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Third-party signals in equity crowdfunding: the role of prior financing

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A Correction to this article was published on 12 January 2019

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Abstract

Drawing on signaling theory, this study provides preliminary evidence that prior financing certifies firm quality to investors and reduces information asymmetries in equity crowdfunding. We examine 221 business plans and project descriptions of start-ups that ran equity crowdfunding campaigns on Crowdcube in 2017 and 2018. Almost half of the start-ups had previously raised funds through business angels, venture capitalists, crowdfunding, or grants. Prior financing positively affects campaign success. Overall, the effect is larger for firms backed by multiple investor types and for firms that have run successful crowdfunding before. To isolate the quality signal from the additional benefits related to an affiliation with other investors, we analyze whether the effect of prior financing is moderated by the uncertainty around a project. In support of a signaling effect, preliminary evidence suggests that prior financing is most relevant for firms in the uncertain seed stage. Among the different investor types, we find that, in particular, an affiliation with venture capitalists signals quality. Such an affiliation is more important for firms with low levels of human and social capital. Our study adds to the understanding of how equity crowdfunding interacts with traditional forms of entrepreneurial finance.

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Change history

  • 12 January 2019

    Unfortunately, the original version of this article was published online with error. The data in Tables 1, 3, 4, 5 and 6 were incorrectly displayed and aligned by the Springer proofreaders/or in the proofread stage of Springer. The corrected Tables 1, 3, 4, 5 and 6 are shown in the next page.

Notes

  1. The data set is limited to projects that are pre-selected by platforms. This sample selection might bias the results as we do not know how platforms screen proposals.

  2. Prior crowdfunding success means a separate earlier crowdfunding campaign that a start-up project ran through successfully before the current campaign under study.

  3. There is already initial evidence on certain third-party signals in equity crowdfunding. For example, Ahlers et al. (2015) use variables for government grants and awards in their econometric analysis.

  4. With regard to Hypothesis 1, a necessary condition for a signal is that it has a positive effect on campaign success. However, prior financing offers additional benefits to a start-up that may also foster campaign success. In Section 2.3.2, we elaborate on these benefits and present hypotheses to isolate the signaling effect.

  5. This argument may not hold for all BAs. Reputational capital depends on individual investors with differences also among more and less reputable VCs. However, we are interested in general differences among the investor types. This is reasonable for the equity crowdfunding context as it is questionable whether unsophisticated crowd investors would notice reputational differences among individual investors within each financing form.

  6. One might argue that firms with more human and social capital also use resources differently, e.g., firms with high levels of human capital are shown to realize more with fewer resources (Chandler and Hanks 1998). Following this logic, as such firms can use resources more efficiently, it is conceivable that they might even benefit more from prior financing related to the substantive benefits, i.e., in this case, the moderation effect should be positive.

  7. We extended the data set with 21 projects posted in July and August 2018 on Crowdcube.

  8. One start-up returned to Crowdcube for the fifth time.

  9. We only consider a start-up to be related to an investor if at least one type of the various sources of financing is clearly mentioned in the business plan or project description. Some start-ups indicate having raised funding before, but do not mention the type of investor. These start-ups are not considered for our variable Prior_Funding because funding could have been raised from family, friends, or founders, which are clearly not related to the certification of an external investor.

  10. Vismara (2016) measures social capital in terms of the founder’s LinkedIn connections.

  11. In total, there are 18 start-ups affiliated with two different investor types, 12 start-ups affiliated with three different investor types, and 1 firm affiliated with four different investor types.

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Acknowledgements

The authors are grateful for helpful comments of Silvio Vismara, three anonymous reviewers, as well as participants of the 6th Crowdinvesting Symposium at the Max Planck Institute for Innovation and Competition. Moreover, we thank Tobias Bürger and Kazem Mochkabadi for extensive discussions and valuable feedback.

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  1. Bergische Universität Wuppertal, Gaußstraße 20, 42119, Wuppertal, Germany

    Simon Kleinert, Christine Volkmann & Marc Grünhagen

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The original version of this article was revised: Due to misalignment of data in Tables.

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figure 3

Average marginal effects of interaction terms with human and social capital. Note: The graphs are based on predicted values of our observations using the estimation models shown in Table 4

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Kleinert, S., Volkmann, C. & Grünhagen, M. Third-party signals in equity crowdfunding: the role of prior financing. Small Bus Econ 54, 341–365 (2020). https://doi.org/10.1007/s11187-018-0125-2

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