The Hidden Cost of Being Different: Equity Crowdfunding as Negative Signal in Subsequent Rounds

Conference Paper
Academy of Management Proceedings 2017(1), 17609
Authors

Jan Niklas Wick

Christoph Ihl

Published

August 1, 2017

Doi

10.5465/AMBPP.2017.17609abstract

Abstract
After having used own funds and potentially borrowed from friends and families, young ventures often reach out to external investors to obtain capital in exchange for equity. In absence of standard means of evaluation, the market for venture financing is characterized by high uncertainty and information asymmetries between players requiring young ventures to invest significant effort in effectively signaling their quality to potential investors. Due to the large numbers of ventures seeking financing investors typically use rapid categorization and filtering mechanism to focus their efforts on the most promising ventures. In the context of the recently established equity crowdfunding providing funds in exchange for equity we highlight the importance for young ventures to diligently assess with whom to partner or not. Building on a comprehensive sample of the funding activities of young ventures that is matched and, hence, balanced in terms of seven key quality controls, we find support for our theory that despite being of the same quality, deviating from the norm in absence of clear a rationale and obtaining equity crowdfunding in a first funding round acts as a negative signal in subsequent funding rounds. In line with prior literature we additionally find that such a negative signal can be mitigated through a greater funding amount in the first round and prior experience of second round investors with equity crowdfunding.

Research

© Anne Gärtner

  • Conference Paper
  • 2017
  • Vol. 2017(1)
  • DOI

Authors

Jan Niklas Wick, Christoph Ihl

Abstract

After having used own funds and potentially borrowed from friends and families, young ventures often reach out to external investors to obtain capital in exchange for equity. In absence of standard means of evaluation, the market for venture financing is characterized by high uncertainty and information asymmetries between players requiring young ventures to invest significant effort in effectively signaling their quality to potential investors. Due to the large numbers of ventures seeking financing investors typically use rapid categorization and filtering mechanism to focus their efforts on the most promising ventures. In the context of the recently established equity crowdfunding providing funds in exchange for equity we highlight the importance for young ventures to diligently assess with whom to partner or not. Building on a comprehensive sample of the funding activities of young ventures that is matched and, hence, balanced in terms of seven key quality controls, we find support for our theory that despite being of the same quality, deviating from the norm in absence of clear a rationale and obtaining equity crowdfunding in a first funding round acts as a negative signal in subsequent funding rounds. In line with prior literature we additionally find that such a negative signal can be mitigated through a greater funding amount in the first round and prior experience of second round investors with equity crowdfunding.

Tags

Crowdfunding Signaling Venture Finance