Literature Review: Impact Of Crowdfunding In Startups

Crowdfunding

Crowd funding is one of the major aspects in initiating startups due to the fact that this strategy is one of the most effective strategies for the small and medium startups. However, there are different and diverse views as well as opinions being given by different authors regarding the impact of Crowd funding in startups (Kirby and Worner 2014). These views and opinions are varied in nature and range from positive impact to negative impact. However, it should also be noted that in order to have the argumentative approach in discussing about the impact of Crowd funding in startup, there are number of factors being identified from the perspective of both the variable, Crowd funding and startups. In this section, literature review will be done based on the opinions given by different authors in respect to the identified factors.

In this section, the major factors affecting along with the advantages and disadvantages of Crowd funding for startups will also be discussed. These aspects will also be critically analyzed on basis of different views of the authors. Conceptual framework will also be designed in accordance to the identified theories. This will further help to understand the impacts of different factors of Crowd funding on startups. Furthermore, in this section, the limitations of the articles to be used will be also be identified and discussed. Identification of these limitations will help to have the fair idea about the shortcomings of the articles or to the views of the authors. This section will also discuss about the limitations of doing the literature review. The core objective of doing the literature review is to identify the extent to which the concept of Crowd funding will have impact on the startups.

Crowdfunding can be essentially described as the procedure of funding a new venture or an enterprise by raising considerably smaller amounts of money from a wider audience. The procedure is essentially covered with the help of the internet. According to The Crowdfunding Blog (2018), in the year 2015, approximately US$34 billon was raised from crowd funding. In the past, the same procedure was carried out with assistance from various mail order subscriptions, benefits and other such techniques, the term crowd funding is primarily concerned with internet based registries.

The modern concept of crowdfunding model is primarily based on three different types of actors, the individuals who support the idea, the project initiator who looks out for the project and the organization which is moderating in order to make the idea successful (Hornuf and Schwienbacher 2017). Various creative projects, ventures, medical expenses, travel based communities and other social entrepreneurship projects make extensive use of the modern crowd based funding techniques.

Crowd funding has been a popular concept for various business aspects, the roots of which can be found in various theories relating to the business. This section will be discussing certain theories in perspective to Crowdfunding which will include theories like Financial Intermediation Theory, Transactions Cost Theory and the Resource based view theory.

The financial intermediation theory explicitly deals with the enticing investors and persuading them to purchase securities which are backed by investments whose risk components cannot be measured adequately (Greenbaum, Thakor and Boot 2015). In such a scenario, the intermediary is a bank, Ordinary Corporation or a hedge fund which is involved in the evaluation of the risk. In such a scenario, the investor who purchases those securities generally is able to do so by analyzing the past performance of the middlemen involved as well as the summarizes about the security being purchased which are available. In general these ratings which are popularly available are in respect to the bond rating agencies with ratings like “AA” and “A+” (Haas, Blohm and Leimeister 2014). This theory considers that this particular method of rating the investment generally ignores information about certain risks available and only the summary information is highlighted. Hence, as a result of this, the kind of investments can be stated to be liquid in nature.

Theories in perspective to Crowdfunding

Hence, for the borrower the given security becomes a much lower risk premium plan and if the loan had to be taken from other sources, the borrower would have to pay a higher risk premium (Maggiori 2013). Hence, in the domain of crowdfuning it can be stated that it is highly based on the theory of Financial intermediation whereby the crowdfunding platforms act as intermediaries who tend to provide a summary about the reason why the funds are being collected and based on this, the crowd funders tend to invest in the projects and thereby can be described as liquid in nature with covered risk information.

The Transaction cost theory is based on the explanation which explains why different companies exist, the reason why certain companies expand outside their external environment and why they prefer to involve external parties in the domain of the company. The theory proposes that very often the different companies aim to minimize their costs of exchanging the resources with the external environment and even try to reduce the bureaucratic costs of exchanges within the company (Brouthers 2013). Hence, the firm often tends to weight the cost of exchanging resources with the external environment and compare them against the costs which are involved in performing the activities within the firm.

According to Zhao et al. (2017), institutions and markets are seen as two different sources of conducting economic transactions. As often the external transaction costs are generally higher than internal, the company tends to engage in that. However, on the other hand, in scenarios where the bureaucratic costs are higher, then that is adopted. For this reason, the transactional costs occur whereby an organization transfers a service across a technological interface. Hence, in the domain, of crowdfunding, the organizations often prefer to outsource the funds because raising the funds through a technological platform is considered to be cheaper than raising it in house. Moreover, in relation to this, the organizations saves managerial conflicts as well and the cost of transaction is   low in crowd funding.

The resource based view theory can be described as a managerial theory and framework which can be used to determine the resources of the firm which are strategic in nature. These resources and capabilities tend to help the firm in gaining a competitive advantage. When a resource tends to have a comparative advantage to it then the firm tends to exploit it and moreover, convert it to a sustainable competitive advantage (Kuti and Madarász 2014). The Resource Based view proposes that as the different firms are heterogeneous in nature, they tend to possess different resources    which means if two companies deal in a similar manner, even then they might work with different strategies and different resource mixes.

Moreover, the RBV is highly focuses on improving the internal resource of the firm in order to build the competencies and capabilities of the firm. These competencies and capabilities then tend to deliver a sustainable and superior competitive advantage to the firm. With respect to this, it can be stated that, a firm with adequate capabilities will be attracting more funds from the crowdsourcing platform as it portrays suitable investment aspects (Hill, Jones and Schilling 2014). Moreover, financial capability is also capable for the firm and any organization who is able to attract higher financial resources will be able to perform considerably well.            

Financial Intermediation Theory

Rewards crowdfunding

The reward based funding is primarily used for different purposes which include software development, inventions development, research based on scientific components, civic projects and motion picture promotion. According to Kuti and Madarász (2014), in this kind of crowd funding, the funding is not necessarily based on a specific locations. The distance between different investors and creators does not matter when this funding is concerned. The project primarily relies on the concept that the different entrepreneurs sell a product or a particular service to give formulation to a business concept which does not invite any equity shares or begins to involve debt. Moreover, in this kind of a funding experience, the finding received tends to increase based on the goals which become closer towards achievement. In this kind of funding systems, the organizations tend to become quite optimistic in nature and when the funding’s are required to revise their budgeted projections.

Equity based crowd funding

In this kind of crowdfunding, the different backers who provide the funding tend to get an ownership of the company in the early stages of the enterprise. This can be described as a collective source of the different individuals who want to support the organizations and hence, the provision of finance is done in the form of equity provided.  According to Vismara (2016), this method of financing is quite different from the non-equity methods of crowd funding because of the higher information asymmetries. In this funding, the creator is required to produce the goods for the organization for which the capital is being raised but also create equity. In the equity crowdfunding, the organization offers securities to the investors and promises them a potential return for the same. In order to solve the given scenario, syndicates are often formed which will contribute towards reducing information asymmetry and this can lead to avoidance of the outcome of market failure which is related to the equity crowdfunding.

Software value token crowdfunding

Another moderate method of crowdfunding involves raising investment for a particular product by the means of software or digital based value token being offered as a kind of return or in the form of reward to the different funders which are resent. This reward which is being offered to them is popularly known as the initial coin offering (Clarkin et al. 2014). This token, later on becomes alive and establishes a market value. The different funds that may be present may be raised for the token or in the form of bonds, enquiries and other seats. For instance, Augur, the distributed market software was successful in raising 3500 participants.  Moreover, Tezos in the year 2017, was successful in raising US$ 232 million.

Debt Based crowdfunding

The debt based crowdfunding is another kind of crowd funding technique which is popularly known as the peer to peer lending which was found in 2005. According to Barnett (2013), in this scenario the borrowers apply online and their application for the request is largely reviewed. Moreover, after the review takes place, the borrower’s credit risk is determined adequately. When the given procedure is completed then the investors are required to purchase the security and make loans to the borrowers. The investors make money from interest on unsecured loans.  In the United States, this kind of a crowd funding is very popular in nature and it allows the different businesses to invest directly in private businesses as well with broker dealings.

Transactions Cost Theory

Litigation crowdfunding

The Litigation crowdfunding can be described as a type of crowd funding which helps the organization to reach out to various peers confidently in order to raise the funds of the organization. The funds can be raised with the help of donations or reward based funding (Mendes-Da-Silva et al. 2016). This kind of a system will allow the investor to purchase a stake in the claim or claim a return in case the investment has been successful in nature.

Donation-based crowdfunding

Lastly, an investment plan running parallel to the reward based crowd funding is the donation based funding which is one of the most popular forms of funding which exists. The charity based crowd funding can be described as a collective effort of the different individuals to assist them in a charitable cause. This can be described as a proc social or pro environmental based funding which is involved (Valan?ien? and Jegelevi?i?t? 2014). An online community is formed which allows the different givers to donate online.

Advantages

The advantages of the Crowdfunding has been given as follows:

Broad range of investors

According to Valan?ien? and Jegelevi?i?t? (2014), the given procedure helps the different investors to have an access to different types of investors and have a wider portfolio base as well.

Combined investment in case of equity funding

In the case of equity funding, the investments as received by the company is very similar to that a lump sum amount received in case of an IPO as received by the organization (Manchanda and Muralidharan 2014). This makes it easier for them to invest in the organization.

Helping companies to form a rally of early investors

The reward based investments which are received go a long way in helping the organization to form a rally of early investors who are ready to back the idea which is being supported by the organization (Moritz and Block 2014).

Disadvantages

However, the concept of crowd funding has some disadvantages as well. These disadvantages are given as follows:

Premature fund raise

According to Sharp (2014), it allows the different companies to have an access to a premature funding which may often boost their idea which may turn out to be not that successful in the long run. Hence, this may lead to a wastage of the investor`s money.

Poor communication

Colgren (2014), states that as crowdfunding investment is an internet based investment, the communication which takes place between the investor and the startup. The investors often lack clarity of ideas which often restrains them to make adequate investments.

Best Practices

Although the different types of crowdfunding techniques are increasingly popular, there are certain crowd funding practices which help in ensuring that the organization is successful in the long run.

Knowing the purpose of investment

The different funders which are present in an organization should understand the purpose of an investment (Metelka 2014). This means that before the investment is being made, the investor is fully aware of the purpose for which the organization is raising the fund and also the number of investors as involved in the funding procedure.

Resource-Based View Theory

Inculcating clarity

The clarity needs to be maintained in the system. The way in which the money is collected from the investors must be ethical and in return they may be given specific documents with respect to the different documentation procedures which certifies them as investors (Ahlers et al. 2015).  

Feedback Loop

Lastly, according to Sharp (2014), a feedback loop must be created for the organization and investors so that both the parties are easily able to understand the procedure and provide their views with respect to the same.

Price Points

According to Stanko and Henard (2017), in the crowd funding process it is very crucial for the organization to ensure that the price point which is set for the investment is one which can be resonated both with the customers as well as the company. This is because the crowdfunding backers are more like customers in nature. They must possess a clear idea about the prices in which they are dealing in order to determine transparency of the system.

As examined from the previous analysis on the various literatures as available on the process and concept of Crowd funding. The given factors can be determined to affect a success of Crowd Funding.

The Crowdfunding is an internet based funds collection procedure. The different companies who may be interested in accumulating the funds from the different consumers and raise adequate finance for their chosen business enterprise, may approach the path of crowd funding. There are various middlemen involved in the given procedure which may assist the organization in ensuring that they are able to gather the adequate finance as required for the given business enterprise and are successfully able to ensure that the entire procedure of crowd funding is carried out successfully. According to Belleflamme, Lambert and Schwienbacher (2013), crowd funding initially became very popular when it was being used for arts and music communities. In the year 1997, crowdfunding in the online domain was done for the music industry whereby US$60000 was raised by a fan based internet campaign. In the same manner, the film director Mark Tapio Kines raised a high amount of US$ 125000 in the year 1999 to complete his movie.

Any company looking out for crowd funding just needs to look out for a platform for the same. The ArtistShare platform gained immense importance back in 2003 and as the model matured, more platforms like the Kiva in 2005, Indiegogo in 2008 and You Caring in the year 2011 came into existence (Agrawal, Catalini and Goldfarb 2015). Hence, these crowd funding sites have increased considerably and presently in the year 2018, there are more than 2500 websites. The project creators can simply exercise their research to understand the platform they would like to select and then lay out their funding requirements.

The risk factors involved in the crowdfunding procedure is considerably low as compared to the other sources of funding for any startup. This is because, the procedure involved in the crowdfunding is considerably easier in nature and that crowdfunding systems like the equity based and reward based do not have high return rates as well. There are various other kinds of crowd funding’s also available which provide the opportunity to an individual to raise money in the form of a social objective whereby the investors who are paying the funds do not need to be given back their money.

According to Colombo, Franzoni and Rossi?Lamastra (2015), this leads on to make the crowdfunding technique a comparatively simpler and easier one which tends to ensure that more startups approach it as a method to raise the funds for their startups.

Another factor which aims to crowd funding an attractive option for the different investors is that significant amounts of funds are available for the given companies on this platform. Past experiences and case studies based on the concept of crowd funding have reflected that the organizations which are involved in the given field have taken adequate help from the crowdfunding platforms and have been easily able to gather a large amount of funds for this purpose (Gerber and Hui 2013).  For instance, the Pebble Time Awesome Smartwatch was able to gain USD$ 20338986 from the Kickstarter platform. Another instance can be given of the Kingdom Death: Monster 1.5 which was able to raise a huge funding amount of US $1239139 from the same Kickstarter platform. 

Hence, from the given analysis it can be easily witnessed that if the purpose and the message given out by the organization is clear in nature then the organization will be able to easily gain a large funding Hence, the crowdfunding method is greatly successful because of the nature of response given by the investors.

There are number of major factors or components are being identified of startup. One of the major factors is source of funding. This factor is being considered due to the reason that startups are majorly being started on small scale with having limited access to funding. Thus it is important for the startups to have an effective source of funding to drive their business operation (Wheat et al. 2013). There are number of sources of finding available to the startups and in the following sections it will be discussed and critically analyzed in details. The next factor or component being identified is the growth opportunity for the startups. This is also important due to the reason that continuous process of growth will help the startups to survive in the competitive business scenario. In the following sections, the opportunities available to the startups in regards to the growth will be critically discussed and the ways that will complement the growth of the business. The last component being identified is the risk factor. This refers to the business risks to be taken by the startups in their daily operation. The following sections will discuss about the level of risks should be taken by the startups and the ways for mitigating these risks.

The major funding options available to the startups are being discussed by Kearns, Bell, Deem and McShane, (2014). According to them, startups and the nonprofit leaders evaluate their funding options on the basis of different criterions. According to the authors, the major criteria that are used by the managers or the leaders are the alignment of the funding source with respect to the organizational mission. This is due to the reason to the reason that some of the establishments especially the nonprofit organizations and the startups has to regulate their funding in line to their organizational process and practices due to their limited resources and infrastructure. It is also being discussed by the authors that small business organizations accept the funding process that is easy to initiate and having less risk. Thus, it can be concluded from this article that source of funding is an important determining factor for the startups and the funding process should be selected properly.

The article by Kearns, Bell, Deem and McShane (2014), named ` How nonprofit leaders evaluate funding sources: An exploratory study of nonprofit leaders. ` was completed by conducting interviews with the upper level managers in order to identify their approach towards the source of funding. Questionnaires are being used for the survey being done in the article. Thus, the data being used is more authentic and reliable due to the reason that the information is gathered directly from the respondents. However, on the other hand, there are some shortcomings being identified with the research process. One of the major issues identified is single side approach of the article. This refers to the fact that this article only discussed about the criteria based on which funding sources are being selected. However, the practical impact of different funding sources on the startups is not being discussed in this article.

According to Butler, Galassi and Ruffo (2016), there are number of funding options being available for the startups. However, the level of risks is different with different funding mode. This article has taken the example of Argentina and discussed about the public funding scenario in the country. According to the authors, majority of the startups are opting for the public funding due to the lack of access to other source of funding. In addition, it is also being said by the authors that other sources of funding for the startups are time consuming and complex in nature. For instance, one of the major sources of funding for the business is the government assistance but in order to have this assistance, startups have to invest more time and they have to adhere to complex government rules and regulations. Thus, according to the authors, these factors are refraining majority of the startups from opting for other sources of funding rather they are sourcing fund from the public.

From this article, it can be concluded that public funding can be considered as one of the most effective sources of fund for the startups. However, the major shortcoming that is being identified in this article is lack of information about the other sources of funding. In this article, no major information is being given by the authors about the different sources of funding. Thus the proper comparison between the available sources of funding cannot be done with this article. Another major shortcoming identified with this article is the absence of information regarding the disadvantages of using public funding. However, in practical there are issues that will be faced by the startups in initiating public funding. 

Growth opportunity is another important factor for the startups due to the fact that the future potentiality of the business is depending on this factor. As told by Eiriz, Faria and Barbosa (2013), growth of the firm will determine the viability of the entire business. Moreover, it is also being stated by the authors that it is important for the small business organizations especially the startups to consider different factors prior to initiating the funding sources. One of the factors identified by the authors is the technology. This refers to the fact that advancement of the technology by the particular startup or the access to latest technologies determines the extent to which the startup will have advantages in the market and can grow further. It is also being stated by the authors that innovation also determines the growth prospect of the business. This is mainly due to the reason that of innovation will help the startup to have distinctive approach in the market and it will also enable them to compete with the existing player in the market.

The last determining factor identified by the authors is funding. This refers to the source of capital for the organization or startup. According to the authors, funding is also a determining factor in growth prospect due to the reason that the more will be the access of funding of the organizations, the more will be their ability to invest in their business and to compete against their rivals (Kuppuswamy and Bayus 2018). It should be noted that doing business requires huge investment in different sectors and having the access to funding sources will enable the startups to continue their business growth by investing accordingly. It is identified that this article concluded with the data sources from secondary resources. Thus it can be concluded that reliability and authenticity will less with this article. In addition, the authors have not discussed about the challenges that may be faced by the startups from their funding strategy. However, without the information of challenges, the effectiveness of the funding strategy in maintaining the business growth cannot be analyzed.

On the other hand, Gupta, Guha and Krishnaswami (2013) have elaborately discussed about the relationship between the different factors and the growth strategy of the small business organizations. According to the authors, technology, innovation and funding will not only determine the growth prospects of the startup but also the external business factors. This is due to the reason that if the organizations are having access to latest technologies and seamless funding sources then also they may get failed due to the unfavorable external environment. However, it is also being stated by the authors that funding sources is an important and key factor for the growth of the business. The authors stated that if the business is having seamless supply of funding with having risk, then they will have more capability to cope up with the change in the external factors.

However, the major limitation of this article is that authors have not discussed specifically about how the change in the external environment can determine and influence the growth prospect of the business. Thus, it is unclear to identify the exact effects on the business. In addition, this article is also based on the secondary data due to the fact that no evidence of primary data is being identified in it. Thus, the authenticity is another limitation with this article.

Risk factor is another important component for the startup due to the reason that small business organizations are having less access to resources and infrastructure. Thus they have to take more risk in the market and they are also more vulnerable towards loss in the competition. According to Drehmann and Nikolaou (2013), one of the major risks taken by the startups is related to their funding. This is due to the fact that startups cannot source their fund requirement by own and within their limited capability. They have to take the external assistances in terms of investments, financial aid, loans and crowd funding. The funds coming from the outside sources should have to be repaid. As per the authors, risk originates in this point when the organization cannot repay their fund due to business turbulences.

The authors have also stated that business organizations mainly the small business organizations have to face this risk of not being able to repay the fund. There are number of external factors ranging from the economic recession to market shrinkages that are responsible in reducing the business capability to repay the fund. Thus, according to the authors, it is important for the small business organizations to properly choose the funding sources according to the requirement of the organization. This article is being done with the help of data collected from the ECB between 2005 and 2008. However, this article lacks the clarity in understanding the certain risks in relation to the funding process.

Vazquez and Federico (2015) stated more in details about the risk related with the funding process. According to them, bank funding is having huge risks for the small business organizations. This is due to the reason that in case of the bank funding, organizations or startups should have to repay within the exact given time frame whether they are incurring loss or not. Thus, it can be concluded that startups should be careful about the funding from bank and they should select other funding methods such as crowd funding that is having less risks and complexities. In this article only the risks related to the bank funding is being discussed and the advantages are being skipped, which is one of the major limitations being identified.

According to Colgren (2014), the primary problem faced by any startup is the funding of the operations. If the organization is unable to find any adequate funding sources then it may face issues and may become obsolete and die at an early stage.  For this reason crowd funding is considered to be essentially effective for startups. The crowdfunding are popularly known to have a positive impact on the different startups as they essential aspects of the crowdfunding tend to have a direct connection to the factors influencing the success of the startups.

 Agrawal, Catalini and Goldfarb (2014), state that the first positive impact of crowd funding on the different startups is that the procedure is very fast and easy in nature. The procedure of attaining an angel funding is very difficult in nature, but this is not the case of crowdsourcing funding as the average length of a crowdfunding campaign is around 30 days long. There exists presence of various Indiegogo and Kickstarter which makes the entire positioning faster. Hence, as the startups are always looking out for funds, the nature of the funding based on crowd funding makes it essential suitable for startups. Using the crowd funding source, a startup will be easily able to kick start their business.

Secondly, the success of a new startup is largely based on the response it achieves from the different customers and investors.  If it is possible for a startup to attain early responses from the customers, the firm can undertake corrective measures to improve their business. Hence, in this aspect, it becomes easier for the firm with the help of crowdfunding to understand whether the startup idea is successful or not. According to Wieck, Bretschneider and Leimeister (2013), crowd funding offers to create an opportunity to find out exactly what the core audience tends to think about the startup. Hence, with the help of crowd funding understanding business flaws becomes considerably easier to understand and correct an early stage of the project design.

According to Lasrado and Lugmayr (2013), the risk taking appetite of the entrepreneur also goes a long way in assisting the organization to understand the different risks which the startup is willing to undertake in order to achieve success. The entrepreneurs which are conservative in nature, like to undertake lower risks than those who have a higher appetite for risk. The crowdfunding source of financing is one such source where the risks involved are considerably lower as compared to other sources of financing. In this scenario, the lower risk component of the crowd funding procedure greatly attracts the entrepreneurs who want to see their business achieve success but want a safer source of funding. Hence, in such a scenario, the crowdfunding comes in useful for the startups which helps them to fulfill their funding aspects without compromising much on their risk taking capacity.

Additionally the amount of funds which can be gathered from crowdfunding is considerably higher in nature. Other sources of financing are sometimes unable to gather large amount of funds due to the uncertainty of startups and other such ventures. However, this is not the case of crowdfunding. The amount of money gathered through different platforms is very high in number. .

Therefore, from the given analysis on the literature available on the topic- Impact of crowdsourcing on Startups, it can be stated that with the advent of technology and globalization, the use of internet has increased considerably. The use of technology and the internet has reached all domains of human activity (Manchanda and Muralidharan 2014). Until now, managing a startup was extensively difficult due to the difficulty undergone by the entrepreneurs to attain the designated finance for their ideas and the capability to sell their imagination. However, with the concept of crowdfunding becoming popular in the 1990s, the dynamics of entrepreneurs has changed considerably. Crowdfunding has made it considerably easier for all the different business enterprises to inculcate finance faster and in a simple manner. Crowdfunding runs with the help of different platforms which helps a startup or a social cause to earn funding investors to invest from all parts of the globe (Belleflamme, Lambert and Schwienbacher 2014). Its components like the low risk factor and the easy to gather aspect, makes it extremely suitable for the startups to accelerate their growth rate at the introduction stage of their company. The review explored the concepts of crowd funding’s as available and determined their positive impact on startups through a conceptual framework. 

                             

According to Mollick (2014), crowd funding has greatly allowed the different investors to invest in growing startups. On the other side of the bench it has even allowed the entrepreneurs involved in the startup to perform well due to the early acceleration of growth being received. The study by the author undertook a dataset of more than 48500 projects with total funding of around $237 million and determined the different success and failures that took place in these ventures. The study represented that over 75% of these projects were being delivered late but a majority of the founders were successfully being able to fulfill the needs of the investors (Aldrich 2014). Other explorative studies taken on the given topic have resulted in the understanding of the fact that crowdfunding has gained utmost importance in the recent years and that on an average around 60% of the new startups who want to increase their business, tend to invest via crowdfunding sources. This has led to an increase in the number of startups and a boost to the economy around the globe.

The paper reviews extensive literature available on the given topic which aimed to analyze the impact of crowd funding on the startups, however, there exist certain limitations in the review. The review did not consider any primary data analysis in its research.

Secondly, as there was limited empirical data available, a theoretical approach to the data has been followed. Various newspaper articles, published journals and books have been reviewed along with certain blogs. However, a more theoretical approach has been followed which makes the study limited with respect to being backed by data.

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