Chapter 1
Introduction
This chapter briefly explores crowdfunding (CF) as a viable alternative finance option for SMBs. It delves into the motivations and significance of the study, emphasizing the examination of investment and non-investment crowdfunding. The subsequent sections address the background of crowdsourcing and SMBs’ challenges in accessing traditional finance. The research question, aims, and objectives are outlined, followed by the significance of the study and the dissertation’s structure.
Background of Study
The financing environment pertaining to small and medium-sized enterprises (SMBs) has undergone significant transformations in recent years. The acquisition of traditional funding sources, including venture capital and bank loans, has progressively posed challenges for SMBs, particularly considering economic uncertainties and stringent lending criteria. However, amidst the ever-changing financial environment, crowdfunding has emerged as an alternative for SMBs seeking to inject capital. It has ranked among the top ten innovations of the twenty-first century. This fundraising approach is innovative compared to traditional methods like equity financing or bank loans. ArtistShare, launched in 2001, was the pioneering online crowdfunding platform that inspired users to commence crowdfunding initiatives in 2003. Since that period, an estimated 1,250 crowdfunding platforms have been implemented worldwide, per Massolution (2015). Colombo et al. (2021) identify Kickstarter and IndieGoGo as two widely recognized online platforms, which were respectively established in 2009 and 2008. Kickstarter operates under an “All-or-Nothing” model, whereby entrepreneurs who establish a project on the platform do not receive any remuneration until they achieve the desired funding amount (Da Cruz 2019). Kickstarter has gained significant recognition for its ability to facilitate the completion of creative endeavors. The platform has successfully facilitated the provision of financial assistance for endeavors that have ultimately led to the formation of thriving businesses, including 9 Pebble3 technology and Ouya4. As of September 2023, Kickstarter has amassed a total of 69530 SMBs funded more than $2.3 billion (KickStarter 2024). Users wishing to participate on Kickstarter must register for free and become community members. Members possess the capacity to propose funding initiatives, contribute financially to ongoing projects, and offer project-related feedback. While there are no geographical restrictions on membership, creators are limited to particular countries. Backers are limited to a maximum pledge of $10,000 or the equivalent. The typical duration of projects on the crowdfunding platform Kickstarter is thirty days, although projects can last anywhere from one to sixty days. Kickstarter is distinguished from other crowdfunding platforms by several essential characteristics. At the outset, its operations are conducted under an “all-or-nothing” fundraising structure. This necessitates that the entire funding goal of the project be accomplished within the specified fundraising timeframe; failure to do so will result in a refund to the funders. Moreover, it should be noted that Kickstarter contributors do not acquire equity in the projects they fund, although they might be granted insignificant “rewards” like a note of appreciation.
Kickstarter, being the platform for crowdfunding, enables retail investors who are not professionals in the investment industry to participate in early-stage investments. Before the advent of crowdfunding, access to this specific investment domain was restricted to accredited professionals only. Therefore, this methodology could be interpreted as a strategy to foster inclusiveness in the investment sector and decouple the considerable capital possessed by individual investors, thus potentially fostering industry expansion. Apart from being accessible by any investor, the platform has led crowdfunding to emerge as a notable financial innovation that provides innovative startups with expanded prospects for fundraising SMBs. Notably, it eliminates the necessity for conventional financial intermediaries such as venture capital firms, business banks, and commercial banks (Shneor & Vik, 2020).
Shneor and Vik (2020) posit that internet-enabled crowdfunding platforms function as a dependable and collaborative system, fostering an alliance between financiers (backers) and supporters (campaign creators) in order to advance their relationship. Four principal crowdfunding models have been identified by Beier and Wagner (2021) in accordance with the contributions made by funders. The aforementioned models comprise reward-based projects, in which non-monetary incentives such as services or products are provided; equity-based projects, in which equity shares are issued; loan-based projects, in which a specified interest rate is applied; and donation-based projects, in which neither monetary nor material rewards are involved. The stakeholders engaged in crowdfunding activities, including creators, supporters, and platforms, collectively strive for the triumph of crowdfunding. Founders aim to achieve the fundraising goals with the intention of obtaining the essential capital required to operate their enterprise. To obtain tangible or intangible benefits, backers desire to endorse a crowdfunding venture in an effective manner (Chaney 2019). Belleflamme et al. (2019) posit that crowdfunding platforms possess the capacity to generate income via fees and payments contingent on the success of projects, thereby fortifying their position within the crowdfunding sector. This paper will examine the potential of crowdfunding as an alternative source of finance for SMEs – Case Study Kickstarter, Indiegogo for Mous Accessories.
1.2. Problem Statement
Historically, SMBs have encountered difficulties in obtaining finance for their development and expansion from banks, venture capitalists, and angel investors (Mollick, 2014). One factor why SMBs need help getting funding is the unpredictability and uncertainties associated with initiating a business. For example, numerous enterprises require a trade history. Banks may exhibit hesitancy in providing loans to these firms and may require directors to provide a costly and risky personal guarantee. According to the 2019 ‘Credit Conditions Survey’ conducted by the Bank of England, SMBs frequently identify capital access as their primary obstacle. The increasing popularity of online campaigns as a viable revenue stream necessitates a deeper investigation into their reliability and effectiveness for SMBs.
1.3. Research Question
Is crowdfunding a reliable source of finance for SMBs?
1.4. Research Aims and Objectives
This study investigates if crowdsourcing may help small firms raise funds. Kickstarter and Indiegogo will be tested for small enterprises. To achieve this objective, the following will be done:
- To analyze the characteristics and dynamics of alternative funding platforms, particularly Kickstarter and Indiegogo, in the context of SMB financing.
- Define the main benefits and disadvantages of UK SMBs using crowdfunding as an alternative source of financing.
- To assess the long-term impact and sustainability of crowdfunding as a financing option for SMBs.
1.5. Significance of Research
This report might be used as a reference by policymakers to draft legislation and regulations for governing SMBs’ use of crowdsourcing platforms. This study will contribute to the existing knowledge on SMBs ‘ financing and crowdfunding platforms, offering valuable information for future studies.
1.6. Research Structure
This dissertation is structured as follows: Chapter 1, which provides the background of the paper. Chapter 2 provides a comprehensive review of relevant literature, exploring the theoretical underpinnings of crowdsourcing and its implications for SMB financing. Chapter 3 outlines the research methodology, detailing the approach adopted for data collection and analysis. Chapter 4 presents the empirical findings derived from an in-depth analysis of Kickstarter and Indiegogo campaigns, addressing the research objectives outlined in Chapter 1. Finally, Chapter 5 offers conclusions, implications, and recommendations based on the findings of this study, along with avenues for future research.
Chapter 2: Literature Review
2.1. Introduction
Crowdfunding has emerged as a significant alternative finance option for small and medium-sized enterprises (SMBs), providing them with opportunities to raise capital outside of traditional channels like bank loans and venture capital. This section reviews the theoretical search bases of crowdfunding and explores its potential impact on the financing of SMBs. It will reveal the basics of Pecking Order Theory, various financial instruments, and how small companies can access finances.
2.2. Theoretical Overview
2.2.1. Pecking Order Theory
The Pecking Order Theory, as proposed by Myers and Majluf (1984), suggests that firms have a hierarchy of preferences when it comes to financing, prioritizing internal funds, followed by debt, and finally equity financing. The leading cause of pecking order theory lies in information asymmetry and the problems proceeding from there, as managers hesitate to go to external funds because that signals possible negative news to other markets (Frank, 2022). Nevertheless, qualifying for conventional credit sources like banks and venture capitalists is an uphill task for SMEs as they may not possess the necessities required by the lenders, so no option is available. For such instances, SMBs can disregard generally accepted principles and may even seek out smaller or different creditors, such as online crowdfunding platforms.
Crowdfunding links big businesses with many small savers who can get funds directly without typical intermediaries, like banks and stock companies. This democratization of finance disrupts the traditional pecking order by providing SMBs with access to capital that may have been otherwise unavailable to them. This leads to creating crowdfunding opportunities for SMBs to support dazzling projects, broaden their on-goings, and bridge the gap in financing, which has been stifling growth in the business sector in previous eras. Incorporating insights from Bottiglia and Pichler (2016), crowdfunding introduces a new avenue for capital infusion, enabling SMBs to overcome the challenges associated with accessing traditional financing sources. The fact that crowdfunding can offer financing to small business owners, therefore not operating in the conventional pecking order, confirms that crowdfunding can transform the financing world to ensure the continuity of small and medium businesses (SMBs).
2.2.2. Agency Theory
Agency Theory, as elucidated by Jensen and Meckling (1976), focuses on the inherent conflicts of interest between principals (investors) and agents (entrepreneurs) and seeks to establish mechanisms to align their interests. In the case of crowdfunding, backers fund the projects under the condition that the project creator will deliver (Panda & Leepsa, 2017). The backer-creator relationship could, therefore, be said to be agent-dominated by nature. Investors hand money to developers with a shared understanding of accomplishing some targets to make financial gains or bring project objectives to life. Nevertheless, that can be accompanied by information asymmetry, moral hazard, and adverse selection between backers and creators that lead to some conflict of interest.
Drawing from Gerber and Hui (2013), the success of crowdfunding campaigns hinges on the alignment of interests between backers and creators. Creators should manifest fairness, diligence, and competence to assure the backers’ trust and diminish the setbacks from agency conflicts. Suppose the creator can communicate clearly with their backers on the project milestones and fulfill their promises. In that case, it will contribute significantly to building a positive relationship between the backers and the creators. Understanding agency dynamics is paramount for evaluating the reliability of crowdfunding as a financing option for SMBs. By considering agency issues and establishing interest harmonization tools, crowdfunding sites will lead to increased trust, information asymmetry reduction, and a high probability of successful results for all parties involved. Consequently, crowdfunding as a powerful tool for SMBs is now available, keeping in mind the characteristic features of their agency behaviors.
2.3. Key Concepts
2.3.1. Small and Medium-Scale Businesses (SMBs)
Small and Medium-Scale Businesses (SMBs) constitute the backbone of economies worldwide, driving economic development, job creation, and innovation (Bosse & Phillips, 2016). As small and medium-sized businesses (SMBs) are an integral part of the whole economy, the truth is that they often face unfair obstacles in getting access to traditional loans due to their small scale and inadequate security. Conventional banks and other commercial lenders usually perceive SMBs as high-risk undertakings and discourage these businesses from submitting loan or investment capital applications through formal borrows.
According to Bottiglia and Pichler (2016), crowdfunding platforms like Kickstarter and Indiegogo present a transformative opportunity for SMBs to overcome these financing barriers. Through these platforms nowadays, SMEs no longer have to go through organizational intermediaries. Instead, they can directly reach a vast network of backers, including individual investors from all levels and philanthropists with a joint mission of supporting innovative projects and entrepreneurial endeavors. To this end, the democratization of financing empowers SMEs with a channel to lure an essential supply of capital and a platform for market validation and customer engagement.
Moreover, Huang et al. (2022) highlight that crowdfunding platforms enable SMBs to showcase their products or services to a global audience, bypassing geographical constraints and traditional gatekeepers. Conversely, the significant spotlight provided might contribute to the growth of brand awareness, customer loyalty, and market expansion for startups (Lunge, 2022). Crowdfunding platforms are a matchless funding source for SMBs, which promotes economic growth and creativity as they present the enterprises with an alternative source of finance and a platform where they can exhibit their innovations.
2.3.2. Shareholders/Founders/Seed Fund
In the initial stages of establishing small and medium-sized businesses (SMBs), founders typically face the challenge of securing adequate funding to kickstart their ventures. Sometimes, they resort to personal savings and contributions from their friends and family or seek startup financing from those who are often angel investors and seed incubators (Bosse & Phillips, 2016). Figure 4 of the speech shows that these early-stage funding sources are crucial for the initial startup expenses, including product development, market research, and operational costs.
However, as highlighted by Gerber and Hui (2013), crowdfunding platforms offer SMB founders an additional avenue to raise capital and garner support from a broader community of investors. Using platforms like Kickstarter or Indiegogo, the founders of the businesses can thus make their business ideas or prototypes known to potential backers and promise donations in connection with rewards or equity. By conducting this principle, founders obtain capital and market validation, enabling engagement with clients. Furthermore, Dai and Zhang (2019) note that crowdfunding allows founders to leverage the power of social networks and online communities to amplify their fundraising efforts. Social media platforms are a proper channel for the founders to broadcast the campaign and reach out to more backers and interested audiences to generate more support for their IPO (Dresner, 2014). Crowdfunding acts as a reinforcing factor or option for traditional funding models of SMB startups and helps these entrepreneurs achieve their goals and add extra propulsion to their entrepreneurial undertakings.
2.3.3. Equity
Equity financing stands as a cornerstone of capital acquisition for businesses, involving the sale of ownership stakes in exchange for capital infusion. Traditionally, these routes were granted to large companies seeking finances from venture capitalists or angel investors as traditional financial (von Belo et al., 2019). Nevertheless, the advent of equity crowdfunding platforms has empowered SMBs, notably lowering their economic gap in accessing this kind of like (Bottiglia & Pichler, 2016).
As highlighted by Huang et al. (2022), equity crowdfunding platforms like Kickstarter and Indiegogo allow SMBs to raise funds from a diverse pool of individual investors. Through those channels, SMBs will sell shares, in essence, to supporters in return for funding and broaden their investor base by including regular people in the equity financing process. This democratization process of equity financing, beyond doubt, adds another feather to the cap for making the investors feel a part of the owned-business community. It develops a sense of community ownership and engagement among investors.
Moreover, Kleinert et al. (2020) emphasize that equity crowdfunding enables SMBs to leverage individual investors’ collective wisdom and networks, who may bring diverse expertise and resources. Drawing together multiple sources of capital in this kind of financing model maximizes the growth potential and stability of an SMB because they get support and advice from stakeholders who are part of a committed group. Equity crowdfunding platforms can be regarded as a transforming component of the finance sector. They offer a genuinely disruptive instrument that allows SMBs to get investment capital and establish the relationships they need for their business growth.
2.3.4. Debt
Debt financing is a common method for businesses to raise capital by borrowing funds that must be repaid with interest over a specified period. Banking and finance companies have been considered the primary loan source for SMB businesses in the past. Therefore, such businesses apply for loans that help develop their operations and support their growth perspectives (Bottiglia & Pichler, 2016). Conversely, crowdfunding layers have brought innovative debt financing to small and medium-sized businesses (SMBs). The SMBs will not be the only option since crowdfunding will offer them the other methods of getting the credit they need.
As Dai and Zhang (2019) highlighted, crowdfunding platforms may facilitate loan-based crowdfunding options, wherein backers provide funds to SMBs in exchange for repayment with interest over a predetermined timeframe. In contrast to credit in traditional banks, which often have rigid and inflexible criteria of eligibility and collateral demands, loan-based crowdfunding platforms like LendingClub and Funding Circle serve hail SMBs with a more accessible and flexible financing market. By implication, this trade between debt financing and democratization induces SMBs to expand their sources of funds and capitalize on a broader capital base of individual investors.
Also, Gerber and Hui (2013) have reported that because loan-based crowdfunding platforms enable SMBs to get financing by circumventing conventional financial intermediaries, they can significantly reduce the back-office bureaucracy and the funding process to a simple procedure. By having a direct backing connection through the crowdfunding system, SMBs can speed up the capital raising process and access funding more effectively, which helps them to nominate growth opportunities and financial challenges quickly. Debt-based crowdfunding platforms are now not just an option but probably better for them than bank loans, enabling small businesses to be more flexible, less restricted, and more efficient in raising capital when exploring business opportunities.
2.3.5. Venture Capital
Venture capital is pivotal in financing early-stage companies with high growth potential, typically investing in innovative ventures in exchange for equity ownership (Sharbaf, 2022). The venture capital domain has been previously mainly controlled by institutional investors and high-net-worth individuals who offer huge funds to entrepreneurs and new businesses at an initial stage. On the one hand, crowdfunding has been established as an additional channel to venture sources, which offers more equality in accessing capital and brings to the table more people to obtain funds for innovative endeavors.
According to Bottiglia and Pichler (2016), crowdfunding and Indiegogo are accessible to famous investors. In contrast, many different venture capitalists become a part of the early-stage company funding process. Through crowdfunding, small startups and SMBs connect with their larger community of contributors by giving small amounts of capital. Subsequently, they become a good source of financial support (Lerner, 2022). This, in turn, helps democratize investment space and opens a whole new stream of avenues for entrepreneurs to raise financing.
Moreover, according to Gerber and Hui (2013), crowdfunding platforms offer startups and SMBs an opportunity to showcase their innovations and gain market validation from a diverse audience of backers. Acknowledging the recognition and endorsement from other industries may help them build their credibility and attract more investments, specifically from premium venture capital companies and angel investors keen to get involved and foster growth and expansion. Crowdfunding adds an extra layer of diversity to venture capital, detracting the gates toward financial support and offering entrepreneurs opportunities to develop their innovative ideas with the effect of a broader investor community.
2.3.6. Crowdfunding
Crowdfunding revolutionizes the traditional financing landscape by enabling businesses to solicit funds from a diverse pool of individuals through online platforms (World Bank, 2013). This approach bridles geographical gaps and contributes to entrepreneurs’ capability of earning external funding from global online investors. Crowdfunding engages different funding types that fit various needs, such as reward-based fundraising, equity-based funding, some loan-based models, and some because of gifts.
Belleflamme et al. (2015) highlight that reward-based crowdfunding involves offering backers non-monetary incentives, such as products or services, in exchange for their financial support. The equity-crowdfunding approach allows investors to obtain equity stakes in enterprises as a form of their contribution. Hence, entrepreneurs bypass the selling part of the control while at the same time having access to capital (Christensen, 2023). Peer-to-peer lending on these loan-based platforms, where the lenders lend money to borrowers who repay with interest, is achieved through mediators. Contrary to this, the financing schemes for donation-based crowdfunding rely on charitable donors who donate to litigation without expecting returns.
Understanding the dynamics of crowdfunding is paramount for evaluating its potential as a financing option for SMBs (Mollick, 2014). Through platforms like Kickstarter or Indiegogo, SMBs can access collective funds and link with a more assorted backers’ network. Additionally, crowdfunding offers a feasible alternative format that provides flexibility in timing, transparency, and market validation that small firms can use instead of the conventional ways of funding. Crowdfunding acts as a multifaceted and inclusive way through which SMBs can call for contributions and get capital based on customized funding frameworks matching their varied financial needs as well as the ambitions of entrepreneurs to turn their ideas into reality..
2.4. Academic Literature Review
The academic literature on crowdfunding offers valuable insights into its implications for small and medium-sized business (SMB) financing. Researchers such as Davis and Davis, Bottiglia and Pichler, Mollick, Hervé and Schwienbacher, and others have written many articles about various subjects and the effects of crowdfunding campaigns on SMBs. Davis holds on to the stand of democratization of finance with the platform in which startups of all kinds and SMBs, particularly, have adequate access to capital (Davis & Davis, 2021). In their article, Bottiglia and Pichler point out that crowdfunding can be helpful for SMBs as it is usually much easier for them to gain capital than traditional fundraising methods.
Mollick focused on crowdfunding dynamics, identifying what it takes to be successful and social networks (Facebook, Twitter, etc.) functioning as a stabilizing factor for publicity. In their study, Hervé and Schwienbacher investigate the compatibility of crowdfunding and innovation and shine a light on crowdfunding platforms’ role in assisting SMBs in achieving their innovative projects. The findings of the academic literature clearly emphasize the role of crowdfunding as a viable alternative mode of financing for SMBs. They are instrumental in supplementing the existing knowledge on motivation and dynamics and determining whether they contribute positively to innovation and entrepreneurship growth.
Bibliography
Banks, G.C., Woznyj, H.M., Kepes, S., Batchelor, J.H. and McDaniel, M.A., 2018. A meta‐analytic review of tipping compensation practices: An agency theory perspective. Personnel Psychology, 71(3), pp.457-478.https://onlinelibrary.wiley.com/doi/abs/10.1111/peps.12261
Belleflamme, P., Omrani, N. and Peitz, M. (2015) “The economics of crowdfunding platforms,” Information economics and policy, 33, pp. 11–28. Available at: https://doi.org/10.1016/j.infoecopol.2015.08.003
Belo, F., Lin, X. and Yang, F., 2019. External equity financing shocks, financial flows, and asset prices. The Review of Financial Studies, 32(9), pp.350-354.https://academic.oup.com/rfs/article-abstract/32/9/3500/5232704
Bosse, D.A. and Phillips, R.A., 2016. Agency theory and bounded self-interest. Academy of management review, 41(2), pp.276-297.https://journals.aom.org/doi/abs/10.5465/amr.2013.0420
Bottiglia, R. and Pichler, F. (2016) Crowdfunding for SMEs: A European Perspective. 1st edn. London: Palgrave Macmillan UK. Available at: https://doi.org/10.1057/978-1-137-56021-6
Dai, H. and Zhang, D.J. (2019) “Prosocial Goal Pursuit in Crowdfunding: Evidence from Kickstarter,” Journal of marketing research, 56(3), pp. 498–517. Available at: https://doi.org/10.1177/0022243718821697.
Davis M, Davis B. Frontmatter. In: Crowdfunding and the Democratization of Finance. Bristol University Press; 2021
Dresner, S. (2014) Crowdfunding: a guide to raising capital on the Internet. 1st edn. Hoboken, New Jersey: John Wiley & Sons, Inc. Available at: https://doi.org/10.1002/9781118746974.
Frank, M.Z. and Goyal, V.K., 2022. Trade-off and pecking order theories of debt. Handbook of empirical corporate finance, pp.135-202.https://www.sciencedirect.com/science/article/pii/B9780444532657500044
Gerber, E.M. and Hui, J. (2013) “Crowdfunding: Motivations and deterrents for participation,” ACM transactions on computer-human interaction, 20(6), pp. 1–32. Available at: https://doi.org/10.1145/2530540.
Hervé, F. and Schwienbacher, A. (2018) “CROWDFUNDING AND INNOVATION,” Journal of economic surveys, 32(5), pp. 1514–1530. Available at: https://doi.org/10.1111/joes.12274.
Huang, S., Pickernell, D., Battisti, M. and Nguyen, T. (2022) “Signalling entrepreneurs’ credibility and project quality for crowdfunding success: cases from the Kickstarter and Indiegogo environments,” Small business economics, 58(4), pp. 1801–1821. Available at: https://doi.org/10.1007/s11187-021-00477-6.
Kleinert, S., Volkmann, C. and Grünhagen, M., 2020. Third-party signals in equity crowdfunding: the role of prior financing. Small Business Economics, 54, pp.341-365.https://link.springer.com/article/10.1007/s11187-018-0125-2
Lerner, J., 2022. The syndication of venture capital investments. In Venture Capital (pp. 207-218). Routledge.https://www.taylorfrancis.com/chapters/edit/10.4324/9781315235110-12/syndication-venture-capital-investments-joshua-lerner
Lunge, L.B., Laursen, I.C. and Nielsen, K.R. (2022) “Choosing crowdfunding: Why do entrepreneurs choose to engage in crowdfunding?,” Technovation, 111, pp. 102385-. Available at: https://doi.org/10.1016/j.technovation.2021.10238
Christensen, M. (2023, October 4). Crowdfunding: What it is, how it works, types & websites. P2PMarketData. https://p2pmarketdata.com/articles/crowdfunding/
Mollick, E. (2014) “The dynamics of crowdfunding: An exploratory study,” Journal of business venturing, 29(1), pp. 1–16. Available at: https://doi.org/10.1016/j.jbusvent.2013.06.005.
Panda, B. and Leepsa, N.M., 2017. Agency theory: Review of theory and evidence on problems and perspectives. Indian journal of corporate governance, 10(1), pp.74-95.https://journals.sagepub.com/doi/abs/10.1177/0974686217701467
Sharbaf, Y. (2022, April 13). Industries with the top funding growth. KingsCrowd. https://kingscrowd.com/top-5-industries-funding-growth/
World Bank. 2013. Crowdfunding’s Potential for The Developing World. Washington DC: World Bank Publishers. Retrieved from: https://openknowledge.worldbank.org
write