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Democratizing Innovation and Capital Access: The Role of Crowdfunding

EXECUTIVE SUMMARY

 

Introduction

Historically, the choice of which inventions become commercialized has been very undemocratic. Small elite groups of experts have been responsible for deciding which innovations receive institutional support. In most cases, the innovators that bring their ideas before these groups are themselves members of a small group of highly educated and well connected individuals. Everyone knows that innovation is not restricted to any one group -- good ideas are everywhere. But even as technology lowers the costs of innovating, turning those innovations into marketable products still requires capital, and access to funding is tremendously limited for many people. Can crowdfunding democratize the commercialization of innovation as well as financing?

Crowd Dynamics

Before crowdfunding, experts traditionally oversaw the fundraising process. How do the opinions and decisions of the crowd differ from those of experts? Venture capitalists are the most well-studied assessors of the value of innovations. Their selection criteria revolve around potential signals of quality. These signals can include endorsements from trusted third parties, the backgrounds of the founders, and the degree of preparation and care that goes into the pitches made by entrepreneurs. The selection process is highly personal in nature, with signals communicated during face-to-face meetings. Nearly 90% of all successfully funded companies relied on such signals (endorsements, pedigree, etc) to establish credibility.

The signals of quality that are used by VCs to assess the viability of a technology venture are also used by the crowd. This suggests that crowdfunding has the ability to distinguish quality potential projects from less promising ones. Evidence supports the idea that the crowd not only selects products, but also does a good job performing due diligence and quality control for projects as well. However, if VC firms and the crowd are sensitive to similar signals when evaluating technology projects, it suggests that perhaps crowdfunding may not be as democratic as expected. But while VC firms skew heavily toward the technology sector, crowdfunding platforms do not.

"Since 2012, Kickstarter has raised more money for art projects than the National Endowment of the Arts."

By sheer number of projects, the arts dominate crowdfunding, making up more than 80% of the projects on Kickstarter. In fact, since 2012, more money has been raised for the arts on Kickstarter alone than the National Endowment of the Arts. This suggests that the crowd now has more influence on the funding of new art projects than expert grant judges. It’s reasonable to believe that crowdfunding will lead a profound shift in how the arts are funded, in addition to the type of arts that are funded -- perhaps degrading the concepts of “fine art” or “high culture” while privileging “low culture.” In reality, the crowd tends to have a strong ability to identify projects based on quality -- often selecting viable projects that are more artistically daring.

Democratization

It has been demonstrated that the crowd is rational and has the ability to select and fund viable projects. However, a rational crowd does not necessarily mean that funding is available to more innovators. Traditional venture capital has demonstrated two major dimensions of inequality in funding, based on geography and gender.

Due to the need for in-person evaluation, VC investments are highly concentrated in just a few geographic areas (like Silicon Valley). Unsurprisingly, crowdfunding is much more democratically distributed than VC funding in terms of geography. One exception is high technology projects, which still tend to be based near a major existing hub of entrepreneurial activity.

Gender bias in funding is more pervasive than geographic bias. Numerous studies have suggested that female entrepreneurs launch firms in sectors with lower capital requirements, such as retail and services, and typically receive significantly smaller amounts of capital. The gap is even more apparent on the investor side: women only make up 26% of angel investors and less than 6% of partners at VC firms. Recent studies have found that crowdfunding could help to correct this gender bias, with women representing 35% of project leadership on Kickstarter. Even more promising is the fact that have 45% representation on the investor-side of Kickstarter projects.

“Crowdfunding shows promise in rectifying existing biases in funding”

Implications

Crowdfunding shows promise in rectifying existing biases in venture funding. The crowd has been demonstrated to act rationally and assess the viability of projects as reliably as industry experts. While high-technology projects are still more often funded traditionally in one of the major geographic hubs, crowdfunding can help those who are located elsewhere connect with funders -- especially for those creators operating outside of the technology industry. Systemic gender biases have been demonstrably improved on crowdfunding platforms. Crowdfunding can help take the democratization of innovation, entrepreneurship, and entrepreneurial finance even further.