In one of our previous posts, I outlined both the theoretical potential of investment-based crowdfunding as well as the possible reasons underlying its delay compared to the consumption-based model. In this paragraph I first summarize the measures that can boost online investment propensity into bullet-points and later describe each one individually.
Key factors
- Offset information asymmetry and prevent adverse selection of high-quality startups: this can be achieved via standardized guidance to information disclosure offered by platform managers to entrepreneurs or via upfront screening of business projects
- Help the entrepreneur to actively involve his existing network of contact and collect the effort into the platform: this is much more efficient than standalone crowfunding campaign
- Create the premises to herding behavior: it is crucial for online crowdfunding campaign to provide the first bulk of investors and then let other people to be influence simply by early-crowdfunders
- Set up reward for the risk: this can be both in consumption or financial terms as well as in social benefits
So far it is clear that information asymmetry must be offset in order to make the crowdfunding market exist. This is likely to be especially true the larger the initial capital requirement and crowdfunding model used –that is, investment decisions takes a large information need compared to consumptions ones. This is why I conclude that online platforms should strive to provide entrepreneurs and crowdfunders with common and standardized means to improve such informational gap. According to Mollick (2012) online websites help in signalling the underlying quality of the project . He claims that online communication has unlimited potential and can drive a lot of potential investors in a while. However such informational potential has to be channelled into the right rails.
The same authors also concludes that standardized platforms have shown to help entrepreneurs to activate their network of contact much better than via independent initiatives. Although his study is based on Kickstarter, this can be extended to all crowdfunding portals.
Another measure that would help to lower the asymmetry is some sort of screening process upfront. Rather than letting every startup register on a platform regardless of its stage of development, portal managers should set up some initial requirements to grant the access. This would work as a warranty offered by the managers to crowdfunders which would increase the average perceived quality of the propositions. Although it may be claimed that such measure would jeopardize the demand-supply rule, a market such massively subject to adverse selection can only benefit of such upfront selection.
The third aspect that drives online investment is herding behavior, as suggested by the paper of Ward and Ramachandran (2010). However the fire first need a spark in order to blaze. Internet portals offer perfect means to light this fire up but it needs an initial effort in order to trigger a domino effect. All other drivers described here can suffice this task, of course.
Another factor in the investment decision is the reward. With regard to the investment-based model, the financial reward has to be set by the entrepreneur in such a way that overcomes the doubts and concerns he has for the business project. Beside the required return for the risk of investment, which is a concept that most of the entrepreneurs seems not to grasp, there are other rewards that positively affect the willingness to invest. Belflemme, Lambert and Schwienbacher (2012b) found that non-profit projects have higher chances to be successfully funded in comparison with similar for-profit projects. According to the authors, the former organizations are better at attracting outside funds because of their possible stronger focus on the social outcome than on monetary gains. Therefore, this works suggests that crowdfunders value social benefits as something that increase their personal utility. However according to Belflemme, Lambert and Schwienbacher (2012a) this increase in utility stems from future expectations of consumption rather than altruism.
Finally, in line with the mere social benefits increasing personal utility, Belflemme, Lambert and Schwienbacher (2012b) econometrically proved that the proxy variable for active involvement by the crowdfunders into project positively affects the appeal for the investment. This is related to the privilege of being one of those early-investors that have been pivotal in the path to reach the market. This involvement comes in the form of participation to strategic decisions especially regarding the product/service development or dome sort of voting rights. This result is remarkable and suggests that crowdfunders are not only looking for financial or consumption benefits, but they are most importantly looking for an experience in entrepreneurial world, although they are not willing to share the entire risk of starting a venture. Entrepreneurs should just consider equity-based investors not merely as capital providers but as partners, willing to share their expertise and suggestions.
References
1) Belleflamme, P., Lambert, T. and Schwienbacher, A. (2012a). Crowdfunding: Tapping the right crowd. Working Paper.
2) Belleflamme, P., Lambert, T. and Schwienbacher, A. (2012b). Individual Corwdfunding Practices. Working Paper.
3) Larralde, B., and A. Schwienbacher, 2010. Crowdfunding of Small En-trepreneurial Ventures. Book chapter for Entrepreneurial Finance” (Ed. D.J. Cumming), forthcoming at Oxford University Press.
4) Mollick, E. (2012). The Dynamics of Crowdfunding: Determinants of Success and Failures. Mimeo.
5) Ward, C. and V. Ramachandran (2010). Crowdfunding the Next Hit: Microfunding Online Experience Goods. Working Paper.