Crowdfunding and Follow-On Investments

Does the identification of prior investors lead to greater follow-on investment in a new venture in equity-based crowdfunding? 

In recent years, a number of alternative avenues have emerged by which entrepreneurs can obtain startup financing. Crowdfunding, one such avenue, allows entrepreneurs to raise capital from the crowd via the Internet, in relatively small amounts. The crowds’ contributions arrive in the form of donations, loans or equity sales, depending on the type of crowdfunding used. 

In 2013, crowdfunding platforms helped to facilitate more than $5 billion in fundraising worldwide. Equity-based crowdfunding, in particular, has attracted a great deal of attention of late from legislators, policymakers and entrepreneurs. While private equity sales are by no means a new phenomenon, taking the process online in this manner has important implications. One apparent benefit is that it has the potential to broaden markets and democratize access to capital for many entrepreneurs by reducing geographic constraints. At the same time, online investing brings with it a number of pitfalls, namely in the form of increased information asymmetry.

Information asymmetry

Start-up investment is characterized by a high degree of information asymmetry between the entrepreneur and the investor. To obtain a positive return, investors need to accurately assess the qualifications and ability of an entrepreneur, as well as the potential of their idea. Institutional investors are thus typically professionals, who have the expertise and experience necessary to evaluate potential investment opportunities. Crowdfunders, in contrast, are typically retail investors, who have relatively limited experience or resources to support their evaluation of new ventures. Making matters worse, the geographic separation between investors and entrepreneurs that characterizes online crowdfunding makes evaluation and monitoring a greater challenge.

Our study leverages data from CrowdCube, the largest equity-based crowdfunding platform in the United Kingdom. Since its founding in 2008, CrowdCube has facilitated more than $60 million USD in transactions. Combined, those transactions have involved nearly 88,000 investors and over 140 successfully funded ventures. The average individual investment is approximately $4,000, though investments range from as little as $15 to as large as $400,000. The average venture attracts 104 investors and approximately $370,000, and roughly 24 percent of all pitches are successful in reaching their fundraising target.

Social media as a signal

Our results indicate that the having a LinkedIn profile is positively associated with the amount of money raised by a project. However, the coefficient of Photo is not significant, which suggests that investors are not influenced by whether the project sponsors post a profile picture. We also find that the number of Facebook likes and tweets is also positively associated with the number of investors on a given day.

This study has several implications for policymakers and practitioners. Platform owners and entrepreneurs can provide incentives to investors who reveal their identity by connecting via their LinkedIn profile. However, the effect identified in our paper also suggests that there is a potential for high-profile individuals to create a herding effect, whereas other investors blindly follow the lead of these individuals. Policy makers should devise regulatory and social mechanisms to protect investors against this herding.

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Sunil Wattal

Sunil Wattal (PhD, Tepper School of Business, Carnegie Mellon University) joined the MIS Department at Temple University as an Assistant Professor in Spring 2007. He also holds a Bachelors in Engineering from BITS Pilani (India), an MBA from IIM Calcutta (India), and an MS (Industrial Administration) from Carnegie Mellon University.

Sunil currently teaches management information systems at the undergraduate level and a capstone course at the masters level. His research interests include economics of information systems, technology adoption, privacy, software security, and internet marketing.