The benefits of online crowdfunding for fund-seeking business ventures

Pre-print version

Main message of the paper

Crowdfunding through the Internet, a new fundraising technique for small

business ventures, can benefit fund-seeking companies by: helping to

overcome funding difficulties; providing value-added involvement; facilitating

access to further funding; providing publicity and contacts; and enabling

fundraising with only limited or no loss of control and ownership.

Authors

Stephanie A. Macht

Newcastle Business School, Northumbria University

Jamie Weatherston

Newcastle Business School, Northumbria University, City Campus East,

Newcastle upon Tyne, NE1 8ST, United Kingdom

Telephone: +441912437179

Fax: +441912273083

E-mail: [email protected]

J.E.L. Classification Code

G23; G24; G29

1
E.F.M. Classification Codes

800; 810

Key Points

1. Crowdfunding through Internet platforms is a new phenomenon, allowing

small business ventures to raise capital from a large number of private

individuals, the so-called ‘crowdfunders.’

2. Crowdfunding can offer a variety of financial and non-financial benefits to

fund-seeking business ventures.

3. Financially, it helps small companies to overcome funding difficulties and

it facilitates access to further financiers, while at the same time allowing

businesses to raise capital with limited or no loss of ownership and

control.

4. In terms of non-financial benefits, crowdfunders can provide value-added

involvement and feedback, while also creating publicity and public

awareness of the business, thus providing new potentially useful

contacts to the business.

Introduction

It is widely known that small businesses are important contributors to the UK

economy. It is also established that young and growing businesses need

access to finance in order to fulfil this important role. However, especially in

recent years, many small businesses have been and are still facing substantial

difficulties in raising outside capital – this is true for both debt and equity

2
(Cressy, 2012). There is considerable interest in policy, practice and academia

to explore ways of overcoming these so-called ‘funding gaps’ (Department for

Business, Innovation and Skills, 2012).

‘Crowdfunding’ through the Internet is a relatively new fundraising

mechanism that can have the potential to help small, young businesses

overcome funding gaps (Van Wingerden and Ryan, 2011). Recently,

crowdfunding has rapidly gained substantial public exposure, particularly

following the launch of an estimated 500 Internet crowdfunding platforms, most

of which are located in the US and the UK (Avery, 2012). These platforms allow

small and young businesses to raise capital, for instance, in the form of

donations, loans or equity, from a large number of unrelated individuals (the

‘crowd’) (Belleflamme et al., 2012; Collins and Pierrakis, 2012). Despite this

increasing publicity, a recent survey showed that over two thirds of small

businesses in the UK are entirely unaware of the concept of crowdfunding

(Moules, 2012).

As will be explained further below, crowdfunding can be used by businesses

requiring small to modest amounts of capital. This often, but not exclusively,

refers to businesses in their seed, start-up and early stages, after they have

exhausted founders’, friends’ and families’ investments but before being

established enough to attract Venture Capital1 or bank loans2. There are other

funding sources, which invest similar amounts into businesses in their early

1
Venture Capitalists tend to not be interested in small, young businesses. On average, they
invest £1m to £2m, whereby their minimum investment tends to be around £100,000 (Pierrakis,
2010).
2
Banks tend to not be interested in small, young businesses because they are not risk takers;
small, young businesses, however, pose much risk to lenders because of their lack of track
record, credit and trading history, and collateral (Mittel and Kraus, 2011)

3
stages of development; particularly Business Angels3 come to mind (Ramadani,

2009). However, they are not enough to bridge the funding gap between

internal (founders, friends and families) and formal external (Venture Capital

and banks) investors (Collins and Pierrakis, 2012).

There is much debate about crowdfunding in the media and amongst

practitioners, but to date, academic literature in this emerging field is virtually

non-existent, consisting of only a very small number of published articles and

working papers. Due to the newness of this funding source, little is known about

it and entrepreneurs, who are thinking about using crowdfunding, have only a

very limited amount of literature at their disposal on which to base their

decisions. On the academic side, the newness of the field results in a plethora

of potential research avenues, all of which require exploration and subsequent

theorising and explanation.

It is on this basis that this article explores the current state of literature in the

field of crowdfunding in order to describe this funding source and to provide an

exploratory summary of its benefits and drawbacks for fund-seeking business

ventures. In achieving this purpose, this article aims to serve two main

audiences:

1. Practitioners, especially fund-seeking entrepreneurs. The review of the

current knowledge within the field of crowdfunding aims to educate

entrepreneurs by providing them with an overview of this new funding

source, thus increasing the number of small businesses knowledgeable

3
Business Angels are high net-worth, private individuals, who invest modest to large amounts
(that is, around £25,000 to £200,000) of their own money into small, young, unquoted business
ventures (Avdeitchikova et al., 2008; Mason and Harrison, 2011); they do not have any
friendship or family relationship with the entrepreneurs they fund (Mason and Harrison, 1996).

4
 about crowdfunding. More importantly, this article aims to present a

framework of crowdfunding benefits, which helps entrepreneurs

understand the advantages (and disadvantages) of this source of capital.

This will support their decision making when considering crowdfunding.

2. Researchers/academics. The review of the current state of knowledge in

the field of crowdfunding aims to serve as an exploratory and descriptive

basis, upon which researchers can build further explorations of various

aspects of this emerging field of study. Moreover, the framework of

crowdfunding benefits presented in this article constitutes a very early

and tentative attempt at developing a theoretical framework in the field,

which can also be used as a starting point for further study.

The remainder of this article proceeds as follows: next, we briefly present the

definition and origins of crowdfunding, while also outlining the reasons why it

emerged as a new funding source. This is followed by an overview of how

crowdfunding works and a more detailed description of what it is. Subsequently,

this article uses a framework of investor benefits (Macht and Robinson, 2009) to

explore the benefits of crowdfunding for business ventures; we amend the

framework in light of the specific benefits of crowdfunding. The article then

outlines the drawbacks of crowdfunding, before presenting a summary and

conclusion, which illustrates the article’s contributions to practice and academia.

Crowdfunding: origins, definition and reasons for emergence

Crowdfunding is a fundraising technique, which allows businesses to obtain

capital from a large number of individuals from the general public, the ‘crowd’

5
(Belleflamme et al., 2012). Crowdfunding is one form of an activity called

‘crowdsourcing;’ in its offline version, crowdsourcing has been in existence for

centuries in a variety of different contexts, all of which refer to companies or

individuals using a large crowd of people to carry out certain tasks (Aitamurto,

2011). Due to the interactive nature of the Internet and the emergence of

various online social and professional networking platforms, crowdsourcing via

the Internet is being widely used by companies of all sizes. Kleemann et al.

(2008) described a number of crowdsourcing activities, including the following:

 companies ask their customers to rate their purchases, for the purpose of

feedback to the companies themselves and to other (potential)

customers;

 companies ask their customers to contribute to the design of new

products/services; and

 customer-to-customer support, for instance, through interactive blogs.

All of these crowdsourcing activities require the crowd (mostly customers in

the case of crowdsourcing), to use the Internet to interact with the company and

one another in order to help the company carry out certain tasks. However,

none of these activities refer to fundraising or financial inputs.

A specific form of crowdsourcing, which has a strong financial element, has

been introduced in the creative and performing arts sectors (Aitamurto, 2011):

in 2006, the pioneer in this context was Sellaband (2012), which allowed

individuals to financially support the production of a band’s or an artist’s CD

(Kappel, 2009). In return, the funders would obtain some rewards, such as a

free copy of the CD or a small proportion of the sales revenue (Ordanini et al.,

6
2011; Schwienbacher and Larralde, 2010). Over the subsequent years, a

number of similar online platforms emerged, which also allow crowds to fund

the creative and performing arts. At the same time, the crowd-based fundraising

model’s applicability to businesses was explored, resulting in the launch of a

number of online platforms aimed at raising funds for business ventures, not

necessarily within the performing and creative arts (Ordanini et al., 2011). The

term ‘crowdfunding’ was coined to describe the application of the Internet

crowdsourcing concept to the fundraising activity, for both creative projects and

businesses. Lambert and Schwienbacher (2010, p. 6) provided the first

academic definition of crowdfunding:

“an open call, essentially through the Internet, for the provision of

financial resources either in form of donations or in exchange for some

form of reward and/or voting rights in order to support initiatives for

specific purposes.”

Although this definition explicitly mentions the Internet as the basis for

crowdfunding, the fact that crowdsourcing has existed for hundreds of years

shows that it is possible to solicit the contribution (including financial

contribution) of large crowds of people on an offline basis. However, due to the

recent emergence of online crowdfunding, this article focuses solely on

crowdfunding through the Internet. To be more precise, we investigate

crowdfunding for business ventures, rather than artistic projects and in so doing,

we consider any form of investment in said ventures, be it donations, lending or

equity (Collins and Pierrakis, 2012).

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 Marsden (2011) described online crowdfunding as a legal minefield. In the

UK, the regulatory environment in the area of equity investing creates barriers

for crowdfunding as businesses are only allowed to use open-calls for equity if

they address them to sophisticated investors (for example, Business Angels) or

if their offering is approved by a person authorised by the Financial Services

Authority (Collins and Pierrakis, 2012). The regulation of open calls for non-

equity investments is less stringent but the Financial Services Authority (2012)

nevertheless cautions non-sophisticated crowd investors against providing

crowdfunding.

Despite being such a legal minefield, the idea of crowdfunding has extensive

potential to support small, young companies because the current financing

options available to them are insufficient to overcome the funding difficulties

they face. Business Angels have previously been mentioned as useful sources

of finance for small, young businesses, which have exhausted funds from

founders, friends and family but are unable to obtain capital from institutional

investors like Venture Capitalists or banks (Ramadani, 2009). Although

Business Angels invest similar amounts as can be raised through crowdfunding,

there are many and varied reasons why Business Angels are not sufficient to

overcome the funding gap for a majority of small companies. It is not the

purpose of this article to review all of these reasons in much detail, so that the

following are merely a brief overview of some of the key reasons why

crowdfunding emerged as an alternative source of capital to help bridge the

funding gap:

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 Business Angels require investees to demonstrate high growth potential

and therefore high return potential (Sohl, 1999; Wong et al., 2009). This

excludes lifestyle ventures, which have very limited growth potential, as

well as not-for-profit or some social enterprises, from attracting such

funding.

 Resulting from strict and highly individual investment criteria (including,

amongst others: the aforementioned high growth potential; investors’

prior experience in the investee’s industry; etc.), Business Angels only

invest in very few of the businesses they come across. For instance,

Mason and Harrison’s (2008a) results showed that BAs only invest in 8%

of deals they encounter. This shows that even businesses with high

growth potential may not be successful in attracting angel funding if they

do not meet Business Angels’ specific criteria.

 There are only around 20,000 to 40,000 Business Angels in the UK and

they all tend to favour investing in close geographic proximity to their

homes (Mason and Harrison, 2000). Moreover, since Business Angels

like to remain anonymous, it is difficult and time-consuming for

entrepreneurs to identify potential angel investors (Mason, 2007).

 It is even more time-consuming and difficult to locate suitable Business

Angels as it is important that entrepreneurs and investors get along. This

is important because Business Angels tend to expect hands-on

involvement in their investee businesses and a lack of chemistry

between entrepreneur and angel can lead to friction and conflict

(Sweeting and Wong, 1997).

9
  Entrepreneurs are frequently unwilling to give up ownership of their

ventures, so that it is often their decision to reject funding offers from

Business Angels if they are deemed to request too much equity (Mason

and Harrison, 1996). Along a similar line, Business Angels’ desire to

become (overly) involved in the business can also be a deal-breaker as

entrepreneurs may be concerned about investors interfering in their

business (De Noble, 2001).

 Businesses may lack ‘investment readiness.’ This means that some

businesses could have the potential to be attractive to Business Angels

but they are not quite investable yet. Often, such businesses require a bit

more time and capital to develop certain areas, before becoming

interesting to Business Angels. Common areas of development refer to,

amongst others, the entrepreneur’s lack of management skills, unrealistic

forecasts, unfocused business ideas, and unclear business models.

Through added investment in the deficient areas, this can be remedied

but it means that such businesses often need additional capital and time

in order to become investment ready (Mason and Harrison, 2004).

Online crowdfunding: how does it work?

Entrepreneurs sign their business up to a crowdfunding site, which vets the

business and decides on whether to allow it to use the site for fundraising

(Collins and Pierrakis, 2012). Following a positive outcome of the vetting

process, the crowdfunding site publishes information about the business and

the investment opportunity it offers. This ‘pitch’ typically includes details about:

10
the target amount desired; the time by which the money needs to be raised; the

reason(s) why the capital is required; and the rewards to be offered to investors

in return for capital investment. Investors – the so-called ‘crowdfunders’ – also

sign up to the platform and can subsequently view the investment opportunities.

If they decide to invest, they use the platform to pledge however much capital

they wish to invest, whereby the amounts invested tend to be rather small,

theoretically as little as $1USD per investment (van Wingerden and Ryan,

2011).

Amounts pledged will show on the online platform, but only if the business

manages to raise the full target amount will the investment actually be made

(Kappel, 2009). Businesses, which are unsuccessful in raising the entire target

amount, will not be able to benefit from the pledges made until that moment – in

that case, pledges will be returned to investors (Collins and Pierrakis, 2012).

The investments are merely facilitated through the online platform, which

means that crowdfunding can be considered a direct investment from the crowd

into the business; this is in contrast to indirect investments, which may occur if

members of the general public provide capital into banks or funds, which will

then in turn make investments into businesses. However, despite this being a

direct investment, the contact between investor and investee tends to not be

direct as the online platform functions as an intermediary, facilitation and

communication tool (Lambert and Schwienbacher, 2010).

Crowdfunding: a review of literature

11
 This section presents a review of literature relating to the concept of

‘crowdfunding’ by describing the investors, the investments and the investees.

Entrepreneurs can use this exploratory description to better understand this

novel type of funding, while researchers and academics can use it as a basis to

further investigate crowdfunding.

Amounts invested

Crowdfunding allows for very small investments, starting theoretically at

$1USD per investment. In Van Wingerden and Ryan’s (2011) US study, the

crowdfunders’ investment tended to be between $6USD and $50USD. In the

UK, there are no detailed statistics relating to all crowdfunding platforms, but

investment amounts typically quoted range from £10 (Watkins, 2012) upwards,

with some investors providing very large sums, such as Crowdcube’s4 largest

individual investment of £100,000 (Crowdcube, 2012).

Nature of the investor

Crowdfunding requires investment from a ‘crowd,’ which is a large group of

individual members of the general public (Schwienbacher and Larralde, 2010).

The investors in these cases are called ‘crowdfunders.’ They are private

individuals, who do not have a background as professional investors (with

exceptions, as it is conceivable that, for instance, high net-worth individuals or

Business Angels invest through crowdfunding platforms) (Ordanini et al., 2011).

4
Crowdcube is the UK’s first equity-based crowdfunding platform and its successes are widely
quoted in current research, case studies and media articles (for example, Collins and Pierrakis,
2012; Williams, 2012).

12
 There is currently no research describing the typical crowdfunder but given

the wide spread of investment amounts indicated above, it is reasonable to

assume that any individual can be a potential crowdfunder. The only academic

piece of work describing some aspects of a crowdfunder’s profile is Van

Wingerden and Ryan’s (2011) thesis: 52% of crowdfunders are under the age of

35; just over 56% have provided crowdfunding only once or twice over the

preceding three months; and just under half rely on the views and decisions of

other crowdfunders when choosing their investees.

Geography

Agrawal and others (2011, p. 1) argued that “perhaps the most striking

characteristic of crowdfunding is the geographic dispersion of

investors.” Their findings stated that on average, entrepreneurs and investors

are 3,000 miles apart. It is interesting to compare this to Business Angels, who

typically invest within an hour’s drive from their home or work place (Harrison et

al., 2003) – crowdfunders, on the other hand, have less stringent geography-

related funding criteria and thus it is conceivable that crowdfunders may even

invest across borders.

Crowdfunders’ motivation to invest

According to Lambert and Schwienbacher (2010), around 22% of

crowdfunders do not obtain any form of reward in return for their capital – the

investment is a donation. However, the remaining 78% of crowdfunders obtain

rewards of various natures, for instance: equity in the business; cash rewards;

13
free access to the investee’s product or service; or an opportunity to have their

names associated with the investee. Aitamurto (2011) identified that

crowdfunders, who provide financial donations to journalistic publications, are

interested in supporting a specific cause, as opposed to obtaining monetary

return on investment.

Lambert and Schwienbacher (2010) suggested two further non-financial

motivations: feelings of personal gain, resulting from crowdfunders’

contributions to the success of the funded business(es); and social reputation.

The latter refers to crowdfunders’ desire to be perceived in a positive light by

others (Bénabou and Tirole, 2006), which can be achieved through contributing

to a worthwhile cause, such as investment in a small business. However, it is

reasonable to assume that other motivations, such as philanthropic or altruistic

reasons, as sometimes found in the motivation of Business Angel investors,

may also play a role (Sullivan and Miller, 1996).

Both Ward and Ramachandran (2010) and Van Wingerden and Ryan (2011)

researched aspects of the investment motivation and concluded that

crowdfunders take into consideration the decisions and actions of other

crowdfunders and investors in the same and related/similar ventures; for

instance, ventures that already have successfully raised some capital or

businesses similar to other successful ventures tend to be preferred. While this

does not explain the motivation of the first-mover, it suggests a certain

bandwagon effect in the motivation of the followers.

Value-added

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 Some other investors, including Business Angels, provide more than just

money – they also provide investee businesses with added benefits, such as

giving them access to their own network of contacts, becoming actively involved

in the business (for instance, as an advisor, mentor or sounding board), and

facilitating access to further financiers. This is called value-added because it

can add value beyond the financial investment, either through prior experiences

of relevance for their chosen investee businesses or through soft involvement,

which refers to people-centred, interpersonal and emotional support (Macht,

2011).

Due to crowdfunders being members of the general public, it is reasonable to

assume that some crowdfunders have relevant experience and contacts, which

can add value to their investee companies; however, at the same time, it is very

probable that many crowdfunders do not possess any value-adding attributes.

Schwienbacher and Larralde (2012) argued that almost two-thirds of

crowdfunders do not become actively involved in their investee companies but if

they do, then such involvement may be limited to providing feedback or being

allowed voting rights regarding further development of the products/services.

Nevertheless, Collins and Pierrakis (2012, p. 24) argued that crowdfunders can

provide the “wisdom of the crowd,” referring to their combined skills and

experiences.

A further value-adding capability of crowdfunding refers to much public

exposure of the business and an increase in awareness of its products/services

as a result of: the large amount of investors; the likelihood that they will use

15
word-of-mouth to promote their investee; and the fact that the crowd members

may feel like members of a tight-knit community (Belleflamme et al., 2012).

Target amounts sought by businesses

According to Schwienbacher and Larralde (2012), most companies

attempting to raise finance through crowdfunding seek small to modest amounts

of capital. Statistics from Crowdcube concur, showing that the average target

amount is £146,552, while the smallest amount raised to date was £12,000

(Crowdcube, 2012).

Nature of the investee

Schwienbacher and Larralde (2012) showed that companies from any

industry are able to use crowdfunding, although they stated that investees need

to be somewhat innovative in order to capture the interest from the general

public – this ‘innovativeness,’ however, is not further specified and it is

reasonable to assume that different crowdfunders will have different attitudes as

to what constitutes interesting and innovative. Crowdcube’s (2012) statistics

agree with this as they include various diverse industries, including consumer

products, financial services and internet/technology.

Lambert and Schwienbacher (2010) further identified that businesses with a

not-for-profit orientation tend to be substantially more successful in raising

capital from crowds than are for-profit organisations or businesses seeking

funding for specific projects only. Kappel (2009) argued that it is particularly, but

16
not exclusively, businesses without a solid track record that can benefit from

crowdfunding.

Overall, there appears to be no specific types of business, which are

excluded from being successful: it seems that any small business can

theoretically raise capital through crowdfunding, independent from its size,

stage of development, growth potential, innovativeness, return potential, or age.

Entrepreneurs’ motivations to seek crowdfunding

Lambert and Schwienbacher’s (2010) survey of crowdfunding-seeking

entrepreneurs identified three main motivations to use crowdfunding: to raise

finance; to create public exposure for the company or project; and to establish

whether the product/service will be accepted into the market once launched.

They also suggested that for some entrepreneurs, it may be the inability to raise

capital from the more established sources, such as Business Angels, Venture

Capitalists or banks, which forces them to use crowdfunding as the only

available alternative – this is a rather necessity-driven motivation.

Other entrepreneurs may deliberately select crowdfunding because they can

see the benefits this source can deliver over other established funding sources

(please see below for a detailed discussion of the advantages and

disadvantages of crowdfunding) or because they deliberately choose

crowdfunding alongside, before or after other types of finance to expand or

complete a certain fundraising target (Belleflamme et al., 2010).

Benefits of crowdfunding for capital-seeking businesses

17
 This article aims to present the benefits of crowdfunding in the form of a

framework, which supports fund-seeking entrepreneurs with their decision

regarding whether to consider crowdfunding, while at the same time

representing a basis for further research. Macht and Robinson (2009) created a

framework of investor benefits in the context of Business Angels (see Figure 1).

Since Business Angels and crowdfunding enable businesses to raise similar

amounts, at least one of the benefits – ‘Helping to Overcome Funding

Difficulties’ – appears intuitively logical to have relevance also for crowdfunding.

Therefore, we tentatively use this Business Angel framework as a guide to

explore the relevance and applicability of these four benefits in the context of

crowdfunding.

[Insert Figure 1 about here]

Helping to Overcome Funding Difficulties

Since Business Angels were said to be able to overcome funding difficulties

(Macht and Robinson, 2009), the fact that crowdfunding can provide similar

amounts suggests that this benefit is applicable also to crowdfunding:

crowdfunding is likely to overcome funding gaps between the entrepreneurs’

own investments and formal, external financiers. Moreover, any individual with

access to the Internet and even just £10 to spare could potentially be a

crowdfunder (Belleflamme et al., 2012; Hurley, 2012). Thus, the pool of

potential investors in the UK is huge.

18
 Since crowdfunding is also not constrained by investors’ desire to invest only

in close geographic proximity to their homes, the pool of potential crowdfunders

is expanded further, to also include individuals from more distant locations or

even other countries (Agrawal et al., 2011).

Moreover, online crowdfunding being an open invite via the Internet, it can be

considered an effective way of reaching very large amounts of potential

crowdfunders (Schwienbacher and Larralde, 2012) and thus removes the time-

consuming process of searching for investors. A related benefit refers to

crowdfunders’ all-encompassing funding criteria, which comprise businesses of

any industry, growth potential, profit orientation, size and age and even includes

businesses without a track record and collateral – as such, crowdfunding seems

to be suitable also for businesses that do not appeal to other investors like

Business Angels or banks. Crowdfunding thus may be able to overcome

funding difficulties for businesses, which are not (yet) attractive to other

investors (Collins and Pierrakis, 2012).

Given that there are an estimated 500 Internet crowdfunding platforms in the

world already (Avery, 2012), fund-seeking businesses have a rather large

choice of intermediaries. We propose that this can also be seen as a benefit as

it not only further increases the pool of potential investors but also enables them

to shop around for the best suitable platform.

Provision of Contacts

If a large crowd of people is interested in a business, they are able to create

‘hype’ around it and generate public exposure for the business and its

19
products/services (Belleflamme et al., 2012; Lambert and Schwienbacher,

2010). While this does not mean that crowdfunders directly introduce the

investee to members of their own contact networks, they, by their investment

decision, quasi recommend the business. This may increase its public

exposure, or raise awareness of its existence with a wider audience. Increased

publicity and public exposure is a benefit for businesses, particularly if they are

still young and suffer from a limited marketing budget.

Facilitation of Further Funding

The added publicity and awareness within the general public may, possibly,

result in exposure to more crowdfunders or even other financiers (for example,

Business Angels or Venture Capitalists). This seems particularly likely given the

fact that many crowdfunders take into account other crowdfunders’ opinions and

actions when making investment decisions (Van Wingerden and Ryan, 2011).

We can tentatively propose that there may be a bandwagon effect: if one

person invests, others follow. Should this proposition prove to be true, the

crowdfunders’ investments are able to benefit investee companies by facilitating

access to further capital.

A further benefit of crowdfunding may refer to the notion of ‘investment

readiness.’ We propose that businesses, which are not quite of interest to other

investors yet, may be able to use the capital obtained through crowdfunding to

not only become investment ready (for instance, to pay for management training

or to further develop the product/service), but also to fund the ongoing capital

requirements of the business until investment readiness is achieved. Although

20
this benefit has not previously been discussed in extant literature, we propose

its potential existence because Schwienbacher and Larralde (2012) showed

that crowdfunding can be used concurrently with or followed by Business

Angels.

Involvement

The use of a large crowd of investors also enables entrepreneurs to benefit

from the “wisdom of crowds” (Collins and Pierrakis, 2012, p. 24), which refers to

the collective skills and knowledge of the investors. Some of these skills and

knowledge may be relevant and useful to the investee business and can thus

benefit it if investors became involved. However, Belleflamme and others (2010)

argued that most crowdfunding does not refer to active involvement of

crowdfunders.

Lambert and Schwienbacher (2010) showed that crowdfunding can easily be

combined with other forms of crowdsourcing. Thus, entrepreneurs can also

obtain non-financial feedback from crowds of people (some of whom may

be/become customers) to develop or even test new product/service ideas prior

to launch. This can be done explicitly by asking the crowd for specific feedback

or implicitly by interpreting the crowd’s actions: for instance, investment from

many individuals suggests that products/services will be accepted in the market

(Van Wingerden and Ryan, 2011). Schwienbacher and Larralde (2012) further

argued that such feedback can speed up the new product/service development

time. Such feedback from a large crowd has a clear potential to benefit

businesses.

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 As the above exploration shows, the four benefits, which Macht and

Robinson (2009) have established in the context of Business Angel investors,

seem to be relevant also in the context of crowdfunding. However, it is clear that

the reasons why these four factors are in fact beneficial to investee companies

differ from Business Angels; for instance, Business Angels are able to

overcome funding difficulties for high-growth businesses – crowdfunding,

however, is able to overcome funding difficulties for any type of business.

Moreover, our exploration of the crowdfunding literature showed a further

benefit, which is not included in Macht and Robinson’s (2009) framework. After

presenting this additional fifth benefit, we amend the Business Angel framework

to reflect and explain the benefits of crowdfunding as identified in current

literature (see Figure 2 for the emerging crowdfunding benefits framework).

Additional Benefit: Limited/No Loss of Control and Ownership

This additional benefit, which emerged from our exploration of the current

literature about crowdfunding, refers to crowdfunders’ attitudes towards

investment contracts, equity and return on investment. Due to crowdfunders not

being professional or sophisticated investors, they tend to require less

information upfront and spend less time (if any at all) negotiating detailed

contracts. This may be of benefit for entrepreneurs as it means limited time and

effort required for contracting (Schwienbacher and Larralde, 2012).

Many crowdfunders provide capital in the form of donations or are content

with obtaining non-financial rewards in return for an investment – entrepreneurs

22
with a fear of giving up ownership and control will especially benefit from this

(Mason and Harrison, 1996). Even those crowdfunders investing in equity will

typically only provide small amounts of money, which means that each

crowdfunder will only be a very small shareholder, leaving the entrepreneur with

the majority of shares; also due to their small shareholding positions, individual

crowdfunders will not have the power or voting rights to interfere substantially

with the entrepreneurs’ decisions (Schwienbacher and Larralde, 2012). This is

again of advantage for entrepreneurs concerned about loss of ownership and

control.

As the above summary of the benefits has shown, it appears that Macht and

Robinson’s (2009) framework of Business Angel benefits can be used as a

basis for exploring also the benefits of crowdfunding for small, young

businesses. However, an additional, fifth, benefit emerged from our review of

the crowdfunding literature, which is not applicable to Business Angels. We can

add this fifth benefit to Macht and Robinson’s (2009) display, thus adding to the

framework; Figure 2 presents our amended version of the benefits framework,

including the fifth benefit (boxes and arrows displayed as dotted lines), while at

the same time displaying the reasons why each of these factors is considered a

benefit of crowdfunding (in gray).

[Insert Figure 2 about here]

Downsides of crowdfunding for capital-seeking businesses

23
 Although the objective of this article is to explore the benefits of

crowdfunding, any exploration of benefits should be complemented with some

reference to the downsides in order to present a balanced picture. This section

will therefore briefly summarise these downsides of crowdfunding for small

businesses, again based on current literature.

Before being able to attract crowdfunders, an entrepreneur has to disclose

some information about the business and its products/services on the

crowdfunding Internet platform – this may raise issues of Intellectual Property

protection and entrepreneurs may be worried that competitors could access the

information published on the website (Schwienbacher and Larralde, 2012).

A further downside of most crowdfunding platforms refers to their ‘All or

Nothing’ approach: the fact that businesses must raise the entire target amount

or the deal will not come to fruition – therefore, businesses may not be able to

raise any capital at all if their initial fundraising target is not met. This seems to

be a major issue, given that Van Wingerden and Ryan (2011) suggested that

less than half of crowdfunding-seeking ventures actually manage to raise their

target amount.

Moreover, even if negotiations, due diligence and contracts are not

sophisticated, the investment of very small amounts by a large number of

crowdfunders can turn out to result in overly high transaction costs for the

venture; the same is true for ventures intending to raise very low target amounts

– the costs of publicising the opportunity on a crowdfunding platform is the

same independent from the amount sought (Lambert and Schwienbacher,

2010).

24
 Relating to the potentially large number of investors is the fact that managing

many shareholders tends to be time-consuming and challenging (Collins and

Pierrakis, 2012). They have an interest in the venture and therefore expect and

deserve attention or they may feel unvalued and become disengaged or

disinterested. This is further complicated by the fact that crowdfunders are

individuals and therefore each crowdfunder is different – they may all have

different expectations and requirements (Schwienbacher and Larralde, 2012).

These complexities are aggravated further by the fact that the pool of potential

investors is not limited geographically – managing investors from various

countries, cultures and languages can be challenging for entrepreneurs

(Agrawal et al., 2011).

The large number of online crowdfunding platforms (Avery, 2012) can also be

seen as a downside because it may be overly complicated and time-consuming

for entrepreneurs to choose a suitable platform.

Despite the possible added value effects of crowdfunders, there are

downsides to that as well: many crowdfunders may not have sufficient or

relevant experience and skills to support entrepreneurs in relation to running

their business, while at the same time not having the understanding required to

support entrepreneurs emotionally. More professional investors (for example,

Business Angels) on the other hand may provide highly useful added value

(Mason and Harrison, 2008b) or at least provide emotional, ‘soft’ involvement if

they do not have relevant experience (Macht, 2011). Alternatively, it is plausible

that many crowdfunders’ lack of interest in financial return and reward can have

negative implications for their willingness to add value as they may not be

25
sufficiently motivated to help make a business profitable and successful

(Schwienbacher and Larralde, 2012).

Finally, there is a key downside to offering products or services in return for

investment: by giving away free products/services to investors, businesses

effectively reduce their sales opportunities as these investors could be potential

customers, who would otherwise purchase the products/services.

Summary and conclusion

This article explored the current state of literature in the newly emerging field

of crowdfunding. This funding vehicle allows small businesses to raise small to

modest amounts of money – via crowdfunding Internet platforms – from a large

‘crowd’ of individual members of the public. Each investor, or ‘crowdfunder,’

invests usually very small amounts.

Crowdfunding is a sub-activity of crowdsourcing, which has been in existence

as an online vehicle for companies and artists since 2006. Because of the

newness of the field, academic literature is very scarce. Our aim was to use this

literature to explore the current base of knowledge in the field of crowdfunding

and specifically to establish in an exploratory way the benefits that this new

funding source can have for capital-seeking business ventures. As such, this

article contributes two main audiences:

1. Practitioners, especially fund-seeking entrepreneurs. The review of

crowdfunding literature, compiled in this article, provides entrepreneurs

with an explanation of crowdfunding, which should enable them to

become more aware and educated of this new funding source. However,

26
 more importantly, this articles explores the benefits and drawbacks of

crowdfunding, which entrepreneurs can use to inform their decision

regarding whether to seek crowdfunding or not. As is clear from our

development of the benefits framework, crowdfunding can present many

advantages to small, fund-seeking business ventures. Not all of these

refer to the capital that can be raised through crowdfunding – there are

also substantial non-financial benefits and drawbacks, which

entrepreneurs should consider carefully to establish whether

crowdfunding is a suitable financing option for them.

2. Researchers/academics. This article not only shows the scarcity of the

literature in the newly emerging field of crowdfunding, but more

importantly, it brings together the current state of knowledge in one

place. By drawing upon a framework of Business Angel benefits, we

explored the benefits of crowdfunding in a structured way, while at the

same time being able to establish, albeit in a tentative way, the

usefulness and applicability of the framework to the field of crowdfunding.

Since this can be considered one of the first attempts of theory-building

in the field, it can be used as a basis for further exploration and

theorising.

Using the benefits framework and the review of extant literature, we have

shown that crowdfunding can help overcome funding difficulties for young, small

businesses, especially if they are not (yet) of interest to other types of

financiers. Crowdfunding can also facilitate the receipt of further finance as the

funding can not only make businesses more investment ready but the online

27
community of crowdfunders can create hype around the business and thus

attract the attention of further crowdfunders and other investors. This hype also

increases publicity and as such enables businesses to obtain access to more

contacts, which can be useful for their future development. Crowdfunders can

provide involvement in the businesses in which they invest; for instance, by

offering feedback or other forms of crowdsourcing or by providing combined

knowledge (‘wisdom of the crowd’), they can support the business post-

investment. A further benefit, which was not part of the original benefits

framework, emerged from our review of the literature: limited/No loss of control

and ownership. This is of particular benefit to entrepreneurs who are concerned

about loss of control to investors: crowdfunders tend to be small shareholders

or do not require shareholding at all (for instance, by donating rather than

investing money); they often prefer non-financial rewards (for example, free use

of products/services) over monetary rewards; and they are unlikely to be

sophisticated investors, carrying out no or only simple due diligence.

Given the exploratory nature of this study and the overall limited amount of

extant research in the field of crowdfunding, there are still vast and diverse

opportunities for researchers to explore and the potential to build upon our

benefits framework is extensive – entrepreneurs and researchers should not

consider this framework as all-encompassing, but instead should use it as a

starting point to explore crowdfunding from both practitioner and academic

sides. Ultimately, this framework can be further developed and improved as the

amount of knowledge of crowdfunding grows in the future.

28
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Biographies

Stephanie Macht received her PhD in the topic of business angels’ post-

investment involvement from the Newcastle Business School at Northumbria

University. Dr. Macht is currently Principal Lecturer in Strategic Management

and International Business. She publishes in the areas of entrepreneurial

finance and entrepreneurship education.

Jamie Weatherston is Programme Director for International Development at

Newcastle Business School. Following a career in education and the small

business sector in various countries, Jamie’s research interests now cover

35
various facets of entrepreneurship, with a particular focus on the effects of

environment and context on entrepreneurial activity and the study of finance,

growth and exporting of entrepreneurial businesses.

36
37