York University professor Douglas Cumming recently contributed to a paper entitled, “Signaling in Equity Crowdfunding“. He and three other scholars wanted to get to the heart of what factors contributed to a successful crowdfunding campaign to raise equity financing.
Equity Goes Up, Success Goes Down
The professors were inspired to write the paper based on the examples of two competing London bars; one (“Rushmore”) was successful at raising £1,000,000, from the crowd, the other (“Meatballs”) aimed at raising £300,000 fell well short with commitments of a mere £4,750.
Oddly, Rushmore was offering just 10% equity for the £1,000,000.00 while the unsuccessful Meatballs was willing to give up 30% for £300,000.00. What accounted for the success of Rushmore and the failure of Meatballs?
Interestingly, according to Cummings and team, the result was not unique. Their study looked at Australia where a form of crowdfunding has been available since 2005. The team was granted access to a database of 104 offerings between October 2006 and October 2011 based on data from the Australian Small Scale Offerings Board (“ASSOB”), an equity crowdfunding shop sanctioned under Australian laws which permit a unique form equity crowdfunding. Over its lifespan, ASSOB has helped raise over $100 million AUD with U.S. $19 million raised in 2011 which puts it in the top five globally behind only SeedUps, which raised U.S. $40 million in 2011.
What can we learn from Professors Cummings’ study? Here’s 6 quick tips:
1. Have More and Better Educated Board Members (and Staff)
More board members involved means the team has access to a greater network, whether in social media or otherwise to get the project rolling. The study found a direct link between having more (and better educated) board members and the success of the crowdfunding campaign. An additional member on the board increases the expected number of investors by a factor of 1.433.
Along the same lines, third party endorsements can have a positive effect on attracting investors. Its not just how many people invest, but who is investing that can attract the crowd. Lastly, the study found that having more staff also suggested to investors that the entrepreneur has been able to convince employees of the firm’s potential.
According the Cumming, eduction (measured by the percentage of board members holding an MBA degree), leads to better networks which are more likely to attract investment and have a higher number of investors.
2. Signal an Intention to Go Public
The study concluded that start-ups who signal their intention to seek an exit by either IPO or a trade sale are more likely to attract investors than those planning to use other forms of exit. In some instances this can be done by having venture capitalists involved with the company at an early stage. Cummings and team say, “ prominent venture capitalists or investment banks are effective signals in an IPO context, and can also act as forms of external certification.”
3. Offer Financial Forecasts or Tell Investors Why You Can’t
The study found that firms that provide neither financial forecasts nor disclaimers are less likely to attract investors, and they tend to raise less capital overall and over a longer amount of time.
4. Wait – Get the Business Running First (and Invest Yourself)
It takes more than just an idea to get funded. Firms that have been in business longer prior to seeking equity crowdfunding are more likely to raise their desired level of capital more quickly. In addition, potential crowd investors take solace in the fact that the entrepreneur, him or herself, has some skin in the game. The percentage of personal wealth an entrepreneur invests in a company is an effective positive signal to investors; as effective as his or her past experience.
5. Don’t Offer Too Much Equity
The study confirmed that the Rushmore vs. Meatballs scenario wasn’t unique. That is, a higher amount of equity offered negatively affects funding success. A one-percentage point increase in equity offered decreses the expected number of investors by a factor of 0.982161.