Written by Ethan Mollick
Crowdfunding has been growing explosively, with over $2 billion raised via equity and reward crowdfunding in the United States in 2015 alone. (This video explains the different types of crowdfunding.) However, crowdfunding is more than another way of raising funds. In connecting creators and entrepreneurs directly with customers and funders, it transforms the opaque and oligarchical market for early-stage fundraising into a more democratic, open one. Rather than relying on venture capitalists and marketers to try to project nascent demand for new innovations, creators can directly reach out to customers and communities to refine ideas and gauge interest. Crowdfunding acts as a platform, matching innovators with those who need innovation, and thus is reshaping which ideas come to market.
For example, the hot technology of the moment, virtual reality (VR), was largely ignored by traditional funders after the disappointment of VR technology in the 1990s. (Watch a bit of Lawnmower Man if you want to cringe at the 1990s version of VR). In 2012, Palmer Luckey, a member of a VR community message board, mentioned that he wanted to launch a Kickstarter project to raise crowdfunding for a new virtual reality headset he had been tinkering with, the Oculus Rift. He asked for help from his community members to support the campaign (for which he said he “wouldn’t make a penny of profit”), but also to assist in developing logos, creating sales pitches, and refining technology. Based on this groundwork, the Kickstarter campaign, launched a couple of months later, was a huge success, raising millions. Suddenly, virtual reality was no longer a forgotten ‘90s trend but had become a hot area of technology. Not only was Oculus soon bought by Facebook for $2B, but the field of virtual reality has experienced explosive growth, with Microsoft, Sony, Samsung, and others announcing major products.
This would not have happened without crowdfunding.
My surveys of successful crowdfunders show that crowdfunding serves to validate demand and build communities of support. In the case of Oculus, crowdfunding acted as a platform that allowed Luckey’s enthusiastic community of VR hobbyists to directly support one of their own, making Oculus a reality without needing to go through traditional gatekeepers. In a variety of research projects, I and my co-authors have tried to understand what this more democratic world of fundraising looks like, and what it means to use the power of platforms to transform the early-stage funding of ideas.
One result of raising money over a platform is that it establishes a direct connection between the project creator and the funder. The community owning the project often comes to feel a sense of ownership for the projects that they support. This ownership is often quite positive, as it can lead to communities creating complimentary products (such as apps that use a new crowdfunded technology) and promotional support.
The pressure of community support also instills a sense of obligation in project creators as well. As a result, despite there being limited ramifications from project creators failing to deliver on their goals, failure is remarkably rare in crowdfunding. Only around 9% of projects fail to deliver, and creators can go through extraordinary efforts, such as spending their own money, to fulfill promises to backers. In a setting where money is given as an impersonal investment, there is still a substantial cost of failure, but it is much less personal. A founder whose first startup fails due to factors outside their control may still receive VC funding in the future, but a project creator who does not deliver to their backers is likely to find a less forgiving audience.
The dynamic between project creators and backers goes beyond just obligation, however. The fact that there are so many backers (over 9 million on Kickstarter alone), means that crowdfunding platforms can create many more kinds of matches between project creators and backers, increasing the diversity of ideas that get funded. Most forms of traditional fundraising rely on personal networks and rules-of-thumb to assess the quality of a founder. Due to (often unconscious) biases in these approaches, fundraising tends to favor certain individuals, such as white males from a few top universities. Women, for example, are much less likely to be funded than men, so much so that less than 8% of all VC backed companies have female cofounders.
In crowdfunding, however, women outperform men. My research with Jason Greenberg of NYU shows that, all else being equal, women are 13% more likely to raise succeed in raising money on Kickstarter than men. Further, we find that this success comes from the support of other women, and especially when the female project creators are operating in a male-dominated space, such as technology or video games. Since crowdfunding operates like a platform, backers can have all sorts of reasons for supporting projects, including the desire to help a community or advance a cause.
Despite the diversity of backers, research I have conducted with Ramana Nanda of HBS shows that they are often at least as good at making decisions as experts. Crowdfunding has eclipsed the National Endowment of the Arts as a source of funding for the arts, a subject of considerable concern to critics who worried that crowds would favor low culture crowd pleasers over serious theater (more musicals about dancing cats, less experimental work). Together, Ramana and I examined whether the crowd and experts agreed or disagreed on what to fund by asking professional critics to evaluate projects on Kickstarter. We found that the crowd and experts largely agreed, and, when they did not, the crowd was more likely to take a chance on projects than experts. Further, the projects the crowd (but not the experts) supported ultimately produced a higher number of critical and commercial hits than the projects that the experts approved of. This suggests that platform-based allocation of resources can supplement more traditional expert-based decision making.
Consumer-oriented platforms are often associated with the “gig” economy – connecting customers to suppliers for short-term contracts. Crowdfunding, however, shows that platforms can also serve as the basis for lasting businesses and important innovations. Moving from an expert-centered process to a platform approach increases diversity, leads to high quality results, and generally results in successful outcomes.