRI Research Report. 1-35.

 

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