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Investors’ evaluation criteria in equity crowdfunding

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Abstract

Equity crowdfunding can provide significant resources to new ventures. However, it is not clear how crowd investors decide which ventures to invest in. Building on prior work on professional investors as well as theories in behavioral decision-making, we examine the weight non-professional crowd investors place on criteria related to a start-up’s management, business, and financials. Our conceptual discussion raises the possibility that crowd investors often lack the experience and training to assess complex and sometimes technical investment information, potentially leading them to place larger weight on factors that appear easy to evaluate and less weight on factors that are more difficult to evaluate. Studying over 200 campaigns on the platform Crowdcube, we find that fundraising success is most strongly related to attributes of the product or service, followed by selected aspects of the team, in particular, founders’ motivation and commitment. However, financial metrics disclosed in campaign descriptions do not predict funding success. We discuss implications for investors and entrepreneurs, as well as platform organizers and policy makers.

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Notes

  1. Ahlers et al. (2015) define equity crowdfunding as a form of financing in which entrepreneurs make an open call to sell a specified amount of equity in a company on the Internet, hoping to attract a large group of investors. The open call and investments take place on an online platform (such as, e.g., Crowdcube) that provides the means for the transactions (the legal groundwork, pre-selection, the ability to process financial transactions, etc.).

  2. Scholars have also shown interest in other aspects of equity crowdfunding such as governance issues (Cumming et al. 2019) and outcomes following equity crowdfunding campaigns (Signori and Vismara 2018).

  3. Table 1 in Maxwell et al. (2011) gives an excellent overview of relevant studies in the angel realm on the relevance of team criteria.

  4. A popular saying is that VCs would rather invest “in a grade A team with a grade B idea than in a grade B team with a grade A idea.” Arthur Rock, a legendary venture capitalist, once said, “Nearly every mistake I’ve made has been in picking the wrong people, not the wrong idea” (Bygrave and Timmons 1992, p. 6).

  5. Equity crowdfunding platforms now account for about one-fifth of all early-stage investment deals and 35% of the number of seed stage deals in the UK (http://about.beauhurst.com/report-the-deal-q3-15) with Crowdcube being the market leader with a market share of 52% (http://www.crowdfundinsider.com/2015/08/72395-crowdsurfer-data-released-crowdcube-leads-uks-investment-crowdfunding-market/).

  6. https://help.crowdcube.com/hc/en-us/articles/206232464-What-fees-does-Crowdcube-charge-for-raising-finance-on-the-platform-https://help.crowdcube.com/hc/en-us/articles/206232464-What-fees-does-Crowdcube-charge-for-raising-finance-on-the-platform-

  7. For more information, see https://www.gov.uk/guidance/venture-capital-schemes-apply-for-the-enterprise-investment-schemehttps://www.gov.uk/guidance/venture-capital-schemes-apply-for-the-enterprise-investment-scheme and https://www.gov.uk/guidance/venture-capital-schemes-apply-to-use-the-seed-enterprise-investment-schemehttps://www.gov.uk/guidance/venture-capital-schemes-apply-to-use-the-seed-enterprise-investment-scheme

  8. Thanks to one of the reviewer’s suggestions, we investigate the possibility of a mediation effect for the target goal in the relationship between management rating and raised amount. We do so because better teams set higher goals (a correlation of 0.516 between management rating and target goal), and this could provide an alternative explanation for why better teams raise more money. We perform causal mediation analysis using the command “PARAMED” in Stata; the total direct effect is 0.048 (p < 0.01), the controlled direct effect is 0.021 (p < 0.01), and the natural direct effect is 0.027 (p < 0.01). The results (available upon request) confirm the presence of the mediation effect.

  9. Given that we imputed zero for observations with missing financials and a dummy denoting this missing observations, we include an interaction term between the dummy and equity offered. We do not report the dummy or the interaction term, which are always insignificant.

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Authors and Affiliations

  1. California State University, 25800 Carlos Bee Boulevard, Hayward, CA, 94542, USA

    Kourosh Shafi

  2. Department of Management, College of Business and Economics, California State University East Bay, Hayward, CA, USA

    Kourosh Shafi

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Appendix

Appendix

Table 6 Correlation matrix for sub-ratings
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Table 7 Models with interaction terms between ratings
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Table 8 OLS models predicting amount raised (%)
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Table 9 OLS models predicting no. of funders (logged)
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Table 10 Models with additional management variables
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Table 11 Models with additional business variables
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Table 12 Models with accounting data
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Table 13 Additional robustness tests
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Table 14 Probit models predicting success: restricted sample that excludes companies with prior CF success
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Table 15 OLS models predicting amount raised (logged): restricted sample that excludes companies with prior CF success
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Shafi, K. Investors’ evaluation criteria in equity crowdfunding. Small Bus Econ 56, 3–37 (2021). https://doi.org/10.1007/s11187-019-00227-9

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