Posted: November 6th, 2015
It is widely-noted that “crowdfunding is in a very early and noticeably unsettled state”. It is like any sprawling new system in that there is an ongoing struggle amongst experts to define it generally and to classify its component parts. The term crowdfunding still means many different things to different people. With that in mind, perhaps the worst mistake one can make in speaking of crowdfunding is to assume one’s audience understands crowdfunding to mean the same thing the speaker does. One’s personal understanding of the term is shaped by experience, jurisdiction, and other variables.
Crowdfunding, as used in this post, means a process by which SMEs receive small amounts of financing from a large number of people. This is a broad and flexible definition. Leaving the definition of crowdfunding broad and flexible does not mean that we are unable to identify its components. In fact, that is a step which should be taken without delay so that the appropriate systems can be built to support distinct crowdfunding models. However, this endeavor is also a difficult one. Just as views on the definition of crowdfunding itself vary, views vary across the global community of experts as how best to divide the crowdfunding space.
Steven C. Bradford, a leading crowdfunding researcher, has classified crowdfunding into four models: lending, donative, reward-based, and equity. Others have sought to pare down the list further. Terence Tse and Mark Esposito, writing for the Harvard Business Review, divided crowdfunding into lending, equity, and donative models. An assumption with the Tse and Esposito view is that whether a donor is given a reward or not matters little in describing the nature of the financing. It is, reward or not, a donation of capital with no desire for, expectation of, or right to profit.
This blog post and its counterpart on the investment model continue the trend of consolidation by dividing crowdfunding into just two models: donative and investment. This simplified classification system draws on the motivation of crowdfunding financiers by basing the only division on whether profit is sought by the financiers. As noted by Tse and Esposito, the prospect of a reward does not change the donative nature of the financier’s act. Therefore, there is no reason to sub-divide donative model offerings. Likewise, whether profit comes from debt or equity securities is of little consequence to financiers choosing the investment model. Therefore, all offerings in which the financier provides capital with the expectation of profit should be classified as investment model offering. This means crowdfunding as just two models: donative and investment. This blog post is dedicated to the former while a post to follow will address the latter.
The Donative Model
“Look at the way the investment industry works. Someone gives you money and hopes that they will make money themselves. I think the art world works by different rules. I love the idea of things existing just because people want them to.”
- Kickstarter CEO Yancey Strickler
The donative model is perhaps the one most people associate with the term crowdfunding. In the donative model people post their conceptualized projects online and ask donors for the necessary funding. The possibility of profit is not suggested by the solicitation. Creative projects like music albums, a series of paintings, and fashion creations are common in the model. The breadth of offerings is much greater though. Any person or entity whose project is unlikely to earn a profit might use the donative model.
The use of donative crowdfunding to-date has been almost as wide as the model’s theoretical scope. The 2008 presidential campaign of Barack Obama used donative crowdfunding to raise funds. The donative model was used to acquire The Three Graces by Lucas Cranach for The Louvre’s collection. Comedian Jon Stewart even launched a humorous campaign on Kickstarter to raise $10 Billion for the acquisition of cable news service CNN. The possibilities within this model are nearly limitless.
The donative model that has been active in the United States is so old that at least one court found a donative crowdfunding site was functioning in 2003 – 3 years before the term crowdfunding was supposedly coined. The donative model is represented in the United States by the highly-successful portals Kickstarter and Indiegogo. Both of those portals provide a portal for people and entities to ask for donations in exchange for rewards. Those rewards might be first editions, special editions, or early delivery of the entrepreneur’s product.
The donative model portals active in the United States keep their operations wholly outside of government financial regulation through the use of well-chosen terms, disclaimers, and disclosures. The sites state that the financiers aren’t investors and they aren’t consumers. They are just good people making sure that good art is made when traditional systems have failed to do so.
For many Americans, the opportunity to contribute to the realization of creative projects is enough to inspire a donation. Millions of people have visited the sites to donate over the past 5 years and the impact on the traditional financial model has been substantial. $5 Billion has been donated through the end of 2013. $3.5 Billion was donated in 2012 and 2013 alone. These astounding sums and the rapid growth of the model is why CNBC listed Kickstarter as the 49th greatest business disruptor of the 2013 alongside names like Uber, Spotify, and Dropbox.
Written by John Sanders (’16), Wake Forest School of Law Student Practitioner