Equity crowdfunding: What motivates an investor?

 
Harriet Green
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Despite investors using information gathered collectively, you don't see herd mentalities in equity crowdfunding (Source: Getty)

How do retail investors really make decisions when investing through crowdfunding platforms? A new paper, released today by the London School of Economics, sheds some light. The focus is whether equity crowdfunding provides a robust alternative to financing entrepreneurship.

To answer this, authors Saul Estrin and Susanna Khavul have looked at the rationality of investor behaviour, using two years of data from platform Crowdcube.

The pair conclude that platforms like Crowdcube are able to exploit the low transaction costs that come with being online and, vitally, bring increasing network effects to bear on investor decisions in early-stage entrepreneurial finance – meaning they enable a “solution to market failure” when it comes to providing this funding. The interaction of the crowd is key to this: here are a few of their most illuminating findings.

Bigger than expected

First, the report found – and this is across crowdfunding platforms in general – that individual investments made by lead investors are frequently between £100,000 and £200,000. Although piecemeal investments of £10 do remain popular on platforms that allow them to be made, average investments are between £1,000 and £3,000.

Herd mentality

Estrin and Khavul also highlight how the accumulation of information through the pitch process is important. “Each incremental investment [provides] additional information, visible to all other potential investors, about how the pitch is currently evaluated,” they say.

But crucially, this does not “generate unstable or explosive investment paths” – i.e. you don’t see herd behaviour playing out, with investors blindly following each other.

For £1 invested on one day of the pitch, an additional 51p of fresh investment was generated on the following day, and an additional 76p over the next five days. And the lagged effects taper quickly, which indicates a pretty rapid absorption of the incremental information behind the initial investment, say the pair. Moreover, “since the sum of [those] lagged effects is less than the unity, the impact of fresh investment is not unstable,” they add.

Sophistication

Estrin and Khavul also looked at what kind of information has an impact on the success rate of a raise. “We find that easily available information in the public domain about the entrepreneur and the firm – such as the sector or location of the business or the gender of the entrepreneur – does not have a significant influence.”

Yet specific details do make a difference – notably, the price of and number of shares on offer, the company’s valuation and growth prospects. Countering the notion that retail investors can get sucked into hugely over-valuated deals without realising it, they found, for example, that as the implicit valuation rises, the likelihood that a pitch will be fully funded declines.

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