Crowd-Funding as a Source of Funding for SMEs - Essay Example

Crowd-Funding As a Source of Funding for SMEs Introduction Crowdfunding refers to the practice of financing projects or ventures through contributions raised from many people through the internet (Bradley, Luong,). Crowdfunding involves collecting small amounts of money from many individuals from the wider population; the European crowdfunding industry was valued at €1 billion in the year 2013 (Members Research Service, 2014). Evidently, the 2008/2009 economic meltdown greatly narrowed banks’ lending to businesses; in that respect, this deficit in financing together with the massive growth of the social media and interactive platforms have led to the increased popularity of crowdfunding as an alternative source of financing (Rees-Mogg, 2013). The European commission is presently dedicated towards releasing the potential of crowdfunding in the European Union, with the aim of enhancing the longer-term funding of enterprises and encouraging innovation (EOS Gallup Europe, 2005). Technology ventures have been on the rise lately, particularly due to high public technology interest; these ventures rely on scientific and technological advancement, selection as well as development of new products, assets or their attributes (Berger & Udell, 1998:1). Small and medium-sized enterprises (SMEs) make up a vast proportion of all the new jobs creations, with start-up companies introducing new ideas or processes of production that revolutionize ways of doing things. In the European Union, SMEs are considered to be non-subsidiary, autonomous businesses that employ fewer than 250 employees while in the US, SMEs entails firms with less than 500 workers. SMEs have gained increased attention in the previous years, as a result of their massive growth that has been attributed to the increased access to financing (Berggren, Olofsson, Silver, 2000). According to Grant Thornton, a guest speaker from Les Ross, SMEs get most of their funding from banks; given that SMEs account for the greatest number of businesses and jobs in the European Union (Kira, 2013), the commission projects that crowdfunding has the capacity to promote economic growth and job creation. This paper critically discusses crowdfunding as a potentially alternative source of funding for technology ventures, with particular attention given to small and medium-sized enterprises (SMEs). Discussion The global crowdfunding industry has experienced massive growth over the years, especially with the rapid growth of internet resources (Deakins & Freel 2012, p.9). By 2013, this industry had been estimated to be worth over $5.1 billion. The concept of crowdfunding was first popularized in the UK when rock band Marillion solicited for funding for its 1997 US tour from fans (Buff, Alhadeff, 2013). Ever since, crowdfunding has taken on much significance as a potentially alternative source of funding for SMEs with the decreasing dependence on external sources of financing (Davis, 2011, p.11). Crowdfunding links individuals or groups willing to give, lend or invest money in those that are seeking funds to support certain projects. Usually, calls for financing are published on internet platforms and marketed on social media, and the campaigns often include the estimated target amount, deadline date as well as project distribution and pitch videos (Ley, Weaven, 2011). The amount of contributions may range from a few euros to a set cap while the typical target amount for every campaign may be over €50,000 (Members Research Service, 2014). There are two major types of crowdfunding namely Rewards and Equity; the former entails pre-selling a product or service to launch a business idea without having to incur a debt or to sacrifice equity while the latter involves exchanging the pledged sum of money with the shares of a company. Precisely, the two primary types of finances that can be obtained through crowdfunding are those with and without financial returns; donations and rewards are the basic non-financial models of crowdfunding (Members Research Service, 2014). In the non-financial return model, individuals or groups funding the project expect a non-monetary reward of symbolic value or no return on investment at all. A variation of this is what resulted to the pre-sales typology, where individuals contribute money to fund the development and production of a new product that will later be shipped to them. On the other hand, lending and equity crowdfunding are the basic financial return models of crowdfunding; the lending model entails individuals or groups funding a project in return for repayment of a loan while the latter involves shareholding or profit-sharing. Financial-return and non-financial return crowdfunding are based on varied philosophical logics and operate on different sets of principles. The choice of the type of crowdfunding to adopt largely depends on the type of business and what the funds will be used for; for example, companies intending to use debt funding must provide evidence of their capacity to service the loan by paying interest. In that case, debt funding is not an appropriate route for start-ups seeking to establish and grow themselves and those that are yet to become adequately profitable to service a loan by paying interests. On the other hand, reward based crowdfunding is most suitable for those businesses that are looking to venture into consumer products at a target of about £100 and below (UKCF, 2014). Reward-based crowdfunding is undoubtedly an incredible way of testing the market available for the consumer products to be launched and effectively pre-selling some of them; the valuable feedback obtained from potential consumers is essentially critical in assessing the market potential for the product to be launched. Unlike the other two types, equity-based crowdfunding is particularly suitable for businesses that can scale and are seeking funding to expand and provide a return for shareholders (Ley, Weaven, 2011), particularly because it does not require collateral (Carpenter & Petersen 2002, p.60). Two perceived needs led to the emergence of crowdfunding as a potentially alternative source of funding for technology ventures, including the fact that smaller retail investors hardly access early stage investment opportunities and that start-up companies often do not have adequate access to capital (Howorth, 2001, p.79). Crowdfunding is a promising alternative source of capital for businesses in their initial developmental stages (Profatilov, Bykova, Olkhovskaya, 2015). Statistically, nearly half of all the SMEs fail within their first years of launching, which imply that investment in start-ups is an extremely risky undertaking. Generally, investing in start-up technology ventures does not often yield any returns, until after years later. In that case, accessing funding from traditional sources of funds is nearly impossible for the SMEs, particularly because it calls for the provision of collateral, and is limited to successful ventures (Oncioiu, 2012). Crowdfunding can significantly improve technology ventures’ access to funding while at the same time possibly remedying specific market failures such as the inadequate supply of funding for start-ups and younger companies (Antonenko, Lee, Kleinheksel, 2014). Crowdfunding has certain advantages that make it extremely suitable for technology ventures including its suitable design that provides flexibility, cost-efficiency as well as an incredibly high speed of collecting financing. Technology ventures can raise as much as £100,000 in just a few days, thereby instantly accessing the funds they need to develop their concepts (UKCF, 2014). SMEs often set a target amount, which, if reached, enables them to receive all contributions. On the contrary, a fruitful financing campaign could potentially expose technology ventures to other funders, thereby enabling them to attract even more financing or funding on better terms and conditions. Apart from that, crowdfunding also provides technology ventures with a market-testing tool that allows them to project demand and to collect valuable feedback from prospective customers about the product idea and how to enhance it. Successfully pitching a business idea through crowdfunding is a brilliant marketing strategy for technology ventures, particularly for novel ideas that would not have access to a receptive audience and funds in normal cases. As a result of the crowdfunding, the audience of the SME inevitably becomes its most loyal customers, thereby facilitating growth of the business. Nevertheless, the huge amount of attention gained by SMEs through the crowdfunding process helps them grow significantly, more than the contributions alone would have enabled them. Although crowdfunding could be a potential alternative source of financing for technology ventures (Howorth 2001, p.78), it also involves many risks such as fraud, platform failure, cyber-attack, as well as donor exhaustion (Members Research Service, 2014). Other potential risks associated with crowdfunding include deceptive marketing practices, legal uncertainty that arises from varying legislation, liquidity risks, as well as breach of intellectual property rights. Before a new project is launched on crowdfunding platforms, there must be significant investment in terms of time and money that that would otherwise be spent elsewhere, where success is guaranteed. Given that crowdfunding exposes the technology ventures and their idea to the public, there is a great risk for other businesses stealing the same idea before its originators have had a chance to develop it. In that case, it is critical for businesses to obtain the requisite intellectual property protection for their ideas prior to posting their campaigns on the internet. Crowdfunding is also susceptible to fraud, just like other industries, as many fake sites are coming up on the internet with duplicate projects that divert investors’ contributions to fraudsters. On the other hand, this risk can be effectively mitigated by checking the credibility of the crowdfunding platform in question before one commits oneself to making the contribution. Although Grant Thornton observes that non-bank lenders are increasing, the alternative form of financing still remains a small market as opposed to the conventional bank lending that totalled £7 billion for the SMEs in third quarter of 2013 (UKCF, 2014). Crowdfunding has numerous disadvantages that make it unsuitable as an alternative source of funding for technology ventures; for instance, for a project to succeed through crowdfunding, it must not only be visible, but also finite and understandable. In addition, the danger of relying on crowdfunding is that if the target amount is not reached, then all other potential investors pull out taking away their contributions, leaving the business empty handed. In that respect, the technology ventures are more likely to suffer bad reputation due to the failed project while at the same time risking the loss of its intellectual rights to the business idea displayed to the public. Unlike traditional sources of financing for technology ventures, the alternative source of funding relies on many small investments from many people (Sigar, 2012). This implies that engaging with potential investors may take substantial amounts of time and efforts. SMEs need a lot of time and resources to mobilize the community, to publish their project and to attract investors before any money is raised for the project (Katila, Rosenberger, Eisenhardt, 2008). Furthermore, SMEs must have a strong established network, for their ideas to attract any funding. Just like SMEs that have a limited network and complicated products, those that do not have sufficient digital or social media presence will also find it extremely hard to crowdfund. SMEs also risk giving a vast proportion of their businesses away to potential investors, by not getting their rewards or returns right from the beginning of the cowdfunding process. The lack of formal regulatory systems and procedures has often been yet another great challenge for players in the crowdfunding industry (Dorff, 2014). However, this has been remedied with the creation of a new appropriate regulatory framework to protect investors (Rees-Mogg, 2013). The Financial Conduct Authority (FCA) has been regulating debt crowdfunding and equity crowdfunding platforms in the UK since April 2014 while the UK Crowdfunding Association established in 2012 seeks to promote crowdfunding as an alternative source of financing for projects (UKCF, 2014). The association has developed a code of conduct that all UK crowdfunding businesses are obliged to abide by; both the code of practice and FCA regulations ensure that contributions go to expected projects. FCA authorised crowdfunding platforms seek to ensure that all campaigns are fair, clear and not confusing while ensuring that risks and returns are well balanced, and that claims are well supported. Conclusion Ultimately, crowdfunding is not only a brilliant way of raising funds from a large number of people over the internet, but also a significant way of establishing a community of followers, engaging with a target market population and building longer term relationships with individuals that will support the future of technology ventures. Crowdfunding as an alternative source of funding for technology ventures is likely to grow further in the coming years as a result of several reasons including the growing need by investors to gain decent returns on their money, and its potential as a quick source of money for companies. Another critical factor that is likely to promote the growth of crowdfunding as an alternative source of funding for technology ventures is the internet platform, which enables SMEs to connect with the billions of potential investors in the world. References Antonenko, P. D., Lee, B. R., & Kleinheksel, A. J., 2014. 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