No longer just for bands looking to tour, or for startups lacking access to financing, crowdfunding has become a way to sound out the market for innovative businesses
Crowdfunding has enjoyed a rapid rise among startups, generating a new path for entrepreneurs to become an overnight success. Once a niche and assumed risky practice, crowdfunding sites such as Kickstarter and Indiegogo provide a platform on which entrepreneurs, companies and artists raise funds for creative projects, ranging from disruptive new gadgets to contemporary dance performances. Investors, individual or institutional, can buy products and donate to projects.
Over the past 20 years, crowdfunding has evolved from a small personal funding platform – it was, for instance, used to fund British rock band Marillion’s reunion tour in 1997 – to a comprehensive validation tool for startups, corporates and artists. Funds raised from crowdfunding last year passed venture capital financing for the first time. The World Bank forecasts global investment through crowdfunding platforms will reach $96 billion by 2025. Goldman Sachs said in a report published in 2015 that crowdfunding was “potentially the most disruptive of all the new models of finance”.
While people commonly think financial constraints are the main reason entrepreneurs turn to crowdfunding, recent empirical evidence suggests otherwise. In a recent research paper, we developed a model to understand why reward-based crowdfunding is so efficient.
We emphasised that, in addition to providing funding, reward-based crowdfunding platforms play an important role in enabling startups to learn about demand for their product or service before making investment decisions. Pre-selling through crowdfunding platforms can be a credible consumer survey; it provides new and valuable information about future sales prospects. Because of that, a startup can hedge its bets by only developing a project after it observes sufficiently high consumer demand — and save on the investment cost if demand is low.