The Donations Model in Crowd Funding

1.0 Overview of Crowd Investing

1.1 A brief Introduction

Crowd investing is a new concept that has increasingly gained dominance in the recent past and which is being accepted as one of the best options to raise capital or finances for new businesses (Best, Dorion and Neiss, 2013). It basically targets to raise small amounts of money from a large pool of people, hence being successful in obtaining sufficient business capital as opposed to traditional sources as elaborated in figure 1. Its main characteristic is that it uses the internet as the main platform to raise funds (Fisher and Dellinger, 2015). Although the terms ‘crowd investing and crowd funding’ are used as synonyms, they greatly differ in principle due to some aspects. For instance, despite the fact that they are sources of financing business ventures using crowd or internet, crowd investing gives an opportunity for the providers of the funds to be business owners or shareholders (Micic, 2015).

Contrary to this, in crowd funding, the providers of capital are viewed as creditors, and hence the source of the funds regarded as debt funding; this gives rise to the two types of crowd financing which are equity crowd-funding and Debt crowd-funding respectively (Cumming and Hornuf, 2018). The third classification of crowd sources of finance is one where the providers of funds do not have monetary concerns, whether interest for the loans provided or dividends for the share capital contribution (Freedman and Nutting, 2015). In this regard, if there are any benefits they are usually non-monetary and it is applicable to charitable organisations and other similar entities by philanthropists.

Figure 1: Traditional Funding vs. Crowd funding

Source: (European Commission, 2018)

Figure 1 above shows a contrast between traditional funding and modern (crowd) funding respectively.

1.2 Relevance of Crowd Funding in Financial Engineering

The primary objective of financial engineering is to make use of the financial model or theory by combining engineering methods, mathematical tools, and programming practice to be able to offer solutions in financial management and practice while administering or establishing projects which includes having new ideas, whether commercial or otherwise (Marwala, 2018). As such, it is basically founded on the grounds of creativity and innovation. Crowd funding is one of such innovative approaches of raising money using online platforms to be able to finance projects of different types and nature (Brüntje and Gajda, 2015). Therefore, it is a relevant topic especially in the wake of technological advancements and use of internet globally. According the European Commission report on market trends of 2018, crowd funding is significant to entrepreneurs for start-ups, companies and businesses especially SMEs, and even for charitable organisations for fundraising purposes.

Although the concept of crowd funding has become popular in the recent past, its origin dates back to the 18th Century’s funding (Freedman and Nutting, 2015). Firstly, in the early 1700s, Alexander Pope, a great poet, wanted to ensure that his literary work of translating poetry from Greek to English was achieved, and he subsequently asked people to contribute and in return be acknowledged in the book (Fletcher, 2012). In the late 1700s, Mozart a composer, offered manuscripts and invitations to those people that had funded his concert through donations. Nevertheless, the modern crowd funding can be traced to 1997 when “the fans helped the British rock band Marillion by funding their US tour: The band managed to raise £39,000 with a crowd funding internet business model” (Spark Up, 2017).

2.0 Business Models

Under the models, the paper will review the most practiced business models as well as the emerging models in crowd funding and then a brief overview of theoretical models respectively.

2.1 Business Models in Crowd Funding

Although for a long time four models have been commonly in use (equity crowd funding, lending, reward and donations), other models have emerged which include pre-sales and hybrid models respectively (Irene, 2012). Fundamentally, crowd funding is disruptive in nature and this has seen the emergency of hybrid models that are seemingly becoming more successful when compared to the traditional models. Moreover, the impact of technological advancement on the concept cannot be underestimated as it has drastically changed the overall practice in a very transformative manner.

2.1.1 Donations Model

For over two decades now, Non-Governmental Organisations (NGOs) have relied on donations model to attract finances used to support different projects world-wide. In contrast to traditional approaches of raising funds, the model allows the organisations to ear-mark and collect donations, specific for a certain project (Outlaw, 2013). As a result, it acts as a motivation for the donors to provide funds given that they are made aware in advance of the kind of projects their funds will be put into. This alone makes them to be willing to provide more funds per person, a fact that makes the model more productive in such scenarios. Loyalty of these donors is further enhanced through regular updates of project progress, a fact that promotes recurring donations in the long-run. It is important to appreciate the fact that the main incentive among these providers of funds is social in nature, which basically emanates from intrinsic inspiration (Vassallo, 2017).

2.1.2 Rewards Model

The model is often used by the owners of projects, whose primary objective is to accomplish collection of donations tailored for specific projects, and in some cases can give small appreciations to the providers of funds (Jian and Shin, 2019). The small appreciations they are often non-financial in nature hence referred to as rewards, and they are not usually considered as legally binding. Although these rewards are generally of symbolic value, they are usually lower in value than the actual amount of money donated, for reasons of ensuring that there is money left to run the anticipated projects. However, the value’s perception can differ and it depends on other factors (Freedman and Nutting, 2015). For example, a reward can be given of VIP tickets to a person whose contribution is higher than others, and to some extent this can depend on what the highest contributor was able to give in comparison to the actual value of a ticket.

2.1.3 Pre-sales Model

In addition to the two models already discussed, pre-sales model is yet another important and exemplary way of crowd funding. It is rooted on the premises of speculation and trust exhibited by the funders, in the sense that they really want the product to be manufactured or made, while anticipating for discounts given their significance role in funding the idea. Basically, business owners or innovators puts an idea for a new product online, and then ask people to give money as a form of purchasing the products, before the actual products are made. The money given is then invested in making the product, which is then delivered to the customers, hence pre-selling (Fasnacht, 2018).

2.1.4 Lending Model

This type of crowd funding is the foundation of debt lending, where a person, business or an organisation simply borrows from a larger group of people online. Generally, the model can further be classified into social lending, peer-to-peer lending, and peer-to-business lending respectively. On social lending, certain platforms provide a possibility of giving funds to projects that are social in nature without any specific interests. For instance, a business in a developing nation can create a platform to receive funds from parties that are not going to be paid any interest on the provided loans (Wales and Crowder, 2018).

Secondly, peer-to-peer (P2P) lending is characterized by a higher financial return motivation. Although P2P lending is not primarily founded on goodwill, it is increasingly becoming a new model for financing in the modern business environment. It is basically rooted on the characteristics of crowd funding with the main difference being that the financiers and those being financed do not know each other. Interest rates are usually calculated based on risk factors inherent and such risk factor is mostly centered on personal financial information and data of the borrowers. Moreover, calculations can be done by specific institutions or online platforms that can be accessed by lenders and borrowers. Additionally, such assessment of risks can be based on all the evaluation criteria used by banks such as the 5 C’s (Character, Capacity, Capital, Conditions, and Collateral), or by a combination of any suitable approaches (Cortese, 2011).

Other innovative models available for risk measuring include the need to provide risk or provision funds as opposed to being borne by the lenders. In spite of the fact that the model is characterized by lenders who are looking for higher returns, it is generally considered as cheaper than loans from banks, hence attracting more people. Further, its merits above that provided by the banks are that borrowers are able to access loans with fewer securities as compared to those issued by commercial financial institutions. With available statistics showing that default rate is below 1%, the segment is continuously growing and becoming profitable in the business environment. Its convenience and lack of systematic risks has made it desirable by borrowers and lenders respectively (Benna and Benna, 2018).

On one hand, Peer-to-Business (P2B) lending is ideally similar to the P2P model as it provides loans for interest earning. However, on the other hand its primary focus is offering such funds to business entities. Most of the target businesses that fall under this model are the Small and Medium Sized Enterprises (SMEs) (Collins and Pierrakis, 2012). It is important to note that this model in the modern business environment has greatly attracted the governments’ attention, in which case the governments are providing funds as a form of co-investment, especially what is common in the United Kingdom (UK).

2.1.5 Equity Crowd Funding Model

Different from lending model, equity funding model aims at attracting new investors by offering them share ownership just like the traditional shares, with the main difference being that it is online based. It is an alternative form of funding from using a private investor or angel funding. Crowd funding is also termed as crowd investing, where equity arrangements are made, with contractual agreements for the funders to receive payoffs for the shares held. Nevertheless, in most cases the funders are interested in those projects whose values are similar or shared by them, and also considered locally engaging with an aim of job creation (Rose, 2016).

2.1.6 Hybrid Models

The most recent emerging model is the hybrid arrangements where a combination of more than one of the above models is used. For example, it is possible to use a pre-sales arrangement together with lending model. Such a platform allows providers of funds to receive the products that are manufactured for a certain portion of the funds while being paid an interest for the excess funds which will later be repaid with an interest. Other options that can be used concurrently with the models include; revenue sharing, in kind reward, and in kind funding. In revenue sharing, providers of funds are promised to share returns based on future flows of incomes. On the part of in kind rewards, providers of funds usually receive some rewards or payoffs in kind. Finally, in kind funding, a funder might opt to offer services and products instead of liquid money to a project or business. For example, in the case of a start-up, a supporter may volunteer to give consultancy services without being paid as a way of supporting the idea or project (Rose, 2016).

Figure 2: Role Model for Donations and Reward Based Crowd Funding

Source: (Branzov and Maneva, 2014)

Figure 2 above gives an illustration of a typical model that can be used in donations as well as in reward based crowd funding applicable to Software Product Development Projects as an example. From this illustration, important aspects include the presence of an online platform, mediator fundraising platform, fundraiser, and the backer. A part from these systems, other important elements includes the transmission of information in order to initiate the fund raising project and coordinate all the parties (Branzov and Maneva, 2014).

2.2 Theoretical Foundations/Models

In crowd funding, there are theoretical models that can be used to elucidate the concept and how significant it is to the business and financial engineering techniques. In this paper, the specific theories that will be reviewed include the financial theory, entrepreneurial finance theory, disruptive theory, and a theory of crowd funding respectively.

2.2.1 The Financial Theory

According to the financial theory or model, the study of assets especially money is of great importance since it determines the overall success of projects and businesses as well. All start-ups need funds as a form of capital in order to be able to establish themselves and grow into big businesses. Moreover, even the existing business entities still need funds for expansion and operations respectively. Irrespective of the nature and size of a business or project, financial management is imperative and cannot be overlooked (Peng, 2015). The main concept of the theory of finance that is related to crowd funding is based on it argument on the approaches and ways by which individuals and businesses are able to raise funds. In overall, the theory offers several sub-theories to explain this and they include; theory of arbitrage pricing, prospect theory, theory of rational choice, theory of cumulative prospect, the model of Monte Carlo, Gordon model, the binomial options in pricing theory, theory of legal origins, black model, and the international effect of fisher among other theories. Each of these theories holds that businesses as well as individuals despite their nature have numerous options they can utilize in raising funds or capital. In this case, the finance theory supports crowd funding as one of the potential options that is widely accepted in the modern business environment owing to its flexibility, convenience and simplicity (Danthine and Donaldson, 2015).

2.2.2 Entrepreneurial Finance Theory

This theory is closely related to the finance theory but its main emphasis is for raising money to support entrepreneurship through star-ups. The theory expounds on the fact that start-ups are more often than not hungry of capital for growth and expansion. There are many challenges facing new business, not only growth needs but survival a midst string competition in the market (Cumming, 2012). According to theory, the best way for such businesses is to attract venture capitalists that can provide initial funding necessary to start and run a business. In this regard, this theory appreciates the fact that new businesses need certain organisations and individuals who are willing to provide their finances to support the existence of such business. This can be anchored on the foundation of crowd funding in which people support in terms of funds or in kind, such businesses and projects which are deemed to share certain values of their own, such as innovation and creation of job opportunities (Smith, Smith and Bliss, 2011).

2.2.3 Disruptive Theory

The fundamental concerns of this theory is on the basis that innovation usually creates a set of new paradigms in the market and as a result, new value network emerges which causes disruptions on the existing markets and value chains or network, to some extent causing displacement, and eventually leading to new services or products. It is also important to acknowledge the fact that not all innovations can be disruptive in nature despite the fact that they can be revolutionary. However, crowd funding can be termed as disruptive owing to the impact it has generally created on the field of financial management and funding of projects and businesses in general (Christensen, 2013).

2.2.4 A Theory of Crowd Funding

According to this theory, the concept of crowd funding is viewed from an economic point of view as an avenue for manufacturers and business persons or project managers, to be able to receive funds from potential funders before the commencement of projects (Strausz, 2015). Ideally, by virtue that funds are received prior to initiation of projects, it implies that more efforts are put to ensure the projects are a success so as not to frustrate the funders (Boudreau et al., 2015). The theory backs up the concept by asserting that it is one of the most convenient ways of funding projects and business start-ups, by recognizing the relevance of technology in the society. Proposers of this theory argue that different models applied in crowd funding are in their right a form of innovation which provides entrepreneurs an opportunity to excel, without having to go through the tedious processes of raising funds. Additionally, the theory offers several advantages associated with crowd funding, not only to consumers but also to business persons. For instance, it argues that through crowd finding, uncertainty in demand is greatly reduced, and this offers an opportunity for improving the overall screening of projects. However, the theory holds that to some extent some negative effects can emanate especially where the moral hazard of entrepreneurs may emerge hence threatening the benefits of the model (Brüntje and Gajda, 2015).

3.0 Strategies

For a crowd funding to be successful, numerous strategies have to be employed for good results to be achieved. Different authors may have different perspectives, but they seem to agree on a common point that strategies that are realistic, specific, measurable, time-bound, and achievable re necessary in achieving desired outcomes (Hogue, 2015). In this paper, twelve such strategies are presented with an elucidation of their significance in the entire process of crowd funding. Firstly, it is important to undertake a thorough research, which is aimed at getting all material facts and information right before committing into funding campaign (Assadi, 2016). Research is growingly becoming an important area for any field of management in business and even to the society at large. It is paramount in identifying challenges, regulations or rules in crowd funding, and more importantly the approaches that have been used and have yielded great success. In case there are identified approaches that have not given better results from the past, it is important to device new techniques in an innovative manner so as not to fall into similar situations (Roebuck, 2011).

Secondly, identification and selecting of right platform is imperative given that not all platforms can lead to desirable results, the most important aspect to be determine in this case is the target audience, based on the project or products being promoted. Moreover, consideration of the model or type of crowd funding to be used is important as it determines the entry strategies and how to enhance an effective campaign. Different platforms are suitable to different products and industries depending on the niches being served or even the overall aims of the projects. Understanding which platform suits a crowd funding campaign provides an opportunity for greater success and support from the right people (Stegmaier, 2015).

The third strategy is to ensure that more than ‘just an idea’ is being offered to the market, as many investors may be looking at the profitable and promising ventures to fund, especially when it comes to equity funding. At this point, product innovation is key and paramount. The entrepreneurs ought to utilize the knowledge in accordance with disruptive innovation so as to ensure that their ideas are having a huge impact in the market, and they can potentially sail through the existing ideas and products by surviving the competitions in the market (Roebuck, 2011).

The fourth strategy is to understand the target audience through knowing their interests, expectations, ambitions, and motivations. For example, philanthropists have a unique and different motivation to provide funds in crowd funding compared to venture capitalists of even equity financiers. As such, based on the nature of product, one is able to narrow down the specific audience’s needs and expectations in order to offer what exceeds their expectations for higher chances of success (Stegmaier, 2015).

The fifth strategy is to create unique and interesting materials for marketing, suitable to the products or project being undertaken. In order to stand out, one should avoid just copying what other companies have done, and focus on tailoring the materials to the current project or products. Although the projects being undertaken or products anticipated to be launched might be similar to previously introduced ones, it is important that innovation and creativity draws lines of distinction for the rest in the market. This way, entrepreneurs are able to win the investors and hence achieve higher levels of success in collecting funds (Roebuck, 2011).

Investors are interested with timelines and deliverables. It is therefore important to have clear goals that are precise in terms of timelines and resources needed to make the project run as the sixth strategy. The seventh strategy is to ensure that rewards are worthwhile, for purposes of attracting investors. Moreover, the next strategy should seek to convince the investors by getting personal, that way differentiating a product from what other have in the market. The ninth strategy is to promote a product through communication and spreading the word. This is to ensure that more and more people as possible are reached. Again, the right platform or channel will determine the level of success for this strategy (Stegmaier, 2015).

Strategy number ten is to express integrity and trustworthiness by communication openly with investors. This will help in winning their loyalty and support for a business idea or project. The eleventh strategy is to openly accept feedback, whether encouraging or frustrating. This should help to improve where there are weaknesses and maximize on the possible strengths. Finally, one should follow the issues promises and laid down plans in order to attain continued support throughout the life cycle of an idea or project. These twelve strategies are extremely important in order to render crowd funding successful especially in the modern business environment (Hogue, 2015).

4.0 Investors

The term investors in crowd funding can be interpreted differently, right from meaning the financiers to the understanding of their interests. There are different types of investors who include individuals, organisation and governments depending on the nature of product or idea. For example, in donation based crowd funding, potential investors are likely to be NGOs, individuals and governments. On the basis of equity funding, potential financiers can be investors with an aim of diversifying their risk portfolios as opposed to governments and NGOs. Therefore, understanding the investors in a project is paramount as it helps the project managers to narrow down their scope and tailored their strategies so as to suit the needs of such investors (Freedman and Nutting, 2015).

Another important element as far as investors are concerned is the concept of risk assessment. As a matter of fact, crowd funding is purely undertaken through online platforms, which implies that identification and disclosures of personal details might be difficult. In other words, most people who engage in such platforms may not have personal contact and know-how of each other at a personal level, increasing the risks involved in such platforms. As such, it is important to know how to engage such people who are much aware of the nature of risks they will get involved to by giving out their funds, a fact that is considered the greatest challenge of crowd funding when compared to traditional sources funds. Communicating openly and trying to disclose as much information as possible concerning products, idea or project is imperative in protecting the interests of investors (Wales and Crowder, 2018).

5.0 Performance of Crowd Funding

A study conducted by Wati and Winarmo (2018) on “the performance of crowd funding in different countries” noted that audience or target, minimum investment requirements, and the number of backers in a funding process greatly determines the overall success of crowd funding. The same assertions are supported by Safarov (2016) who also observed that these parameters are important, and they eventually determine the level of success of a small enterprise that is being funded through crowd funding. Contrary to these assertions, Mia (2014) established that the greatest success indicators of crowd funding are the consumer insights gained by business people or entrepreneurs after the entire process is concluded.

In another study that focused on crowd funding in Europe, Dibrova (2016) noted that performance of crowd funding can be said to be evident given the impact it has caused on the development of start-ups especially after the 2008 economic crisis, particularly in Europe. Similarly, in a literature review on the elements of crowd funding performance, it is also noted the main parameters affecting all campaigns in crowd funding include; factors related to fund seeker, platform chosen for crowd funding, crowd funder, and the nature of campaigns (Kaartemo, 2017). In this regard, the overall performance of crowd funding can be said to be affected by a number of factors and its indicators include whether the overall goals are attained or not.

6.0 Conclusion

In conclusion, the analysis has provided that crowd funding is the most modern approach of sourcing funds for business and projects, supported by theories such as financial theory, entrepreneurial financial theory, disruptive theory, and crowd funding theory among others. Moreover, some of the models that can be used include debt/lending model, equity model, donations, rewards, pre-sales, and hybrid models among others. It is important that specific strategies are followed to make is successful and performance indicators include the level to which overall goals are achieved. Finally, it is a favorable platform given its reliance on the internet and technology which is the most advancing field in the society.

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