Is Crowdfunding the Best Way to Raise Finance for New Businesses?

Crowdfunding in the current business world has been defined by Larralde (2010) as: ‘An open call, essentially through the internet, for the provision of financial resources either in the form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes.’
 

However crowdfuding isn’t a new phenomenon in the way of raising finance and was actually used to fund the pedestal that holds the statue of liberty. People donated money to fund this pedestal with only the promise of their name in a magazine with $102,000 dollars raised with the majority of donations less than a dollar. This shows the power and influence a crowdfunding campaign can have even before the power of the internet.
 

There are several ways to raise finance through crowdfunding with the rewards that backers can receive. The statue of liberty pedestal was raised through civic crowdfunding/ philanthropic donations, but there are also equity based crowfunding and reward based.
 

Crowdfuding has become an increasingly popular way to raise finance for new businesses or ideas as bank finance has become increasingly difficult to obtain since the economic crisis. The majority seeking finance this way use a reward based crowdfunding strategy and do so through websites like kickstarter and indiegogo. This initially sounds like the best option for businesses looking for finance as it is also a form of advertising as their ‘investors’ will promote their projects and are actively involved from the beginning.
 

The most popular websites that are used for crowdfunding differ in the way they allow a project to be funded. The idea is that the new business posts a video showing the idea/ concept they have that they wish to fund and state an amount of finance they need for the project. Indiegogo allow the funds to be released even if the target hasn’t been reached with Kickstarter only allowing the funds to be released when the amount has been reached.  Therefore if I was pledging money to an entrepreneur I would prefer to do so through Kickstarter as their conditions would incentivise them to work hard and try and create more pledges and if the money was falling short, would encourage them to put the money in themselves. This would surely mean they would protect your money more as they have used their own as well and would have the amount of money they would need to successfully complete the project. However as both the website take a percentage of the money raised would it not be more beneficial for an entrepreneur seeking finance to create their own website similar to ‘just giving’ as then the cut would not have to be taken into account for the target and through the variety of social networks and the internet surely the could be just as successful as if they went through the platform of social media as that is the key attribute that these websites use as your are more likely to back something if your friends have.
 

There are also hidden controversies that some entrepreneurs are not aware of as most crowdfunding platforms attempt to exempt themselves from blame if the project fails to deliver or breaks the law in some way eg through breaking a patent. This however is still an unknown area as it is yet to be tested by law. But surely if the project fails to deliver or break the law the project creator should surely take the blame as it would most likely to be from lack of research. In the terms and conditions there is also the condition that they will be viable for sales tax and VAT which generates the question whether many are aware of this or how many to do disclose this which would significantly affect the amount of funding they would receive. However if research is done the project creator could always find ways around this like registering their company in a place that doesn’t pay sales tax eg Delaware (USA).
 

Although it may seem like there are many things to consider when choosing to use crowdfunding as a way to raise finance, the success stories from using this method can’t be ignored with over 18,000 projects successfully funded through Kickstarter and a 200% growth from 2011 to 2012 shows that this way for raising finance is becoming an increasingly more popular especially with game creators. The graphs below show the areas where the most success is generator so a project, especially within dance is extremely likely to be successful.

Crowdfunding, if successful, can create an increase in strategic options compared to those that use more traditional ways of raising finace like bank loans. These options are available as having a significant amount of money generated from crowdfunding allows the company to have a lower WACC through utilising their capital structure.

For the future it is clear that crowdfunding as a way to raise finance will continue to grow and if a project is carefully risk managed  and contingency money is built in and the initial costing and budgeting are done right then more and more projects should be successful.