How early contributions affect crowdfunding success

Seed funding from family and friends can send the wrong signal

This article is republished with permission from China Business Knowledge, the knowledge platform of Chinese University of Hong Kong (CUHK) Business School. You may access the original article here.

Entrepreneurs are increasingly relying on internet crowdfunding – the use of online platforms to raise money from multiple contributors. It's reported that active global crowdfunding platforms generated more than US$34.4 billion (A$45 billion) in 2015.

The World Bank estimates the crowdfunding industry will reach US$90 billion by 2020. In terms of scale, crowdfunding has become a viable alternative to venture capital and angel investment.

For most entrepreneurs, seeking funding from family and friends is a popular and effective way to round up their initial capital for business. The reason is simple: these are the people who are more likely than anyone else to believe in your ability and fund your dream.

But is there any downside of this source of funding? Will early contributions from family and friends be a good signal for other potential funders?

A study conducted by assistant professor Fan Tingting and associate professor Gao Leilei from the department of marketing at the Chinese University of Hong Kong (CUHK) Business School, and their collaborator Yael Steinhart, an associate professor of marketing at Tel Aviv University, looks into the effect of early contributions from family and friends on subsequent contributions to a crowdfunding project.

'A past study revealed that the more Facebook friends you have, the higher the success rate for your crowdfunding project'

FAN TINGTING

Funders' perceptions

When it comes to what contributes to the success of crowdfunding projects, a lot of literature in marketing and management focuses on characteristics of the project (such as, description, information disclosure and fundraising goal); the entrepreneur (previous successful initiatives, education, geographic locations, social connections); and the backers and their affiliations.

However, according to Fan, there isn't enough research looking into other factors, such as how funders perceive the contributions from friends and family.

"Existing research tells us that early contributions from friends and family – what we call the 'seeding investment' – establish a positive signal regarding the trustworthiness of a project. For example, a past study revealed that the more Facebook friends you have, the higher the success rate for your crowdfunding project," Fan says.

"Yet, few studies [have] adopted the perspective of potential funders. Little is known regarding whether consumers are aware of the fact that entrepreneurs raise seed money from their friends and family, and how they might react upon such seed financing," she adds.

The study explores the role of friends and family contribution by considering consumers' reactions to potential seeding behaviour at the early stage of a crowdfunding campaign launch.

The researchers conducted five studies, including a field study, which collected real-world crowdfunding data from more than 900 projects comprising 116,153 contributions from 68,036 funders. The data was utilised from DemoHour between July 31, 2011 and August 30, 2014.

One of the largest reward-based crowdfunding platforms in China, DemoHour enables an entrepreneur to create a webpage to introduce their project, and set its funding goal within a certain period (usually 30 to 40 days).

A potential funder can visit any projects with profiles on DemoHour and observe individual funders' contributions before deciding which project and how much to contribute.

The research data revealed the average funding goal per project was US$3089 while the average funding period was 43 days. Moreover, 56% of the projects succeeded in attaining their fundraising objectives. Each project had 115 funders, with each of the funders contributing US$32 on average.

'When the majority of early funders contribute large amounts, potential funders are more likely to infer that they are the friends and family of the entrepreneur'

FAN TINGTING

Indebted to our friends

Next, the researchers looked at how small contributions differed between successful and unsuccessful projects on the first launching day of these projects.

Consequently, they revealed several important findings: First, friends and family of entrepreneurs contributed more money in the early stage of a crowdfunding campaign compared with strangers.

Second, a potential funder is more likely to contribute to a newly launched crowdfunding campaign when the majority of the existing contributions are relatively small amounts.

Third, this positive effect of small prior contributions on prospective funders' likelihood to contribute to a crowdfunding campaign will be weakened at the later stage of the campaign.

To understand these findings, Fan explains, we need to understand the 'friendship-giving lay belief'.

It is common sense that we are more likely to feel indebted to our friends than to complete strangers, and that we would feel obligated to helping them.

Such 'friendship-giving lay belief' manifests itself in crowdfunding in a way that people would generally believe friends and family of entrepreneurs are more likely to contribute large rather than small amounts of money to their projects than strangers.

"In the early stage in crowdfunding, potential funders will only see limited information of a project, such as the funding goal and contributions. Based on the 'friendship-giving lay belief', they will tend to infer that large contributions would probably come from friends and family of the entrepreneur, and small contributions would be from strangers. Such inference will influence their funding behaviour," says Fan.

"They will be more willing to fund a project with small contributions in the early stage," she continues.

Why is that the case? Psychologists have long believed that people are more likely to adopt the opinions and behaviours of their peers rather than of people they don't affiliate with.

"In the case of a potential funder who doesn't know the entrepreneur, he or she will consider the other funders (who also don't know the entrepreneur) to be his or her peers, thus following their behaviour to contribute to the project," she says.

Fundraising goals

The study carries important implications for entrepreneurs, particularly those who would like to make use of crowdfunding to launch their projects.

"We demonstrated that consumers may rely on the amount given by early funders as a signal of their relationships with the entrepreneur and such inference has significant influence on their funding behaviour," Fan says.

"When the majority of early funders contribute large amounts, potential funders are more likely to infer that they are the friends and family of the entrepreneur, and thus be less willing to contribute to the crowdfunding project.

"Hence, from a practical perspective, entrepreneurs may want to devise effective strategies to leverage the help of their friends and families when promoting a crowdfunding campaign. For example, it may be better to gather small rather than large contributions to improve the likelihood of achieving the fundraising goal," says Fan.