Choosing the Right Crowdfunding Type for Each Stage of the Startup Life Cycle

See discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/311854157
Choose wisely: Crowdfunding through the stages of the startup life cycle
Article in Business Horizons · December 2016
DOI: 10.1016/j.bushor.2016.11.003
CITATIONS
18
READS
1,795
1 author:
Some of the authors of this publication are also working on these related projects:
The role of IT for value creation in service ecosystems View project
Jeannette Paschen
KTH Royal Institute of Technology
15 PUBLICATIONS 30 CITATIONS
SEE PROFILE
All content following this page was uploaded by Jeannette Paschen on 06 October 2017.
The user has requested enhancement of the downloaded file.

Choose wisely: Crowdfunding through the
stages of the startup life cycle
Jeannette Paschen
Royal Institute of Technology (KTH), Stockholm, Sweden
1. Startups and crowdfunding
Startups require resources to succeed and one of the
most important resources is money. Traditionally,
the options for capital formation available to start-
ups were few and comprised primarily of FFF
(friends, family, fools), angel investors, venture
capitalists, and seed funding (Startup Explore,
2014). More recently, there has been a surge in
alternative models. Among these, crowdfunding
has emerged as a popular source of capital forma-
tion in various fields–—from purely for-profit to social
causes, technology, performing arts, real estate,
and music.
Crowdfunding draws inspiration from the ideas of
microfinance (Morduch, 1999) and crowdsourcing. It
encompasses the outsourcing of an organizational
function (capital formation) to a strategically
defined network of actors (crowd) in the form of
an open call (Kietzmann, 2017) via dedicated web-
sites (crowdfunding platforms). And small amounts
of money from a large number of people add up. In
2010, crowdfunding was a relatively small industry
Business Horizons (2017) 60, 179—188
Available online at www.sciencedirect.com
ScienceDirect www.elsevier.com/locate/bushor
KEYWORDS
Crowdfunding;
Startup funding;
Crowdsourcing;
Crowd capital;
Information
asymmetry;
Crowd communication;
Startup strategy
Abstract Crowdfunding is attractive to startups as an alternative funding source
and offers nonmonetary resources through organizational learning. It encompasses
the outsourcing of an organizational function, through IT, to a strategically defined
network of actors (i.e., the crowd) in the form of an open call–—specifically, requesting
monetary contributions toward a commercial or social business goal. Nonetheless,
many startups are hesitant to consider crowdfunding because little guidance exists on
how the various types of crowdfunding add value in different life cycle stages and
which type is best suited for which stage. In response to this gap, this article
introduces a typology of crowdfunding, the benefits it offers, and how specific
benefits relate to the identified crowdfunding types. On this basis, we present a
framework for choosing the right crowdfunding type for each stage in the startup life
cycle, in addition to providing practical advice on crowdfunding best practices. The
best practices outlined have shown demonstrable contributions toward achieving
funding goals and are likely to prove valuable for startups.
# 2016 Kelley School of Business, Indiana University. Published by Elsevier Inc. All
rights reserved.
E-mail address: [e-mail]
0007-6813/$ — see front matter # 2016 Kelley School of Business, Indiana University. Published by Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.bushor.2016.11.003

to the tune of $880 million worldwide. In 2015,
estimates put the global crowdfunding industry at
$34.4 billion (Massolution, 2015).
Crowdfunding is especially suited for startups
trying to turn an idea into a viable business and
young companies aiming to maintain or grow their
venture (Stemler, 2013). Both face challenges when
trying to secure funding. Due to lack of credit and
operating history, startup founders often have diffi-
culties conveying the value of their proposed venture
to investors. Startups, therefore, have difficulty
accessing traditional funding options such as bank
loans, venture capital, or angel investments. These
challenges are exacerbated for social ventures,
which are driven by the ambiguous and sometimes
dichotomous goal to achieve a double bottom line:
to balance social and for-profit goals (Lehner, 2013).
In addition, it is often prohibitively expensive for
young businesses to access wider traditional capital
markets (Tunguz, 2013). These and other factors,
such as the shortage of capital provoked by the
global financial crisis and the growth in other forms
of crowdsourcing, have contributed to the rise of
the crowdfunding phenomenon in recent years
(Giudici, Guerini, & Lamastra, 2013).
As crowdfunding has been growing in popularity,
so has its exposure in academic and practitioner-
oriented literature. A number of articles have de-
veloped independently of one another but without a
unifying framework to understand crowdfunding in
the context of the startup life cycle. As a result,
startups considering crowdfunding have little guid-
ance on how to decide among the different types of
crowdfunding available and the benefits each type
can offer in different startup stages. This is an
important consideration since funding needs vary
significantly across stages, as do the types of returns
and assurances offered to a crowd in different
crowdfunding variants.
This article closes the research gap by elucidating
which crowdfunding type is most appropriate for
startups in each life cycle stage. It first lays out a
typology of crowdfunding, the benefits crowdfund-
ing offers in terms of financial and nonmonetary
resource provision, and how these two aspects in-
tersect. This leads to a framework for decision
making, enabling the startup to choose the crowd-
funding type best suited for its specific life cycle
stage. Once crowdfunding alternatives are consid-
ered and a choice has been made, startups face the
next problem: how to attract a crowd and its con-
tributions. This article addresses this by outlining
best practices for crowdfunding alternatives at each
stage.
2. Types of crowdfunding
Crowdfunding as an online distributed funding model
suggests that requesting relatively small monetary
contributions from a crowd helps startups acquire
critical financial resources. In this context, crowd-
funding is viewed as a homogenous concept: a gen-
eral request for money via an open call. However,
just as the funding needs for startups vary, crowd-
funding varies by the type of rewards offered to
supporters. The following section outlines a typology
of crowdfunding (see Table 1) by considering if re-
wards are offered and whether they are tangible or
non-tangible (Belleflamme, Lambert, & Schwien-
bacher, 2014; Canada Media Fund, 2016; NCFA,
2012).
2.1. Donation crowdfunding
In the donation crowdfunding model, the founder
receives money from a crowd without any tangible
return for that contribution (Canada Media Fund,
Table 1. Typology of crowdfunding
180 J. Paschen

2016; NCFA, 2012). In the pure donation model, no
rewards at all are offered to contributors. The funds
received are essentially a grant given for a specific
purpose, but without the expectation of a specific
return to the funder. According to a 2015 industry
report by Massolutions, donation crowdfunding gen-
erates the second-largest funding volume globally
(NCFA, 2015) and the idea of donation crowdfunding
has been successfully utilized in social marketing for
a number of years (Lehner & Nicholls, 2014).
The rewards-based donation model employs an
incentive system whereby backers receive nonmon-
etary rewards that include personal recognition or
experiential rewards, such as the opportunity to
meet the creators, attend special events, or even
to participate in the creation of the product. Dona-
tion crowdfunding is more popular for projects with
smaller funding goals; globally, 90% of donation
crowdfunding campaigns raised less than $10,000
(NCFA, 2012).
2.2. Lending crowdfunding
Lending crowdfunding, often referred to as peer-to-
business (P2B) or peer-to-peer (P2P) crowdfunding,
raises money with the expectation that founders
will repay supporters. Lending crowdfunding is the
largest crowdfunding type by funding volume (NCFA,
2015) and takes one of three forms: (1) the presales
model, (2) the traditional lending model, and (3) the
forgivable loan (NCFA, 2012). The presales model
offers the finished product in return for the contrib-
utor’s pledge; the contribution amount requested
from each crowd member is determined by an as-
sessment of the fair market value of the product.
How many presale copies the founder offers de-
pends on the funder’s total contribution amount–—
larger contributions typically mean a supporter
receives more copies (NCFA, 2012). The first-
generation Pebble smartwatch is among the most
well-known presale campaigns. It raised more
than $10 million from nearly 70,000 funders on
Kickstarter, more than 100 times its funding goal,
and Pebble delivered its first round of watches
10 months after the campaign ended (Schroter,
2014). The traditional lending agreement uses stan-
dard terms where loans are repaid with interest
determined pre-campaign launch. The forgivable
loan repays contributions only if and when the
project begins to generate revenue or profit. With
both the traditional and forgivable loan, crowdfund-
ing projects are assessed according to their risk
levels–—either by the platform itself or by a third-
party evaluator. Lenders choose the level of risk
they are prepared to accept and support projects
accordingly.
2.3. Equity crowdfunding
In the equity crowdfunding model, also referred to
as investment crowdfunding, the venture raises
money from a crowd in exchange for an ownership
stake in the firm. That is, investors are offered
equity or bond-like shares (Ahlers, Cumming,
Guenther, & Schweizer, 2015). Equity crowdfunding
is the fastest growing crowdfunding category and
the average campaign value is high. 1 Investor-led
equity crowdfunding typically involves accredited
investors, such as venture capitalists, angel inves-
tors, or sector specialists who negotiate with the
founder on funding terms. These projects are then
promoted to accredited investors via platforms that
are often subscription-only (Wagner, 2014). In
entrepreneur-led equity crowdfunding, campaigns
are accessible to all crowd investors and the cam-
paign proponent sets the valuations and determines
the terms of the offering.
3. Benefits of crowdfunding for
startups
The previous section introduced a typology of
crowdfunding that considers the type of return or
reward to backers. While this is an important first
aspect to understand, a startup also needs to con-
sider the specific benefits it aims to achieve in
pursuing crowdfunding efforts. First, crowdfunding
helps alleviate the capital crunch many startups
face. Many campaigns aim to raise a relatively small
sum of money for a one-time project or event (Mollick
& Kuppuswamy, 2016). Other projects intend to raise
a substantial amount of money for more complex
and long-term undertakings, providing founders with
the funds to turn an idea into a viable business
(Mollick, 2014). This method works; 9 in 10 successful
projects on Kickstarter have turned into ongoing firms
and existed up to 3 years later (Painter, 2014).
However, crowdfunding in a startup context is not
just about funding; it also offers nonmonetary bene-
fits that encompass the following (Belleflamme,
Lambert, & Schwienbacher, 2010; Brown, Boon, &
Pitt, 2017; Gerber & Hui, 2013; Mollick, 2014):
 Validating the overall business idea–—Does the
idea actually solve a consumer problem (prob-
lem/solution validation)?
 Refining the product or service with potential
customers by receiving their feedback, likes,
1 About 175,000 in North America (Canada Media Fund, 2015)
Choose wisely: Crowdfunding through the stages of the startup life cycle 181