Is crowdfunding a good option for entrepreneurs, investors and consumers?

And why Kickstarter is failing to deliver on its promise to consumers

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Crowdfunding campaigns are turning millions of ideas into reality. Companies and individuals have raised billions by using this method through the collective efforts of people who believe in these ideas.

In this podcast, Lisa Hehenberger, Lecturer and Director of the Esade Entrepreneurship Institute, talks with Daniel Blaseg, Assistant Professor of Entrepreneurship, about the possibilities of crowdfunding for entrepreneurs, investors and consumers. The podcast also looks into Blaseg’s latest research on Kickstarter, the benefits and risks of this type of crowdfunding, and how consumers sometimes are overly optimistic and the platform fails to meet their expectations.

TRANSCRIPT

Lisa Hehenberger: My name is Lisa Hehenberger and I'm a Professor in the Strategy Department at Esade and also the Director of the Esade Entrepreneurship Institute. Today we are going to talk about crowdfunding with our latest addition to the team, Dr. Daniel Blaseg. Crowdfunding has become very popular in recent years as a means to engage the general public in funding innovative projects. We have an expert with us today to help us understand a little bit more about crowdfunding. Thank you so much for being with us this morning.

Daniel Blaseg: Good morning, Lisa. 

Lisa Hehenberger: We would like to understand a bit more about your research on crowdfunding, but perhaps let's start first with the basics: What is crowdfunding and how did that start?

Daniel Blaseg: Crowdfunding is a way of raising funds in exchange for some form of reward from a large group of people through the internet. But this concept is not entirely new. We had crowdfunding without the internet many years ago. For example, the base of the Statue of Liberty in New York was funded by an early form of crowdfunding. People supported this project by spending one or two dollars and then the New York Times published their names in the newspaper in exchange for their financial contribution. They were able to build the base for the Statue of Liberty by raising many small contributions from a large group of people.

Lisa Hehenberger: That's really fascinating. So it is actually something that has been around for a long time. But how would you say that the internet has actually enabled a surge in crowdfunding initiatives?

Daniel Blaseg: The internet is a big point here in crowdfunding because it enables people around the world to start a crowdfunding campaign without spending a lot of money and it also allows people to directly support campaigns, so they can find innovative products, ideas or projects they want to support very easily on dedicated platforms.

Lisa Hehenberger: What motivates people to engage in crowdfunding campaigns, from both the investor and the consumer perspective?

Daniel Blaseg: It depends very much on the kind of reward consumers are offered. We usually differentiate between four different types of crowdfunding. One of the oldest or most established kinds of crowdfunding is donation-based crowdfunding to raise money for a social project or philanthropic initiative. And usually the backer – the consumer supporting the crowdfunding campaign – receives no tangible reward. Maybe she receives a thank you email, or her name is put on the wall of supporters or donors. It's a new way of online fundraising for social activities.

The second one is lending-based crowdfunding, where people raise money by giving out some kind of loan. So people receive interest for giving money for a project. For example, it can be a person raising funds to buy a new computer, but also to cover other costs such as college fees. They receive fixed interest payments for their financial contribution.

I think the best-known form of crowdfunding is reward-based crowdfunding, which is very well established on platforms such as Kickstarter, where people can pick a wide range of different products or projects. They offer some kind of innovative, tangible product, which the supporter receives in exchange for his support. So they promise to develop a new product and you give a little bit of money to this project, hoping that later you will receive this kind of product. 

The last form of crowdfunding is equity-based crowdfunding, where people can invest in very early-stage companies, something that was previously only available for professional investors such as venture capitalists or business angels. With equity-based crowdfunding, people can invest in equity instruments and young start-ups, and if they perform very well, they will also profit from them.

Lisa Hehenberger: So is it actually also a means of engaging retail investors in this more risky type of investment?

Daniel Blaseg: Yes, but it is way more than raising funds. Crowdfunding allows entrepreneurs to validate the market at a very early stage and use this interest to develop a product that can test different pricing schemes. It also democratizes access to capital. We know that in capital markets and other sorts of finance, minorities were not able to raise funds freely on the market. But with crowdfunding, they are able to start a crowdfunding campaign worldwide and it opens up access to minorities. So that's a big point, though the motivation differs a lot. 

Some people want to support a project and bring it to life by being an early-stage backer. Others see more the financial benefits or the tangible products – they are shopping around. So it differs a little bit based on the project or category you support.

Lisa Hehenberger: You mentioned the benefits of crowdfunding and how it provides entrepreneurs access to finance that perhaps they would not get otherwise. Could you provide more facts on this topic? Is crowdfunding really changing the landscape for entrepreneurs around the world?

Daniel Blaseg: I totally believe this because in earlier times we had a small group of people deciding what products came to the market. You would  go to a banker, or to an equity fund, or to a venture capitalist, and they would decide whether or not there would be a need. With crowdfunding, you can directly test if there is a need and further develop the idea. You get feedback from the investors, who may say: “Yes, that version was very good, but you could improve this, this and this.” So it helps you to show the interest and the market need for your product, but also to improve your products in the following rounds.

And what we see nowadays is that really established companies are using crowdfunding to introduce new products without using large marketing budgets. They target early-stage consumers or backers, who are usually very expensive to convince. There are a lot of different benefits besides raising money, which is also very helpful in many terms.

Lisa Hehenberger: That's really interesting. So there is one part that is more about validation of early-stage products or services?

Daniel Blaseg: It is not possible to concentrate this on one thing. There are also people offering services. For example, an app that is a product on its own could also have a monthly service subscription by crowdfunding. This is often used by media outlets for podcasts, for example, where you pay a monthly fee. This crowdfunding model is called Patreon, and it allows for continuous funding, so you spend a few dollars every month to support a podcast and they raise this money and use it for the product.

Lisa Hehenberger: That's great. And I guess it is also a means of funding new start-ups. You mentioned earlier that it might also help minorities get access to finance. Sometimes there is a bias towards certain groups of society from the perspective of regular investors. Has that been shown in research?

Daniel Blaseg: There have recently been many papers. For example, we know that women were less likely in the past to raise funds from venture capitalists because now they are also on the boards of venture capital firms. Men usually prefer to invest in other man-based companies. And with crowdfunding, we see that the share of women starting a crowdfunding campaign is really high and they are often more successful than their male counterparts. So, it really helps women to raise funds in this sense.

Lisa Hehenberger: That's really fantastic. Let's move on to your own research on this topic. I know that you have been studying Kickstarter. I just read a little bit about it and I saw that co-founder Perry Chen says that Kickstarter focuses on the middle ground between patronage and commerce. So, it's actually a hybrid model. Also, there's obviously no guarantee that the products that are funded will work or that the money will be used efficiently. Kickstarter’s own data shows that 9% of Kickstarter products fail to deliver rewards. What can you tell us about this topic from your own research?

Daniel Blaseg: My main research focuses on two issues. The first one is “Why do firms use crowdfunding?” We have different models to understand why they enter this new kind of market. Maybe it is because they are of lower quality that they don't get funding from other sources? Or maybe because they are connected to a bank that is not able to serve them because they are stressed from the financial crisis? That's what we show in one paper – that the firms are sometimes of lower quality. But the other part is that they are not able to raise funds because of the current capital markets. So again, it helps grant access to finance.

I'm also looking into what happens after the crowdfunding campaign. As you said, about 9% of ideas on Kickstarter don’t deliver the product, because it is not guaranteed. Crowdfunding is a mass market today. There are many, many millions of people registered on Kickstarter. In our research, we show that many people are not aware of these risks. So when you back a project, Kickstarter states that it is not a store. 

But we show that many people are not aware of this risk and are very disappointed when the project is delayed. We also checked these numbers: 9%. What we find is that most projects, especially in the technology and games category, are delayed for a long time, at least about 80 or 90 days. We show that more than 9% are not delivering. I'm not saying these projects are scamming. 

Lisa Hehenberger: They are over-optimistic... 

Daniel Blaseg: Exactly, that's the point. So they promise they create a new product that is usually not on the market today. It's not that they sell an existing product. They raise funds to develop the product and in many cases they are over-optimistic. They promise too much, they give too many discounts, for example, dismissing discount margin. Or the demand is too high, and when the demand is too high, you have to switch suppliers later. You planned to produce on a small scale, but then you have more than 250,000 backers on Kickstarter and you have to deliver. Then you have to switch everything. So there are many risks in the process and it depends on how you define delivery. Many projects fail but have a good explanation, but some projects do not communicate this afterwards.

Lisa Hehenberger: Why do you think consumers buy products through Kickstarter if they know that there is a risk?

Daniel Blaseg: That is the question. Do they know that there is a risk or not? It's very difficult to say “buying” because that's not the case on Kickstarter. You're not buying the product.

Lisa Hehenberger: But they think they're buying.

Daniel Blaseg: What we see from analysing more than 9 million consumer comments on Kickstarter is that many of them think that they bought the product at this place and that there is a guarantee.

Lisa Hehenberger: But actually it's an investment in the project.

Daniel Blaseg: Formally, I think it's more like donating money to a project and you are offered the reward in exchange. But it’s very difficult to analyse the legal side. This is not like Amazon. On Amazon, when you pre-order something, there is a guarantee that you will get the project because there is a valid contract. It’s way more difficult to think about this on Kickstarter. Many consumers are maybe not aware of this product risk. But there's also recent research showing that scams are very rare on Kickstarter. So it's very important to say yes, maybe they are over-optimistic – which is important because otherwise maybe they would not start a project – but they are not cheating. They are not fooling around.

Lisa Hehenberger: So you still recommend that consumers continue supporting projects through Kickstarter.

Daniel Blaseg: Exactly. I do. I now support more than 90 crowdfunding campaigns. I got most of them. Most of them are delayed. Some of them are not up to date. At any moment, you receive the product. But still, I totally believe in this market and it can help us to define a new way of putting the consumer in the middle of the process of discovering ideas because you can decide what you want to support and how to bring it to the market.

Lisa Hehenberger: And if you actually identify a particularly interesting product through Kickstarter, can you then invest in that company later on?

Daniel Blaseg: Usually not, but it depends on the type. As we discussed, on Kickstarter it's the reward-based type and there are some cases where people were really disappointed because they backed the project. For example, Oculus Rift, which is virtual reality glasses depicted on Kickstarter – backing this project was really risky. It was early-stage, and then the company was bought by Facebook. But consumers did not profit from this one because it was reward-based. 

Lisa Hehenberger: They got no upside from this. 

Daniel Blaseg: Exactly. But when the company is on equity-based crowdfunding, by using this model, then you could profit from this one. There are already some unicorns, especially in the UK, funded by Kickstarter. For instance, the banking start-up Revolut.

Lisa Hehenberger: Are there new research topics that you are interested in engaging with on this overarching topic of crowdfunding?

Daniel Blaseg: Yes. On the topic of over-optimism, my co-author and I are currently looking into why people are over-optimistic and how can we help to develop more realistic plans. We are developing a model (a website) where we can help consumers and entrepreneurs to create more realistic plans. Because we have seen that many people forget, for example, the shipping costs. It often happens that backers change their address and the possibility of something being sent back creates a lot of additional return costs. Many people forget about this. Our model will help entrepreneurs to develop more realistic plans and consider all these unforeseen costs.

Lisa Hehenberger: Thank you so much, Daniel, for sharing your insights from your research. I do think that crowdfunding is a really fascinating topic. What we've seen from Daniel's research is really that it's a means of getting access to financing for really new entrepreneurial projects, but it's also a way for consumers and retail investors to invest in these types of projects and organisations. Thank you so much for listening today.

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