Signaling in Equity Crowdfunding

Abstract

This paper presents an empirical examination of which start-up signals will small investors to commit financial resources in an equity crowdfunding context. We examine the impact of firms' financial roadmaps (e.g., preplanned exit strategies such as IPOs or acquisitions), external certification (awards, government grants and patents), internal governance (such as board structure), and risk factors (such as amount of equity offered and the presence of disclaimers) on fundraising success. Our data highlight the importance of financial roadmaps and risk factors, as well as internal governance, for successful equity crowdfunding. External certification, by contrast, has little or no impact on success. We also discuss the implications for successful policy design. Signaling in Equity CrowdfundingABSTRACT This paper presents an empirical examination of which start-up signals induce small investors to commit financial resources in an equity crowdfunding context. We examine the impact of firms' financial roadmaps (e.g., preplanned exit strategies such as IPOs or acquisitions), external certification (awards, government grants and patents), internal governance (such as board structure), and risk factors (such as amount of equity offered and the presence of disclaimers) on fundraising success. Our data highlight the importance of financial roadmaps and risk factors, as well as internal governance, for successful equity crowdfunding. External certification, by contrast, has little or no impact on success. We also discuss the implications for successful policy design. JEL Classification: G21, G24, L26Keywords: Entrepreneurial Finance, (Equity) Crowdfunding, Micro Lending, Internet, Given the recent passage of the JOBS (Jumpstart Our Business Startups) Act in the U.S., which will permit equity crowdfunding by early 2013, this number is likely to increase sharply. Small investors, who are often the primary support of start-ups, do not usually have the capability to extensively research and assess potential investments. In order to successfully raise money via an equity crowdfunding platform, therefore, start-ups need to find ways to clearly signal their value to small investors.Two contrasting London-based crowdfunding cases illustrate the issues discussed further here. In December 2011, The Rushmore Group, a start-up that now operates three bars in London, sold 10% of its equity for £1,000,000 to 143 small investors through Crowdcube.The aspiring entrepreneurs of The Rushmore Group accomplished this feat in a little over two weeks -a remarkable success story.A strikingly different outcome, however, is illustrated by our second example. In early April 2012, another owner and operator of a London bar, Meatballs, offered a 25% equity 2 stake for £300,000 on Crowdcube. Two months after the start of the offering, they had raised only £4,750.The Rushmore Group and Meatballs perform essentially the same service in the same city.Both start-ups were presented in the same fashion and on the same online platform. Why, then, di...

Which updates during an equity crowdfunding campaign increase crowd participation?

“…In the specific setting of crowdfunding, startups aim to collect capital from a large number of mostly anonymous investors, who contribute small amounts of money via the Internet Belleflamme et al 2014;Hemer et al 2011;Hornuf and Schwienbacher 2016). The average crowdfunding investor is not likely to have the time, capacity, and incentive to investigate firms and their business model in detail (Ahlers et al 2015;Lukkarinen et al 2016). Due to the specific characteristics of crowdfunding, establishing personal relationships to reduce information asymmetries typical for business angel or venture capital investments (Landström 1992;Sapienza and Korsgaard 1996;Kollmann and Kuckertz 2006) is not feasible in equity crowdfunding markets.…”

“…The clarity of the signal directly relates to the interpretation by receivers: Members of a group of very heterogeneous receivers are more likely to translate the signal differently (Perkins and Hendry 2005;Connelly et al 2011). As the receivers of signals in crowdfunding markets have been found to be very heterogeneous (Ahlers et al 2015), the clarity of the signal is particularly important. Clarity, however, depends on the complexity of the language used in the updates.…”

“…Furthermore, Aoterra, (2015), Lukkarinen et al (2016), Polzin et al (2017) Share of retained equity Mixed Entrepreneurial intention Ahlers et al (2015), Ralcheva and Roosenboom (2016), Vismara (2016a) External certification Social network (size) Mixed Social capital; quality disclosure; larger investor base Ahlers et al (2015), Lukkarinen et al (2016), Vismara (2016a) Reputable investors (business angels, experts) + Quality disclosure; certification Kim and Viswanathan (2013), Ralcheva and Roosenboom (2016) Investors with large investments + Quality disclosure Vulkan et al (2016) Intellectual capital (patents) Mixed Quality disclosure Ahlers et al (2015), Ralcheva and Roosenboom (2016) Reception of grants None Quality disclosure Ralcheva and Roosenboom (2016) Campaign developments…”

“…Prior research has investigated the success drivers of equity crowdfunding campaigns and has shown that information provided by the start-up, such as the human and social capital of the founders, risks involved, and financial projections, have a positive influence on campaign success (Ahlers et al 2015;Vismara 2016b;Polzin et al 2017). This information usually does not change during a crowdfunding campaign and is typically provided by the start-up before a campaign starts.…”

“…We analyze how start-ups can use updates during the campaign to encourage the crowd to provide funding. This particular determinant of equity crowdfunding participation has been overlooked in the literature so far, and as such, there is an important gap on the effects of information disclosure on crowd participation (Ahlers et al 2015;Bernstein et al 2017;Vismara 2016b;Polzin et al 2017). Updates enable start-ups to signal their value to the crowd and to establish credibility and legitimacy during a crowdfunding campaign.…”