CFIRA

Wharton Study: Crowdfunders Use Similar Benchmarks As VCs To Fund Entrepreneurs

Crowdfund donors examine entrepreneurial quality in similar ways as venture capitalists, according to Wharton management professor Ethan Mollick. His new study casts some doubt that crowdfund donors are an unsophisticated lot. The Securities and Exchange Commission currently is drafting rules to implement crowdfund investing under the federal JOBS Act.

Illustration by Sergio Carreira

Illustration by Sergio Carreira

According to Professor Mollick’s recent paper, “Swept Away by the Crowd? Crowdfunding, Venture Capital and the Selection of Entrepreneurs,” a draft of which was published in March, entrepreneurial quality is being examined in similar ways by donors on Kickstarter and also by venture capital firms. “Despite the radical differences in selection environments, I find that entrepreneurial quality is assessed in similar ways by both VCs and crowdfunders, but that crowdfunding alleviates some of geographic and gender biases associated with the way that VCs look for signals of quality,” Prof. Mollick reported. ”They are looking for similar signs of quality.”

Prof. Mollick examined 2,101 crowdfunded projects on Kickstarter that match characteristics of more traditional VC-backed seed ventures, such as technology related projects. Prof. Mallick’s research team reviewed factors such as the history of success of a project, the influence of endorsements on a crowdfund project, the level of preparation demonstrated by an entrepreneur, quality, social networks, geographic outcomes and gender. Prof. Mollick discovered that crowdfunders act like venture capitalists or other tranditional sources of capital.  He found that crowdfund funders and venture capitalists focus on the following, similar factors:

  • The quality of the product.
  • The Team.
  • The likelihood of success.

Since some projects are better than others, they receive funding, according to Prof. Mollick, and lower-quality projects receive little to no backers. “{T]he finding suggest that the signals of quality that are used by VCs to assess the viability of new ventures are also used by crowdfunders,” he observed. “This bolsters the validity of these signals as indicators of start-up potential, but also suggests that crowdfunding has the ability to distinguish quality potential projects from less promising ones.”

Prof. Mollick also found that crowdfunding seems to avoid some of the biases that are, in his words, pervasive in VC selections. “Crowdfunding is more democratically distributed than VC funding,” he wrote. “The proportion of crowdfunded start-ups with female founders was larger by an order of magnitude than that of VC- backed firms.”
“In his 2012 remarks upon signing the JOBS Act to legalize equity crowdfunding, President Obama stated that ‘for start-ups and small businesses, this bill is a potential game changer,’” Prof. Mollick wrote in his conclusion. “Crowdfunding does represent a major shift — a ‘game changer’ — in the way that start-ups receive vital resources.”

Review by A. Brian Dengler. Mr. Dengler is an information technology attorney and college instructor and member of CFIRA.

 

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