Just as platform lending compliments bank lending on the debt side, many new type of fintech innovations aim to drastically expand access to capital on the equity side, particularly for smaller startup companies. In the next few videos, we'll look at crowdfunding, which is quickly becoming a viable alternative to standard private equity or venture capital financing. The common starting point for most crowdfunded ventures is a very small start-up with a highly uncertain project. As an example, say you come up with an idea that's a bit ahead of its time. Maybe back in 2012, you came up with some sketches for some virtual reality goggles that you think could change the entertainment landscape. But because it's so new, venture capitalists and private equity financiers are not really on board with the idea just yet. Now, online crowdfunding is a new vehicle that potentially allows you to get financing. The idea is that instead of going to the banks or venture capitalists you appeal directly to the crowd. You try to get small capital contributions from individual backers online. And if enough people see value in your ahead of its time idea, then maybe you'll have enough initial capital to get going, moving from the idea to a blueprint and maybe to a prototype. To do that, to appeal to the crowd, you need a venue and that's where crowdfunding portals come in. Again, the technology itself is very simple. Similar to platform lending, crowdfunding portals are a platform or an online marketplace that directly connects the entrepreneurs on one side and individual investors on the other side. Note here that we're not talking about the purely charity-based portals like GoFundMe. We're talking about for-profit portals, where the entrepreneur it will take small capital contributions and in return, promises to return something to the backers. And the something is what distinguishes the different types of crowdfunding platforms? In the first type, the entrepreneur takes the money and promises to send the backers the finished products or services or access to these products. This is called reward-based crowdfunding platform and the most prominent example is Kickstarter, which is the focus of this video. In the second type, the entrepreneur takes the money and promise control rise to the backers. In this case, the entrepreneur is essentially selling private stock certificates to the investors. This type of platforms is not surprisingly called equity-based crowdfunding and we'll talk more about that in the next video. Finally, in the last few years, a third type has popped up that is a hybrid of the two types and it's based on the blockchain platform. We'll call this the crypto-based crowdfunding and we'll talk about it in the final video of this module. Let's first take a look at the reward-based model, first popularized by Kickstarter. Again, it's an online venue for entrepreneurs to appeal to the crowd with their projects or ideas. And they do so by starting a funding quote unquote campaign on the portal where they'll devote a considerable amount of time to put out a good description of the project. Going back to the virtual reality goggles example from the previous slide, is actually a real campaign on Kickstarter, one of the more famous cases and you now know it as Oculus Rift. In designing the campaign the entrepreneur will also set some funding targets and funding limits. As you can see here, the original Oculus Rift campaign had a minimum funding required of 250,000. It did not have a maximum at ended up raising about ten times the minimum amount. In fact, because the entrepreneurs have complete discretion in setting their funding limits and goals, they often use these crowdfunding campaigns to gauge interest on their products before potentially going to venture capitalists. And again, we need to highlight what they're promising to the backers in return to their capital contributions. In a reward-based campaign, the entrepreneurs are not promising any form of claim on cash flows or any form of corporate control to the backers. Instead, they promise purely to deliver a finished product was launched to the backers. In the Oculus Rift campaign, for example, backers contributing higher amounts are getting progressively higher discounts on the finished prototype goggles. So in the reward-based case, the entrepreneur can be seen as simply pre-selling their products. And it's important to note that participants are not really seeking to speculate, they merely want the product. It's the utility of the product that attracts them to provide the capital instead of speculative motives. Keep this in mind when we compare and contrast this with equity and crypto-based platforms. In the next stage, the reward-based campaign transitions from primarily marketing to primarily R&D and prototyping. Suppose that the minimum funding goal is met, now, the entrepreneur is committed. Because presumably now, they have enough money to get started and get their product developed and prototyped. Now, of course, because it's a very early stage idea, no one, not even the under preneur himself, knows whether the product can actually be developed. Maybe the entrepreneur drastically underestimated the technical difficulty in making the product and he wasn't able to develop a successful prototype. In this case, the contributed capital is essentially lost. For the entrepreneur, the platform levies no additional punishment except possible reputation loss, with the investors less likely to back the same entrepreneur again in the future. On the other hand, if the development is successful, the project further transitions into the scaling and fulfillment stage. Now, things are getting a lot more serious and the entrepreneur is supposed to deliver on the promise and actually fulfill the contributors orders. If there are many backers, the entrepreneur needs to think carefully about production, supply chain, and scaling in order to fulfill that demand. Again, the entrepreneur could do a good job at that and fulfill the orders on time. In this case, the project will be deemed successful and possibly it will also attract some attention from venture capitalists. If not, say the deliveries delayed and the backers have to wait a really long time to receive their promised products, then this signals entrepreneurs inability to manage and scale the project leading to, again, a lost reputation. In the meantime, the entrepreneur is supposed to put out periodic project progress updates on the portal for all backers to see. But those reports are usually not audited by third parties and of course, projects whose minimum funding goals are not met will not even proceed. And of course projects whose minimum funding goals are not met will not even proceed. And most platforms will just return the money back to the contributors. As you can see, both the technology and the operations of a reward-based crowdfunding portals are quite straightforward. But there are also some important risk factors that you should be aware of. Specifically these platforms usually are not regulated, they don't need to register because they're not offering securities. Therefore, anyone can launch a portal and anyone can participate on either side of a portal. This leads to a significant problem of asymmetric information, namely, the entrepreneurs and possibly also the platforms know more about their projects than the backers. They might have some private information on the success likelihood of the development and the fulfillment but they don't necessarily disclose that information upfront to the backers. And unlike a regulated financial system, there are no intermediaries that gather this information or force the disclosure of this information. Consequently, there's a non-trivial risk of both project delay and project abandonment. Kickstarter and researchers at the University of Pennsylvania conducted an analysis of their projects in 2015 and found that over 75% of the projects have experienced delays in fulfillment while about 10% of the projects had their funding goals met, but nothing was delivered at all. So when analyzing these platforms, we should take into account that inherently high degree of information asymmetry on these platforms and their associated risks. In fact, many entrepreneurs simply use reward-based crowdfunding like a viral marketing campaign, hoping to either attract attention from the media or from private venture capitalists.
