Exploring the opportunities and risks of crowdfunding
April 28, 2017
Rotman researcher explores the costs and benefits of raising capital online.
When crowdfunding platforms such as Kickstarter and Indiegogo emerged almost a decade ago, Avi Goldfarb, Professor of Marketing at Rotman, knew that these sites were worth a closer look.
“Innovation is what drives the economy. Crowdfunding presents a new way to bring about more and different types of innovation. That’s why we need to be thinking about it.”
—Avi Goldfarb, Professor, Marketing
In recent years, Goldfarb’s research — conducted with fellow Rotman Professor Ajay Agrawal and now-graduated PhD student Christian Catalini — on crowdfunding trends and potential risks, has informed public discussion and policy decisions. In fact, Goldfarb and his coauthors contributed to the development of the Ontario Securities Commission’s recently-released LaunchPad program, which enables certain Canadian startups (including those housed at Rotman’s Creative Destruction Lab) to use the platform AngeList to attract international investors.
“It’s exciting to see these types of platforms that truly support emerging startups come to Canada — and to contribute to the underlying discussion,” says Goldfarb, who met with the OSC, over a number of months, to review the risks, opportunities and best practices while Launchpad was being shaped.
Goldfarb was well positioned to advise the OSC and drive the conversation in how Canada could introduce new platforms that enable online investing, in early stage companies, by accredited investors.
“Early on, my colleagues and I knew that if we could understand crowdfunding, we could see into the future of innovation and potentially influence it,” Goldfarb adds.
In the late 2000s, when online crowdfunding first became popular, it seemed like an effective and more equitable way for entrepreneurs to raise startup funds quickly. Presumably, an online platform would eliminate the need to find, meet and persuade hard-to-access venture capitalists.
However, as Goldfarb found—and noted in a paper published in the Journal of Economics & Management Strategy—the reality is much more complex.
Goldfarb and colleagues observed that the best predictor of whether a project idea successfully reaches its fundraising target is how much money is raised during the early stages of a crowdfunding campaign. What’s more, those who pledge early in a campaign tend to be local investors — likely family or friends.
In other words, offline or ‘real-life communities’ still matter in the realm of online crowdfunding, says Goldfarb.
“If you’ve raised a substantial amount of money quickly — perhaps because of your friends, family and personal network — it can be signal to the market that you must be doing something right, and you will likely attract future investors,” explains Goldfarb.
Still, even if a project attracts several early investors, it doesn’t mean the idea will succeed.
“In our research, we often came up against the problem of trust in the crowdfunding community,” explains Goldfarb. “How could potential investors really know whether particular projects or people were truly worth investing in?”
In a subsequent paper published in California Management Review, Goldfarb and his colleagues explored and encouraged the idea of ‘syndicate crowdfunding’. In this approach, a syndicate lead, with experience identifying and investing in successful startups acts as a lead investor. This lead would vet ideas by meeting with the emerging entrepreneurs offline before investing.
“This can mitigate the risks and that problem of knowing which companies to back,” says Goldfarb. “Instead, people could look to trusted investors who have made smart investment decisions and know how to identify good ideas.”
Going forward, Goldfarb is interested in how crowdfunding data might provide new insights in how business ideas are formed and how new enterprises launch.
“We’ve gotten the ball rolling and we have a sense of how crowdfunding operates,” explains Goldfarb. “Now it’s time to look deeper into the data and see what it can tell us about management fundamentals.”