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Investors' Evaluation Criteria in Equity Crowdfunding Small Bus Econ https://doi.org/10.1007/s11187-019-00227-9 Investors’ evaluation criteria in equity crowdfunding Kourosh Shafi Accepted: 28 June 2019 © Springer Science+Business Media, LLC, part of Springer Nature 2019 Abstract Equity crowdfunding can provide signifi- and entrepreneurs, as well as platform organizers and cant resources to new ventures. However, it is not clear policy makers. how crowd investors decide which ventures to invest in. Building on prior work on professional investors Keywords Equity crowdfunding · Decision-making as well as theories in behavioral decision-making, we criteria · Evaluability examine the weight non-professional crowd investors place on criteria related to a start-up’s management, JEL Classification D26 · L26 business, and financials. Our conceptual discussion raises the possibility that crowd investors often lack the experience and training to assess complex and 1 Introduction sometimes technical investment information, poten- tially leading them to place larger weight on fac- This study explores the decision criteria used by a tors that appear easy to evaluate and less weight on newly emerging class of investors: the “crowd” of factors that are more difficult to evaluate. Studying non-professional individuals who can invest in entre- over 200 campaigns on the platform Crowdcube, we preneurial ventures through equity crowdfunding plat- find that fundraising success is most strongly related forms (Ahlers et al. 2015; Mohammadi and Shafi to attributes of the product or service, followed by 2018;Vismara2018).1 We consider three sets of criteria: selected aspects of the team, in particular, founders’ (i) attributes of the venture’s management team, (ii) motivation and commitment. However, financial met- characteristics of the product or service and the market, rics disclosed in campaign descriptions do not predict and (iii) the venture’s financial potential. These crite- funding success. We discuss implications for investors ria are sourced from surveying a large body of research K. Shafi () 1Ahlers et al. (2015) define equity crowdfunding as a form of California State University, 25800 Carlos Bee Boulevard, financing in which entrepreneurs make an open call to sell a Hayward, CA 94542, USA specified amount of equity in a company on the Internet, hop- e-mail: [email protected] ing to attract a large group of investors. The open call and K. Shafi investments take place on an online platform (such as, e.g., Department of Management, College of Business Crowdcube) that provides the means for the transactions (the and Economics, California State University East Bay, legal groundwork, pre-selection, the ability to process financial Hayward, CA, USA transactions, etc.). K. Shafi in finance and entrepreneurship that has examined this group of investors compared with those of the how professional investors decide which ventures to more professional investors such as angels and VCs. invest in (Tyebjee and Bruno 1984; Zacharakis and Unlike professional investors, crowd investors suppos- Shepherd 2001; Mason and Stark 2004). edly lack organizational resources, relevant industry Studying crowdfunding investors is important and financial expertise, and venture investing experi- because prior findings on professional investors may ence to perform extensive due diligence. Additionally, not generalize to the crowd for at least two rea- non-professional investors typically take smaller sons. First, whereas professional investors tend to have stakes in new ventures and therefore have limited access to significant organizational resources as well incentives to engage in time-consuming and complex as personal knowledge and experience when making processing of multi-dimensional information required investment decisions, crowd investors may lack the for evaluating a venture. For these reasons, the cur- resources and experience to perform extensive due rent research in crowdfunding benefits from attempts diligence on young firms that are often characterized to study not only the relevant criteria used by non- by high uncertainty and information asymmetries. professional investors but also the underlying decision Second, crowd investors tend to invest relatively small processes that investors use to integrate and process amounts of money and also receive a relatively small information. We employ the evaluability theory in stake of a company in return (Ahlers et al. 2015). As behavioral decision-making (Hsee and Zhang 2010) such, even if crowd investors could potentially employ that offers the bounded rationality assumption that the more sophisticated decision-making approaches decision-makers select decision strategies that balance used by professional investors, the associated (fixed) decision accuracy with the costs such as cognitive costs are unlikely to be justified given the relatively effort and time required to arrive at those decisions. low stakes. Instead, crowd investors may prefer sim- In doing so, we show that the crowd places little pler heuristics that allow for fast decision-making at weight on financial metrics and appears to place more relatively low cost. weight on characteristics of the product and service To examine crowd investment decisions empiri- than on the founding team. Additionally, we offer new cally, we analyze 207 equity crowdfunding campaigns insights into the moderating effect of perceived risk started on Crowdcube, the largest equity crowdfund- of investing in a venture: as the percentage of equity ing platform in the UK. For each project, we acquired offered in the campaign increases, crowd investors from an independent rating agency standardized rat- seem to value information on financials more. ings of three broad sets of criteria: (i) management We also contribute to a growing literature on quality (capturing the experience, skills, and commit- the drivers of crowdfunding success (Mollick 2014) ment of the start-up team), (ii) attributes of the prod- and, in particular, equity crowdfunding (Ahlers et al. uct, market potential, and competition, and (iii) finan- 2015;Vismara2016; Vulkan et al. 2016). Much of cial metrics (capturing profitability, cash flow, and the the emerging work in equity crowdfunding inves- potential rate of returns). While these ratings were tigates whether and how the crowd responds to likely unobserved by crowd investors, they provide certain information on campaign quality or to sig- us with unique measures to compare a comprehen- nals such as awards and the presence of prominent sive set of attributes across campaigns and to examine investors (Ahlers et al. 2015; Ralcheva and Roosen- the weight given to different aspects of crowdfund- boom 2016), early investors as endorsements (Kim ing proposals by investors. We also assess whether and Viswanathan 2014), or early funding collected the perceived risk of investing in a given venture from private networks (Lukkarinen et al. 2016). Using influences the relative weight given to these criteria. a novel set of measures, our study adds to this body Our study contributes to two mainstreams of lit- of work by assessing the relationship between funding erature. We contribute to the literature on investor success and a broad range of campaign characteris- decision-making (Zacharakis and Meyer 1998; tics related to the quality of the management team, Zacharakis and Shepherd 2001) by studying an attributes of the venture’s product/service and target increasingly important type of investor—the crowd. market, and financial metrics. While some of our In fact, our knowledge in terms of both investment cri- results (such as the relationship between the quality teria and decision-making processes is limited about of human capital and success) support prior findings Investors’ evaluation criteria in equity crowdfunding in this literature (Ahlers et al. 2015; Piva and Rossi- logics, and the unfolding dynamics during fundrais- Lamastra 2018), we use finer-grained data that extend ing (resulting from interacting with prior investors previously considered set of criteria. For example, the and entrepreneurs’ posted updates during campaign). measures used by Ahlers et al. (2015) do not take into Several studies suggest how information cascades can account that ventures might have different financial form among crowd investors that leads to herding performance (as presented in the financial statements) (Vulkan et al. 2016; Hornuf and Schwienbacher 2018; that, if processed by investors diligently, can presum- Vismara 2018), which is prevalent in other types of ably help investors assess the equity crowdfunding crowdfunding markets (Colombo et al. 2015). For ventures better. Additionally, while the signaling the- instance, Vismara (2018) reports that a larger number ory employed by Ahlers et al. (2015) views the avail- of initial early investors increase the number of subse- ability of financial forecasts or disclosures of risk quent investors, the total funding amount, and thus the as a proxy for increased information and uncertainty probability of a successful campaign. Investors with a reduction, we adopt behavioral theories of decision- public profile make the offer more appealing to early making as our theoretical lens to better understand investors, who in turn attract subsequent investors. when financials influence crowd investors’ judgments. Relatedly, entrepreneurs can post updates about their The premise in the signaling theory is how investors new developments, such as funding events, business use signals
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