Crowdfunding: Tapping the right crowd

https://doi.org/10.1016/j.jbusvent.2013.07.003Get rights and content

Highlights

  • Two forms of crowdfunding are compared: pre-ordering vs. profit sharing.

  • Profit sharing is optimal for entrepreneurs with large capital requirements.

  • Building a community that supports the entrepreneur is crucial for crowdfunding to be a viable funding mechanism.

Abstract

With crowdfunding, an entrepreneur raises external financing from a large audience (the “crowd”), in which each individual provides a very small amount, instead of soliciting a small group of sophisticated investors. This article compares two forms of crowdfunding: entrepreneurs solicit individuals either to pre-order the product or to advance a fixed amount of money in exchange for a share of future profits (or equity). In either case, we assume that “crowdfunders” enjoy “community benefits” that increase their utility. Using a unified model, we show that the entrepreneur prefers pre-ordering if the initial capital requirement is relatively small compared with market size and prefers profit sharing otherwise. Our conclusions have implications for managerial decisions in the early development stage of firms, when the entrepreneur needs to build a community of individuals with whom he or she must interact. We also offer extensions on the impact of quality uncertainty and information asymmetry.

Section snippets

Executive summary

In recent years, crowdfunding has become a valuable alternative source of funding for entrepreneurs seeking external financing. Existing empirical analyses report an impressive growing volume of money collected through crowdfunding worldwide. Crowdfunding allows entrepreneurs to raise funding through an open call on the Internet. An important characteristic is the extra private benefits that funders (i.e., “crowdfunders”) enjoy by participating in the crowdfunding mechanism. These additional

What is crowdfunding?

Our objective in this section is to provide insights into the various crowdfunding practices. We first provide a general definition of crowdfunding. We then present selected crowdfunding initiatives. We close this section by providing a review of the related literature.

Uncertainty about product quality

Because crowdfunding initiatives involve the introduction of new products and services, they occur in environments in which uncertainty and information asymmetries are prevalent. However, crowdfunding initiatives often rely on products that are not yet on the market in finished form. Furthermore, many times, entrepreneurs only offer a description and promise on what the final product will be.

Thus far in our analysis, there was no uncertainty, and asymmetric information was only present on the

Discussion and implications

In this section, we discuss several issues surrounding crowdfunding that we have not properly addressed so far; we also derive empirical and managerial implications from our theoretical results.

First, in our context, crowdfunding consists of a mix of operating and financing decisions. On the one hand, it is a financing decision, because the entrepreneur needs to raise money for production and thus compares the cost of capital of the different forms of crowdfunding. On the other hand, it is an

Concluding remarks

This article sheds light on managerial implications of crowdfunding practices used for entrepreneurial activities. It stresses the need to build a community that ultimately enjoys additional private benefits from participation to make crowdfunding a viable alternative to investor- or creditor-based funding, such as through banks, business angels, or even venture capital. In setting up the initiative, the entrepreneur potentially faces the following tradeoff. Crowdfunding allows for price

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    The authors are grateful to Gavin Cassar (the editor), Pegaret Pichler, Marco Sahm, three anonymous reviewers, and seminar and conference participants in Antwerp, Atlanta, Bologna, Brussels, Cergy-Pontoise, Copenhagen, Ghent, Groningen, Hong-Kong, Lille, Louvain-la-Neuve, Mannheim, Montpellier, Munich, Nice, Paris, Prague, Porto, and Taipei for their helpful comments on previous versions of this article. A preliminary version of this article was previously circulated under the title “Crowdfunding: An Industrial Organization Perspective”.

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