The role of funding portals as signaling offering quality in investment crowdfunding
Introduction
Investment crowdfunding is a relatively new financial market that brings important changes for issuers, investors and funding portals. By opening the financing of innovation and of startups to small retail investors, investment crowdfunding helps closing the early-stage funding gap (Wilson et al., 2018) and fosters innovation. Moreover, investment crowdfunding is not only attracting fresh funding to early startups, but it is also helping to shape the future of the business landscape and of society at large by directly addressing sustainability and social issues. These aspects are ingrained in the DNA of crowdfunding since its genesis, with reward crowdfunding campaigns originating mostly from creative and social ventures (Hemer, 2011). By directly linking firms with retail investors, the decision of who is funded now incorporates, to some extent, the preferences and goals of society. While providers of funding such as grants, seed and venture capital in early stages, or even IPOs in later stages (Levin, 2015), might favor yields and risk considerations, crowdfunding success is also linked with the extent to which campaigns match the personal values and aims of retail investors, which many times differ from those of professional investors (e.g. Bretschneider et al., 2014).
Although investment crowdfunding has great potential and it has been showing important growth rates,1 it still comes with great financial challenges and unknowns. It is particularly important to analyze how small retail investors behave, to alleviate concerns on investor protection and to help issuers and portals define successful issuing strategies. In this sense, concerns on investor protection are at the heart of regulators’ actions, mainly due to the important information asymmetry between issuers and investors and the high risk of these business ventures (Nadauld et al., 2019).2 Similarly to an IPO, the financing of startups represents a market-for-lemons problem (Akerlof, 1970). Uninformed investors face the decision to buy an asset of uncertain quality. These concerns explain the latter opening of the investment crowdfunding market in the US and the restrictions imposed on issuers and investors such as caps on the yearly amounts issued and on the amounts invested.3 Several mechanisms, such as screening and signaling, can mitigate this adverse selection problem (Spence, 1973).4 With respect to screening, although crowdfunding portals are not required to conduct due diligence into issuer projections or forecasts, they must ensure that issuers comply with all the regulatory requirements and provide prospective investors with disclosures required by SEC Crowdfunding Rule 303(a), including details on the issuers, securities, or intended use of funding. SEC Crowdfunding Rule 301(c) requires portals to bar access to issuers or cancel issues when they have concerns about investor protection and portals are required to provide educational materials (SEC Regulation Crowdfunding Rule 302(b)(1)(2)) and create channels for an effective communication between prospect investors and issuers (SEC Regulation Crowdfunding Rules 303(c) and 204(c)). With respect to signaling, portals play the role of an independent third party with the ability to signal the quality of an issue through the type of issuer's fees that the portals charge the issuing firm. Issuer fees may include fixed gross fee and a share of securities issued and, since the amount and type of the fees are part of the disclosure requirements, this makes them an effective signaling mechanism. Security type fees align the interests of prospective investors with those of the portals. Theoretically, when the more-informed agent (portals) has skin in the game, the less-informed agent (prospective investors) perceives this as signaling quality.5
This paper analyzes the effects of issuer fee on the success of crowdfunding offerings in the US. Most of the research on the determinants of the success of crowdfunding offerings relies on data from UK, Germany, or Italy (e.g. see Cummings et al., 2020) and focuses on retail investors, offering and firm-level characteristics (Hornuf et al., 2018; Kleinert et al., 2020; Lukkarinen et al., 2016; Ralcheva and Roosenboom, 2020), managerial team attributes (Barbi and Mattioli, 2019; Hornuf et al., 2018; Signori and Vismara, 2018) or duration and attractiveness of business ventures (Salahaldin et al., 2019; Vismara, 2019). With respect to signaling effects, existing literature analyzed signaling from the issuer concerning the project's quality, level of uncertainty or market interest and investment appeal (Ahlers et al., 2015; Bapna, 2017), signals from previous investors such as banks (Blaseg et al., 2021) or high public profile investors (Vismara, 2018). Walthoff-Borm et al. (2018) analyses the motivations that drive firms to use equity crowdfunding offerings based on Mayers and Majluf (1984) pecking order theory, showing that issuers access equity crowdfunding when other less informationally sensitive sources of financing are exhausted.
Few papers have analyzed the role of signaling effects by portals. Hornuf and Schwienbacher (2018) or Rossi and Vismara (2018) indicate that the information provided, and the type of services offered by the portal, might play an important role in success. Shafi and Colombo (2020) directly analyzes the effects of signals from the portals on the success of equity offerings in the US crowdfunding market. It considers the type of issuer fee as an intermediate and potentially moderating signal with respect to signals emitted by the issuer.
Our paper contributes to existing literature by analyzing the response of retail investors to the portal signals and its ultimate effect of the success of the issue. Our paper differs from previous research by focusing on the US market and by performing a broader analysis of investment crowdfunding, whereas previous research mostly focused on other western markets and strictly on equity crowdfunding. Our results may have important implications for financial markets, portals, issuers and even regulators.
Section snippets
Data
We work with data from the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system for indexing information from firms that are required to file forms with the SEC in the US. We developed a tailored crawler to download the information. On top of the extraction layer, a series of labeling procedures were written to reach the final variables at firm-, offering-, and portal-level.
We gathered all the offerings under the Form C exemption from its inception date, in May 2016, until September
Results
Table 2 presents the results from the probit estimates explaining success. Columns (1) and (2), report individual effects for GrossD, and GrossIntD. On average, when the issuer fee does not include securities, there is a negative effect on the success of the offering. However, when this fee combines a gross fee and financial securities, the sign of the coefficient becomes positive and statistically significant. These results highlight the relevance of the signal sent by the portals regarding
Conclusions
We examine the relation between issuer fee type and offering success in US Form C issues. A mixed issuer fee fosters offering success by signaling quality, therefore mitigating adverse selection problems. This signaling effect is stronger in older and smaller firms and it persists even when other firm- and offering-level characteristics are included.
Our results may have important implications for financial markets, portals and issuers. With respect to financial markets, and although the JOBS
Authors statement
All the above-referred authors certify that they have participated in the concept, design, analysis, writing, and revision of the manuscript.
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We thank participants at the 2020 International Conference in Banking and Financial Studies, the anonymous reviewer, and the Editors, Vincenzo Verdoliva and Samuel Vigne, for the insightful and helpful comments. Financial support from the Spanish Ministry of Economy and Competitiveness, Project PID2020-118064GB-I00 is gratefully acknowledged. This research benefited from the Professorship Excellence Program in accordance with the multi-year agreement signed by the Government of Madrid and the Autonoma University of Madrid (Line #3).