Delhi Business Review X Vol. 13, No.

2 (July - December 2012)

THE ROLE OF CROWDFUNDING IN ENTREPRENEURIAL

FINANCE

Devashis Mitra*

P
URPOSE
THIS study seeks to examine the relatively new trend in alternative financing; namely,
crowdfunding and its role in funding start ups and new enterprises. Crowdfunding is the
financing of a project by a group of individuals (collectively, “the crowd”) instead of professional
“accredited” entities or individuals such as banks, venture capitalists or business angels.

Design/Methodology/Approach: The study examines how crowdfunding works.The concept of

crowdfunding is also examined in the context of the related concept of crowdsourcing. The study
examines the global market for crowdfunding and the rationale of businesses to crowdfund or
crowdsource their new ventures, given the challenges of capital access for fledgling enterprises. The
market for crowdfunding is examined in the context of different crowdfunding models. In this context,
the study also includes illustrations of enterprises that have adopted specific models given their
strategic objectives.

Findings: The study finds that crowdfunding as a means of alternative financing is growing globally.
Donation and reward-based entities still remain the largest group. However, equity based platforms
are also raising funds in some European countries and Australia. Presently, equity crowdfunding is
not legal in Canada and is sought to being legalized in the U.S. under the JOBS Act.

Research Limitations/Implications: The study has a number of implications for future research,
for instance, whether crowdfunding does indeed provide benefits of clustering? Also, future studies
can examine different revenue sharing models in the context of equity crowdfunding models.

Practical Implications: Insights on data pertaining to different crowdfunding models, garnered

from crowdsourcing.org, can be useful to potential entrepreneurs and policy makers.

Originality/Value: Presently very few published academic studies of crowdfunding exist. Also, to
my knowledge, there are none that provide a discussion on crowdfunding in Canada.

Key Words: Crowdfunding, Alternative Financing, Entrepreneurship.

An Introduction to Crowdfunding
Fledgling businesses and start-ups often face significant challenges in accessing capital from traditional
sources such as bank loans, venture capital or angel funds. Paucity of capital access prompts
entrepreneurs to seek alternative financing venues. This phenomenon has spurred the global growth of

* Associate Dean and Professor of Finance and Entrepreneurship, Faculty of Business Administration, University of New
Brunswick, Frederiction, N.B., Canada.

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crowdfunding. Crowdfunding can be defined as the financing of a project or a venture by a group of

individuals (“the crowd”). Funds are typically raised on the internet through relatively small contributions
from a large number of people (see also Bradford, 2012).

Crowdfunding Vs. Crowdsourcing

In this context, it would be interesting to examine a related concept, that of “crowdsourcing”.

According to Schwinbacher and Larraide (2011), crowdsourcing enables a firm to outsource specific
tasks essential for the making or sale of its product to the general public (the crowd) with the aid of an
open call over the internet. Consumers “volunteer” to contribute to production processes and create
value. Crowdfunding: can be viewed as combining concepts of crowdsourcing (i.e. seeking financing
from the crowd) and microfinance (small amounts contributed; no collateral).

Why Crowdsource and or Crowdfund?

What are some benefits of crowdsourcing? A major benefit is thought to be the voluntary task-force of
consumers that often helps save costs. Also, to the extent that the crowd may provide more insights
faster than a small team of employees, this can in effect reduce the length of new product development.
Crowdsourcing can also be very beneficial from a marketing standpoint since involving a committed
crowd is likely to result in better customer acceptance, and also more awareness of the “newness” of a
product. The central idea is that “collective intelligence or wisdom” creates efficiency, more so for
diverse crowds (Schweinbacher and Larraide, 2011). However, there are differing views on the extent
to which a crowd provides such collective wisdom.

How does Crowdfunding Work

Griffin (2012) points out that, crowdfunding is like posting a classified advertisement on a website like
Craiglist.com with the difference that, through crowdfunding sites, entrepreneur can also advertise a
business concept and request for funding from “the crowd”. Entrepreneurs provide a pitch, usually a
business plan, detailing the business activities and objectives, and the entrepreneur’s plans for using
the funds that are sought to be raised. The platforms also inform funders what, if anything, he or she
will receive in return for the capital contribution. This is typically done through a terms and condition
sheet.

Crowdfunding therefore essentially involves a sequence of processes whereby the entrepreneur posts a
funding request on the crowdfunding platform or website, describing a proposed project. Depending on
the nature of the project the entrepreneur may or may not provide a business plan. The entrepreneur
also indicates what, if anything, individuals who contribute money to finance the business will receive
in return (Bradford, 2012, Schweinbacher and Larrade, 2011). “All crowdfunding transactions are
facilitated through internet-based crowdfunding platforms which also provide a convenient means for
all exchanges of funds” (Burtch et. al., 2012).”

Types of Crowdfunding
In this section, I examine various models of crowdfunding that have been adopted by different
platforms. For an excellent detailed discussion of the different types of crowdfunding models, see
Bradford (2012).

Donation Sites: Contributors donate funds mostly for charities and other non-profits and sometimes
for-profits as well (Griffin, 2012; Bradford, 2012). These represent a small proportion of overall
crowdfunding activity (about 22% in 2011, please also see crowdsourcing.org). Two examples of
donation sites are: (a) GlobalGiving.org which enables donors to directly contribute to development
projects worldwide (http://www.globalgiving.org/) and (b) EpicStep.com (http://epicstep.com/)
which is a donation platform for financing billboards. One of EpicStep’s well known successful
initiatives that received good publicity in the media is the WikiLeaks billboard campaign in Los
Angeles.
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Reward and Pre-Purchase Sites These sites typically do not involve direct revenue sharing
arrangements through, for instance, payment of interest or profit-sharing from the business.
However, depending on the amount of contribution, they could offer different categories of rewards.
Rewards could range from notes of thank you to small tokens of appreciation, such as key chains,
to having the contributor’s name on the credits of movies that are sought to be financed through
crowdfunding. An increasing number of movies are being financed in this manner, including a
sizeable proportion that were screened at the recent Sundance Film Festival (Bradford, 2012, Griffin
2012).

Sites offering the pre-purchase option enable contributors to receive the product that the
entrepreneur is making, often at a reduced price (Griffin 2012). For instance, if a music album is
being sought to be financed through crowdfunding, through the pre-purchase option, contributors
would have the right to buy the album at a reduced price upon completion. Leading Reward and
Pre-purchase sites include Kickstarter (http://www.kickstarter.com/) and IndieGoGo (http://
www.indiegogo.com/).

Business models of crowdfunding platforms are typically based on fees that are charged for each
project that is sought to be funded. Often, crowdfunding sites charge fees only if financing is
successful. If fundraising is unsuccessful, entrepreneurs pay no fee. An example of a site that
charges fees in this manner is Kickstarter (http://www.kickstarter.com/). Fees can range from 4
to 9 percent.

Lending Crowdfunding Sites

There are two categories of lending sites; those not offering interest and those that do offer interest
(see Bradford 2012). Perhaps the most prominent example of a crowdfunding portal site that does
not offer interest is Kiva (http://www.kiva.org/). Kiva provides funds to microfinance lenders, or
“field partners” in 66 different countries worldwide. Entrepreneurs post loan-requests on the Kiva
site. Lenders only receive their principal back; the field partners use any interest received to cover
their operating costs (Bradford 2012).

There are also a number of lending crowdfunding sites that offer interest. Two U.S. based examples
of such sites are Prosper and Lending Club. These are also known as peer-to-peer platforms. Lenders
purchase notes issued by the sites which use those funds to lend through WebBank or Paypal to
borrowers. In this respect, they function more as investors than lenders. Lenders get paid if borrowers
pay back. Transaction fees and interest on loans depend on theborrowers “credit risk”. Loans that
charge interest typically are viewed as ‘securities” and, therefore, for regulatory purposes fall within
the domain of securities regulation (see Bradford 2012). As we will be seeing in a later section, the
issuance of securities by crowdfunding sites is still in the process of being legalized in the U.S. In
Canada, at present crowdfunding sites cannot legally issue securities.

Equity Crowdfunding Sites

These exist mostly in Europe and to some extent in Australia. Equity crowdfunding sites offer
investors a share of the profits of the business they are funding. Such sites do not exist in Canada
because of regulatory issues pertaining to the sale of securities. Indeed, at present, these sites exist
mostly outside North America. A prominent German site that has been successful with the revenue-
sharing model is SellABand.com (https://www.sellaband.com/). This site raises funding through
donations as well as investments to fund independent musicians seeking to complete albums.

The State of Crowdfunding Globally

According to the website, crowdsourcing.org (http://www.crowdsourcing.org/), as of April 2012, 452
crowdfunding platforms (or CFPs) were operating globally. In aggregate, CFP’s had raised almost $ 1.5
billion in funds in 2011. By and large, while the United States remains the largest market for fundraising
the European market has been growing rapidly. Funds raised through crowdfunding initiatives grew at

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a 63% compounded annual growth rate (CAGR) over the last 3 years. (http://www.crowdsourcing.
org/).

As of 2012, most CFP’s belong to the reward-based category of CFPs, although equity-based platforms
represent the fastest-growing category in terms of net year-on-year growth (http://
www.crowdsourcing.org/).At present, there are no equity-based platforms in Canada or the United
States. Not surprisingly, therefore, reward-based and equity based platforms are higher in numbers in
Europe than in North America.

Crowdfunding platforms have been very active and, in 2011, ran over 1 million successful campaigns.
Although the majority of campaigns were still donation or rewards-based, equity-based campaigns
were picking up and were, on average, much larger in size in terms of funds raised. Lending-based
campaigns had the smallest share. For instance, on equity-based platforms, about21% of funds raised
were for projects of $250,000 or more in funding of which 80% exceeded $25,000 (for a detailed discussion
see the most recent report at (http://www.crowdsourcing.org/).

Given the relatively larger sums are raised through equity-based platforms, these could be viewed as a
viable option for raising capital to fund small business and start-up initiatives.The campaigns in the
donation and reward categories are generally smaller in size.

Crowdfunding Type and Nature of Projects

Are different funding models more suitable for certain types of activities or initiatives? In general,according
to crowdsourcing.org (http://www.crowdsourcing.org/), crowdfunding enterprises that provide for
financial return through equity-and lending-based platforms appear to be best suited for digital
applications or computer games, films, music, or literature. On the other hand, based on the statistics
provided by the website, donation-and reward-based crowdfunding models appear to be best suited for
cause-based campaigns that appeal to funders’ personal beliefs and interests, for instance, the
environment, community or faith-based initiatives, or those pertaining to the performing arts.

Challenges of Capital Access

Can crowdfunding play an useful role given the well-known challenges associated with capital access
for small and fledgling enterprises? Since businesses face a scarcity of capital access, they often, have
to resort to “bootstrapping”; that is, rely on personal funds or funds from friends and family members,
credit card debt, or second mortgages on their homes. The “capital funding gap” can have a societal
impact. For instance, scarcity of funding could result in promising projects going unfunded costing an
economy jobs and loss of potential innovations (Bradford, 2012). Also, often those looking for funding
opportunities do not have sufficient information about potential sources of capital. This results in a
problem of informational inefficiency that is fostered by the failure to match sources of capital with
opportunities. The creation of geographical clusters can often help mitigate such challenges (Bradford,
2012) challenge. Crowdfunding platforms, by enabling virtual clusters on the internet, can potentially
provide powerful benefits in this regard.

Benefits and Costs of the Crowdfunding Exemption

An often cited benefit of crowdfunding enterprises is that these facilitate capital formation, especially
for very small startups that would otherwise not have access to fund-raising opportunities through, for
instance, funding provided by angels or venture capitalists.

Another cited benefit of crowdfunding is that it also enables less affluent entrepreneurs access to capital
that they may not get even through “bootstrapping” (Griffin, 2012). A limitation of the crowdfunding
model relative to venture capital or angel funding is that the latter also, often, provide valuable mentorship
to investee enterprises.

Since a fundamental tenet of the crowdfunding model is to seek funding from the public, if such funding
is sought through the issuance of securities, then registering such securities through the provincial
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securities commissions in Canada or the Securities and Exchange Commission becomes a requirement.
However, proponents of crowdfunding exemption feel that this is not a viable option because the securities
registration process can be prohibitively expensive. One way of being exempt is to offer securities as
“private placements” to accredited investors. However, the nature of crowdfunding prevents security
issues to be classified as “private placements’ to accredited investors At present, therefore, there is a
great deal of discussion and debate on whether the potential benefits of crowdfunding in terms of
facilitating capital formation outweigh the costs that pertain largely to investor risks associated with
business failure or fraud. A counter-argument, however, is that a securities exemption would not open
investors to new risks because they are already contributing through “non-securities” crowdfunding.
Under this perspective, issuing securities could offer higher returns to offset those risks (see Griffin,
2012).

The JOBS Act (2012) in the United States

Following an intense lobbying effort by different interest groups, the Jump-start our Business Startups
(or JOBS) Act was passed in the United States in 2012. The enactment, in effect, legalizes, under Title
III, debt and equity-based crowdfunding. Until the passage of this Act, investors could not publicly solicit
funds from “unaccredited” investors. The legislation is still in its formative stages and the Securities
and Exchange Commission in the United States is in the process of designing many of the rules.

Some salient aspects of this Act are provided below (CATA2012):

(i) Companies can raise upto $1 million from investors and upto $2 million if they provide audited
financial statements
(ii) Financial statements disclosure is not needed for enterprises in which the number of shareholders
is below 1000.
(iii) Investors with annual income of less than $100,000 may invest upto the greater of $2,000 or 5% of
their annual income in such enterprises. For income above $100,000 per year, and investment is
permitted upto 10% of total salary but should not exceed $100,000.

The JOBS Act is not expected to be fully effective until 2013.

What about Canada?

Securities-based crowdfunding is still not legal in Canada. However, Canada does have crowdfunding
platforms that use donation, reward or pre-purchase models. An example is FundWeaver (http://
www.fundweaver.com/en) that is aimed at funding Native Canadian ventures and projects. Another
example is Podium Ventures that uses social networks to connect new high-tech ventures with accredited
investors. Some other crowdfunding platforms based in Canada include Sokap and IdeaVibes.

Conclusions
This study has attempted the relatively new trend in alternative financing; namely, crowdfunding and
its role in funding start ups in new enterprises. Crowdfunding is the financing of a project by a group
of individuals (collectively, “the crowd”) instead of professional “accredited” entities or individuals, such
as, banks, venture capitalists, or business angels.

The study examines how crowdfunding works. It has endeavourred to trace the link between
crowdfunding in the context of the related concept of crowdsourcing. The study examines the global
market for crowdfunding and the rationale of businesses to crowdfund or crowdsource their new ventures,
given the challenges of capital access for fledgling enterprises. The market for crowdfunding is examined
in the context of different crowdfunding models. In this context, the study has listed enterprises that
have adopted specific models given their strategic objectives. Presently, equity crowdfunding is not
legal in Canada and is sought to being legalized in the U.S. under the JOBS Act. These issues have
been discussed in the study.
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Devashis Mitra

The study has a number of implications for future research, for instance, whether crowdfunding does
indeed provide benefits of clustering? Also, future studies can examine different revenue sharing models
in the context of equity crowdfunding models. Insights on data pertaining to different crowdfunding
models, garnered from crowdsourcing.org, can be useful to potential entrepreneurs and policy makers,

References
Bradford, C.S. (2012), “Crowdfunding and the Federal Securities Laws”, Columbia Business Law, Available through Social
Sciences Research Network website at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1916184, accessed on November
17, 2012.
Burtch, G., Ghose, A., and Wattal, S. (2012), “An Empirical Examination of the Antecedents and Consequences of Investment
Patterns in Crowd-funded Markets”, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928168, accessed on November
17, 2012.
Griffin, Z.J. (2012), “Crowdfunding: Fleecing the American Masses”, (March) Available through Social Sciences Research
Network website at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2030001, accessed on November 28, 2012.
Schweinbacher, A. and Larraide, B. (2011), “Crowdfunding of Small Entrepreneurial Ventures”, forthcoming “Handbook of
Entrepreneurial Finance”, New Delhi, Oxford University Press, Available through Social Sciences Research Network
website at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1699183, accessed on November 28, 2012.
Bibliography
http://www.globalgiving.org/, accessed on February 18, 2012.
http://epicstep.com/, accessed on February 18, 2012.
http://www.kickstarter.com/, accessed on February 18, 2012.
http://www.indiegogo.com/, accessed on February 18, 2012.
http://www.kickstarter.com/, accessed on February 18, 2012.
http://www.kiva.org/, accessed on February 18, 2012.
https://www.sellaband.com/, accessed on February 18, 2012.
http://www.crowdsourcing.org/, accessed on February 18, 2012.
http://www.fundweaver.com/en, accessed on February 18, 2012.

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