Crowdfunding revolutionises venture funding

Through its powerful ability to remove intermediaries from transactions, the internet excels at making once-bizarre ideas the norm.

Buy things directly from total strangers, send them your money and actually expect the items to arrive at your door, rather than have the seller abscond on a Caribbean holiday? Well, hello eBay.

Give money to someone online that you’ve never heard of because they want to make something that intrigues, form a company or borrow some cash?

That is the rapidly developing world of internet crowd funding, a market worth about $8 billion annually.

As unlikely as the idea initially seemed to many, it has turned out that there were – and are – millions of people willing to give money to people whom they have never met. That notion immediately intrigued an Israeli finance graduate student named Dan Marom.

In 2009, Marom was looking for a subject for his dissertation, just as the crowdfunding phenomenon began to take off. A former entrepreneur with experience in research and development, Marom began to gather datasets, look more closely at the idea and think about where crowdfunding was likely to go.

It was too early, with too little happening on the ground for the topic to make a scholarly dissertation, but it led Marom to author a co-written book (with Kevin Lawton), The Crowdfunding Revolution, one of the very first books on crowdfunding. And it was – of course – crowdfunded into publication in 2010. Mainstream publisher McGraw-Hill released a revised second edition in 2012.

“I think crowdfunding is a crucial toolkit for an entrepreneur,” he says, noting there are now more than 1,000 online sites for the activity. “It’s the democratisation of entrepreneurship.”

During an interview after giving a talk at the Innovation 2.0 conference at the Convention Centre Dublin last Thursday, Marom noted many misunderstand what crowdfunding is about.

To begin with, he said, it is not just about Kickstarter, the well-known funding platform for various projects and products that helped launch, and continues to shape, how we view internet fundraising. Kickstarter alone has raised nearly a billion dollars in the last 4½ years – “but Kickstarter is only the tip of the iceberg”.

Broader market

Crowdfunding is much broader and covers four areas, as he sees it: reward-based efforts such as the projects on Kickstarter (where donors get something in return, such as the initial run of the product or other perks); donations (an area pioneered by then presidential candidate Barack Obama); debt (peer-to-peer lending); and equity (investing in a company and receiving shares).

“Many policy makers are beginning to understand the importance of it,” he said. “It’s injecting new energies into the economy.”

It’s more than just a funding mechanism, he believes. “It’s not only about returns. It’s a social phenomenon. People feel attached.

“It is a combination of functional and emotional values. People think, ‘I want to be part of this emotional journey. I’ll get to see it happen and be a part of it’.”

Certainly, going just on anecdotal evidence and comments on various projects on fundraising sites, people do like the journey, with many willing to give modest amounts for no direct benefit except to see a product come into existence they might later buy.

However, Marom noted people can also feel let down by the process, as some did when virtual reality headset makers Oculus Rift – one of Kickstarter's most famous successes – went on to be acquired by Facebook.

“I think that was a misunderstanding of the process,” he says. “People bought a product [on Kickstarter], not a share of the company.”

Now, however, company shares are also part of the crowdfunding menu, with some commentators predicting it will turn conventional venture funding upside down.

“It’s very popular to say it will destroy conventional venture fundraising, but my personal view is that the future lies in a synergy,” he said.

Funding from the bottom up, via crowd- funding, means potentially, many expert eyes perform due diligence on a company and its ideas. Funding from the top down, via venture capital, means a limited number of experts examine the company.

“Sometimes it’s wiser to have the crowd do due diligence,” Marom noted, but this raises the issue of both capability – are the crowd’s eyes truly that informed? – and of trust.

Certainly, the crowd is likely to have more experts than a given venture firm, he said and, he argued, “it’s not easy to fool the crowd, but it can happen”.

However, online funding platforms like Kickstarter do have measures in place to protect investors against fraud, such as a fake company being set up to gather financing.

Market regulators are now getting in on the act. Late last year, the Obama administration initiated a new set of rules around online fundraising and investing.

That is not surprising, if one considers just the huge peer-to-peer market now for loans. Half a billion dollars are transferred each month between peers using online platform Lending Club, in which Google has invested $125 million, Marom said.

Given such developments, budding entrepreneurs should learn how to use crowdfunding as one potential finance platform,and it’s a subject that should be included in university business curriculums, according to Marom.

Disappointing results

He had heard about Trinity College Dublin’s recent disappointing results with its own new crowdfunding platform. None of the three companies seeking funds met its target, but the idea for a university-based platform is essentially good, he says.

“I think it’s a great initiative. Today’s universities should give students a set of crowdfunding tools – and you do learn from failure.”

Overall, better market awareness of the process is needed on both sides – that of the funder and the funded – to manage expectations.

Marom is thinking now about a new book, on borderless organisations, which again will be co-authored. It is “the idea of the corporation meeting crowdfunding”. Businesses will increasingly begin to think about crowd assets, “not just funding, but also crowd-sourcing new ideas and also, crowd-sourcing execution”.

Already, companies like IBM are using crowd-sourcing internally to find innovative ideas the company might further develop, he noted.

The new book will be about how companies can find their crowd assets, and monetise and fund them, he said. “I think it’s a crucial way of thinking and companies should look at it and see if it fits. I’m certain the next generation organisation will look quite different.”