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Choose Wisely: Crowdfunding Through the Stages of the Startup Life Cycle 3

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Choose Wisely: Crowdfunding Through the Stages of the Startup Life Cycle 3 BUSHOR-1348; No. of Pages 10 Business Horizons (2016) xxx, xxx—xxx Available online at www.sciencedirect.com ScienceDirect www.elsevier.com/locate/bushor Choose wisely: Crowdfunding through the stages of the startup life cycle Jeannette Paschen Royal Institute of Technology (KTH), Stockholm, Sweden KEYWORDS Abstract Crowdfunding is attractive to startups as an alternative funding source Crowdfunding; and offers nonmonetary resources through organizational learning. It encompasses Startup funding; the outsourcing of an organizational function, through IT, to a strategically defined Crowdsourcing; network of actors (i.e., the crowd) in the form of an open call–—specifically, requesting Crowd capital; monetary contributions toward a commercial or social business goal. Nonetheless, Information many startups are hesitant to consider crowdfunding because little guidance exists on asymmetry; how the various types of crowdfunding add value in different life cycle stages and Crowd communication; which type is best suited for which stage. In response to this gap, this article Startup strategy introduces a typology of crowdfunding, the benefits it offers, and how specific benefits relate to the identified crowdfunding types. On this basis, we present a framework for choosing the right crowdfunding type for each stage in the startup life cycle, in addition to providing practical advice on crowdfunding best practices. The best practices outlined have shown demonstrable contributions toward achieving funding goals and are likely to prove valuable for startups. # 2016 Kelley School of Business, Indiana University. Published by Elsevier Inc. All rights reserved. 1. Startups and crowdfunding has emerged as a popular source of capital forma- tion in various fields–—from purely for-profit to social Startups require resources to succeed and one of the causes, technology, performing arts, real estate, most important resources is money. Traditionally, and music. the options for capital formation available to start- Crowdfunding draws inspiration from the ideas of ups were few and comprised primarily of FFF microfinance (Morduch, 1999) and crowdsourcing. It (friends, family, fools), angel investors, venture encompasses the outsourcing of an organizational capitalists, and seed funding (Startup Explore, function (capital formation) to a strategically- 2014). More recently, there has been a surge in defined network of actors (crowd) in the form of alternative models. Among these, crowdfunding an open call (Kietzmann, 2017) via dedicated web- sites (crowdfunding platforms). And small amounts of money from a large number of people add up. In E-mail address: [email protected] 2010, crowdfunding was a relatively small industry 0007-6813/$ — see front matter # 2016 Kelley School of Business, Indiana University. Published by Elsevier Inc. All rights reserved. http://dx.doi.org/10.1016/j.bushor.2016.11.003 BUSHOR-1348; No. of Pages 10 2 J. Paschen to the tune of $880 million worldwide. In 2015, This article closes the research gap by elucidating estimates put the global crowdfunding industry at which crowdfunding type is most appropriate for $34.4 billion (Massolution, 2015). startups in each life cycle stage. It first lays out a Crowdfunding is especially suited for startups typology of crowdfunding, the benefits crowdfund- trying to turn an idea into a viable business and ing offers in terms of financial and nonmonetary young companies aiming to maintain or grow their resource provision, and how these two aspects in- venture (Stemler, 2013). Both face challenges when tersect. This leads to a framework for decision trying to secure funding. Due to lack of credit and making, enabling the startup to choose the crowd- operating history, startup founders often have diffi- funding type best suited for its specific life cycle culties conveying the value of their proposed ven- stage. Once crowdfunding alternatives are consid- ture to investors. Startups, therefore, have ered and a choice has been made, startups face the difficulty accessing traditional funding options such next problem: how to attract a crowd and its con- as bank loans, venture capital, or angel investment. tributions. This article addresses this by outlining These challenges are exacerbated for social ven- best practices for crowdfunding alternatives at each tures, which are driven by the ambiguous and some- stage. times dichotomous goal to achieve a double bottom line: to balance social and for-profit goals (Lehner, 2013). In addition, it is often prohibitively expensive 2. Types of crowdfunding for young businesses to access wider traditional capital markets (Tunguz, 2013). These and other Crowdfunding as an online distributed funding model factors, such as the shortage of capital provoked suggests that requesting relatively small monetary by the global financial crisis and the growth in other contributions from a crowd helps startups acquire forms of crowdsourcing, have contributed to the rise critical financial resources. In this context, crowd- of the crowdfunding phenomenon in recent years funding is viewed as a homogenous concept: a gen- (Giudici, Guerini, & Lamastra, 2013). eral request for money via an open call. However, As crowdfunding has been growing in popularity, just as the funding needs for startups vary, crowd- so has its exposure in academic and practitioner- funding varies by the type of rewards offered to oriented literature. A number of articles have de- supporters. The following section outlines a typology veloped independently of one another but without a of crowdfunding (see Table 1) by considering if re- unifying framework to understand crowdfunding in wards are offered and whether they are tangible or the context of the startup life cycle. As a result, non-tangible (Belleflamme, Lambert, & Schwien- startups considering crowdfunding have little guid- bacher, 2014; Canada Media Fund, 2016; NCFA, ance on how to decide among the different types of 2012). crowdfunding available and the benefits each type can offer in different startup stages. This is an 2.1. Donation crowdfunding important consideration since funding needs vary significantly across stages, as do the types of returns In the donation crowdfunding model, the founder and assurances offered to a crowd in different receives money from a crowd without any tangible crowdfunding variants. return for that contribution (Canada Media Fund, Table 1. Typology of crowdfunding BUSHOR-1348; No. of Pages 10 Choose wisely: Crowdfunding through the stages of the startup life cycle 3 2016; NCFA, 2012). In the pure donation model, no 2.3. Equity crowdfunding rewards at all are offered to contributors. The funds received are essentially a grant given for a specific In the equity crowdfunding model, also referred to purpose, but without the expectation of a specific as investment crowdfunding, the venture raises return to the funder. According to a 2015 industry money from a crowd in exchange for an ownership report by Massolutions, donation crowdfunding gen- stake in the firm. That is, investors are offered erates the second-largest funding volume globally equity or bond-like shares (Ahlers, Cumming, (NCFA, 2015) and the idea of donation crowdfunding Guenther, & Schweizer, 2015). Equity crowdfunding has been successfully utilized in social marketing for is the fastest growing crowdfunding category and 1 a number of years (Lehner & Nicholls, 2014). the average campaign value is high. Investor-led The rewards-based donation model employs an equity crowdfunding typically involves accredited incentive system whereby backers receive nonmon- investors, such as venture capitalists, angel inves- etary rewards that include personal recognition or tors, or sector specialists who negotiate with the experiential rewards, such as the opportunity to founder on funding terms. These projects are then meet the creators, attend special events, or even promoted to accredited investors via platforms that to participate in the creation of the product. Dona- are often subscription-only (Wagner, 2014). In tion crowdfunding is more popular for projects with entrepreneur-led equity crowdfunding, campaigns smaller funding goals; globally, 90% of donation are accessible to all crowd investors and the cam- crowdfunding campaigns raised less than $10,000 paign proponent sets the valuations and determines (NCFA, 2012). the terms of the offering. 2.2. Lending crowdfunding 3. Benefits of crowdfunding for Lending crowdfunding, often referred to as peer-to- startups business (P2B) or peer-to-peer (P2P) crowdfunding, raises money with the expectation that founders The previous section introduced a typology of will repay supporters. Lending crowdfunding is the crowdfunding considering the type of return or largest crowdfunding type by funding volume (NCFA, reward to backers. While this is an important first 2015) and takes one of three forms: (1) the pre-sales aspect to understand, a startup also needs to con- model, (2) the traditional lending model, and (3) the sider the specific benefits it aims to achieve in forgivable loan (NCFA, 2012). The pre-sales model pursuing crowdfunding efforts. First, crowdfunding offers the finished product in return for the contrib- helps alleviate the capital crunch many startups utor’s pledge; the contribution amount requested face. Many campaigns aim to raise a relatively small from each crowd member is determined by an as- sum of money for a one-time project or event (Mollick sessment of the fair market value of the product. & Kuppuswamy,
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