How Risky Are Companies Searching For Equity Crowdfunding? [Paper]

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“In line with the pecking order theory, the empirical evidence shows that firms listed on equity crowdfunding platforms are less profitable, more often have excessive debt levels, and have more intangible assets than matched firms not listed on these platforms.” (Walthoff-Borm et al., 2018)

Whilst the debate on where the industry is heading to and how sustainable will be the model in the next future, researchers argue that

companies searching for equity crowdfunding are the riskiest ones.

In line with the pecking order theory, according to which entrepreneurs would look for equity when their internal funds and debt capacity are exhausted, the findings of this new study suggest that entrepreneurs that consider searching for equity crowdfunding end up in a pool of firms that try to raise financing as the last resort.

Researchers also found out that more than 40% of companies that unsuccessfully searched for funds via equity crowdfunding have failed and that:

this percentage is 2.9 times higher than for the firms in our sample that successfully raised equity crowdfunding and a staggering 7.2 times higher than firms that raised debt.

Practical implications of the research include policy making as to find the right balance between protecting investors and facilitating access to financing that can reduce entrepreneurs’ financial constraints.

Researchers also pointed out that:

The findings are also important for crowd investors with limited means and incentives to perform detailed due diligence and monitoring activities. Investors should be cognizant that while equity crowdfunding might provide prospects for good financial returns in the future, the flip side is that firms on these platforms are high risk in nature.

Limitations of the study include the fact that scholars focused on just one platform, namely Crowdcube, so that

Future research could test whether our findings are generalizable to other equity crowdfunding platforms and to other countries, which may exhibit other platform structures, due diligence approaches, and contracting mechanisms.

***

Reference List:

Walthoff-Borma, X., Schwienbacherb A. and Vanackera, T. (2018) ‘Equity crowdfunding: First resort or last resort?’ in Journal of Business Venturing. Article in press. Available at: https://doi.org/10.1016/j.jbusvent.2018.04.001

Myers, S. C. and Majluf, N. S. (1984). ‘Corporate financing and investment decisions when firms have information that investors do not have’. Journal of Financial Economics. 13 (2): 187–221. Available at: https://doi.org/10.1016/0304-405X(84)90023-0

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