Is equity crowdfunding always good? Deal structure and the attraction of venture capital investors
Introduction
In the last ten years, equity crowdfunding has become an established source of funding (Hornuf and Schwienbacher, 2018) for entrepreneurial firms (Cumming et al., 2016). Hand in hand with its growing role for early-stage financing, equity crowdfunding has also gained momentum in the academic community. The seminal articles on this topic have mainly focused on the factors associated with the success of crowdfunding campaigns (see e.g., Vismara, 2016b; Ahlers et al., 2015; Piva and Rossi-Lamastra, 2018; Lukkarinen et al., 2016; Mahmood et al., 2019; Ralcheva and Roosenboom, 2016; Bapna, 2017; and Mochkabadi and Volkmann, 2018 for a review). Only recently, several studies have started to investigate the aftermath of launching an equity crowdfunding campaign for entrepreneurial firms (see for a review Vanacker et al., 2019; Ahlstrom et al., 2018). Within this debate a few studies focus on crowd investors' post-campaign contribution. Di Pietro et al. (2018) showed that crowd investors provide entrepreneurs with two main types of input: knowledge (product, strategy, and market-related), and network ties with industry players and other relevant stakeholders. Related to this study, Walthoff-Borm et al. (2018a) moves from the idea that, through crowdfunding, entrepreneurs can access extra-financial resources, such as feedback and direct involvement (i.e., ties) by crowd investors. Contrary to expectation, they show that equity crowdfunded firms exhibit lower financial performances and have significantly higher failure rates. Hornuf et al. (2018) find a similar result, they report that German equity crowdfunded firms have a higher likelihood of failure. They further demonstrate that the hazard of failure increases with the valuation of the firm, while decreases with the amount raised during the crowdfunding campaign.
Within the research stream on firms' performance after an equity crowdfunding campaign, only a few studies have investigated the relation between crowdfunding and follow-on financing. Moreover, this literature is far from being conclusive, actually, the results are often diverging. Signori and Vismara (2018) find that 34.9% of the companies that obtained equity crowdfunding raised additional funding, either in the form of private equity injection (9%) or follow-on offering on a crowdfunding platform (25%). Hornuf et al. (2018) show that firms that received equity crowdfunding register a higher chance of obtaining follow-on financing by business angels or venture capitalists. Drover et al. (2017) show that VC have a higher willingness to conduct due diligence on firms that raised reward-based crowdfunding,1 but they do not find any association for firms raising equity crowdfunding. Also, a recent study by Cumming et al. (2019) contributes to this debate, by looking at the ownership structure of firms seeking equity crowdfunding. They found that a higher separation between ownership and control rights lowers the likelihood of attracting professional investors.
Besides some contrasting results, none of these studies have examined directly how different shareholder structures (Walthoff-Borm et al., 2018a) affect firms' capacity to obtain follow-on investments from professional investors and, in particular, venture capitalists, after an equity crowdfunding campaign. We believe this omission has significant implications. Equity crowdfunding may represent a valuable signal that reduces professional investors' information asymmetries. However, crowd investors' involvement after an equity crowdfunding campaign may also generate governance issues (Cumming et al., 2019) and agency conflicts with potential follow-on investors. We argue that the relevance of coordination problems and agency conflicts varies depending on the shareholder structure chosen for the equity crowdfunding offering. We expect high agency conflicts vis-a-vis follow-on professional investors for firms that received equity crowdfunding through a direct shareholder structure, wherein crowd investors become direct shareholders. These conflicts may off-set the signaling value of having received equity crowdfunding. On the contrary, we argue that potential agency conflicts with follow-on professional investors are lower for firms that chose a nominee structure,2 wherein the equity crowdfunding platform holds and manages firm's shares on behalf of the crowd investors. Thus, in this case, the signaling value of crowdfunding holds.
This paper adds to the literature on follow-on financing by venture capitalists (VCs) after an equity crowdfunding campaign by investigating how the functioning of different shareholder structures affects the investment patterns following the campaign. Particularly, we aim at answering the following research questions: i) How does having received equity crowdfunding affect the attraction of VC financing? ii) How does the shareholder structure of the crowdfunding campaign affect the attraction of VC financing?
We investigate these research questions using a comprehensive dataset of firms that raised financing from the two largest equity crowdfunding platforms in UK: Seedrs and Crowdcube, between 2011 and 2018. Through a Cox survival model (Cox, 1972), we analyze whether and how equity crowdfunding facilitate the reception of follow-on VC financing. We compared equity crowdfunded firms with two different control groups. The first control group consists of firms from the same industry and age that did not receive any external seed financing, but were similar in terms of size, geographical location, and debt structure. Secondly, we compared equity crowdfunded firms against those that received seed financing from business angels.
The empirical analysis delivers key results, which can be summarized as follows. First, from the comparison with the control group of firms that did not received any seed financing, we found a positive association between equity crowdfunding and the reception of follow-on VC financing. We found that this association is stronger for equity crowdfunding campaigns with a nominee shareholder structure, while it is weaker when the direct shareholder structure is chosen. Second, compared to angel-backed firms, receiving equity crowdfunding through a nominee shareholder structure positively affects the attraction of follow-on VC financing.
This paper unfolds as follow: in Section 2, we describe the research setting and the direct vs. nominee shareholder structure. In Section 3, we formulate hypotheses on the association between shareholder structure and the attraction of VCs follow-on investment. In Section 4, we describe the material and methods, and Section 5 describes the empirical results. Finally, section 6 concludes the paper.
Section snippets
Equity crowdfunding in the United Kingdom
The United Kingdom (hereafter UK) is, by far, the largest and fastest growing equity crowdfunding market in Europe, both in term of number of campaigns and capital raised (Cambridge Centre for Alternative Finance, 2018). This market accounted for nearly 40% of the global equity crowdfunding market in 2016 (Walthoff-Borm et al., 2018a) and represented 73% of the European market in 2017 (Cambridge Centre for Alternative Finance, 2019). Using data from the UK entails a number of advantages for
Equity crowdfunding as a signal of venture quality
In making investment decisions, VCs face substantial information asymmetries associated with the discerning of firm quality. Young entrepreneurial ventures have usually limited track record, high intangible assets (especially high-tech ventures), lack internal funds and have low debt capacity (Carpenter and Petersen, 2002), which makes it challenging for traditional investors to apply proper and effective screening. Indeed, the level of information asymmetry is very high as well as the risk of
Data sources and sample
We combined data from multiple sources. First, we used Crowdcube and Seedrs websites to identify and collect data on companies that successfully raised funds via these two equity crowdfunding platforms, between 2011 and March 2018. Crowdcube and Seedrs are the two largest equity crowdfunding platforms in the UK for volume raised and for number of transactions (Cambridge Centre for Alternative Finance, 2018, Cambridge Centre for Alternative Finance, 2019). Both platforms are located in London
Results
Tables 6 shows the estimates of hypothesis 1 computed for our two control samples. Models 1–3 are computed against Control Sample 1 comprising firms that have not received any external equity finance before VC, while models 4–6 are estimated for Control Sample 2 of angel-invested firms. All estimates are semi-parametric Cox models,7 computed with robust
Discussion and conclusion
In this paper, we conducted a quantitative analysis to investigate whether and how having received equity crowdfunding affect the attraction of VC financing after the campaign.
From an analysis of firms that obtained crowdfunding through the two largest UK equity crowdfunding platforms, we find that, in comparison to a control group of firms that did not receive any seed equity financing, a successful equity crowdfunding campaign facilitates the attraction of subsequent VC financing. For these
Funding
This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.
Acknowledgements
The authors wish to thank Massimo G. Colombo, Massimiliano Guerini, Michael Moedl, Silvio Vismara, the participants to the workshop “Entrepreneurship, Finance and Innovation: current debate and future research trend”, the participants to the research seminar held at Trinity Business School, and the attendant to the 4th Entfin Conference, in Trier, for their insightful comments. Livia Tenani and Giti Malekian provided excellent research assistantship. Responsibility for any errors rest solely
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