The Closed Bank, Edoardo Matania, 1870s (Courtesy: Dorotheum www.dorotheum.com)
Ideas for Leaders #593

Crowdfunding Still Attracts Local Investors to Local Ventures

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Key Concept

Entrepreneurs seeking funding through crowdfunding Internet platforms must still overcome the ‘home bias’ of investors — that is, their preference for funding projects located close to their homes.  

Idea Summary

Entrepreneurs need money to fund their ideas. Many legendary start-ups received their early funding from venture capitalists. However, VC’s are now more interested in contributing to later stage companies rather than take a chance with early stage start-ups that have a much greater chance of failing.

Into the breach steps the Internet-based crowdfunding platforms, in which entrepreneurs put a description of their project online where potential investors can discover them. The individual investment on these platforms is often small, but as the name implies, the investors are part of a crowd that together can represent a significant sum.

Crowdfunding platforms can also benefit from one of the defining features of the Internet: the irrelevance of geographic distance. Just as geography plays no part in a Google search for information on Mary Queen of Scots, for example (the geographic location of either the searcher or the source of the information is irrelevant), investors can invest in any venture no matter whether they or the venture might be located.

However, a new study shows that when it comes to investing, the earth, to borrow a familiar phrase, may not be as flat as all that. Researchers Christina Guenther of the WHU Otto Beisheim School of Management, Sofia Johan of York University’s Schulich School of Business, and Denis Schweizer of Concordia University’s John Molson School of Business studied more than 400 investors in an Australian-based crowdfunding platform, and discovered that the investor home bias was alive and well.

Specifically, the researchers found that both retail investors (unsophisticated, occasional investors who invest small sums), and accredited investors, (wealthy, knowledgeable investors who contribute significant sums to ventures) preferred to support ventures close to their homes. Overseas investors (investors from another country) were less sensitive to distance, but still relatively sensitive (the researchers used different algorithms and models to define sensitivity for each investor category).

In conclusion, crowdfunding does have the potential to alleviate distance bias. For example, potential investors access the same information about a new venture at virtually no cost whether they live within 50 miles or 5000 miles of the venture. In addition, through video-conferencing, investors at any distance can communicate with the entrepreneur.

However, there remain advantages to investing in local ventures that are not overcome by the Internet. There is still some value in personally (i.e., in person) familiarizing yourself with a potential investment, by visiting the store, for example, or engaging in face-to-face conversations with employees or entrepreneurs.

The researchers also note that, given the significant size of their investments, accredited investors are more likely to want to see first-hand where their money is going. As for retail investors, the researchers suspect that some may be mimicking the behaviour of wealthy investors with their in-person due diligence, and why not: retail investors assumedly hope to some day be part of the wealthy, accredited investor category.

Business Application

The results of the study highlight the continuing challenge of entrepreneurs seeking funding for their projects — especially entrepreneurs who might not live near highly populated areas. An Australian-based crowdfunding platform is well chosen to highlight the hurdles of rural entrepreneurs given Australia’s broad expanse of lowly populated areas.

The bottom line: If you are going to start up a venture and hope to acquire investors from crowdfunding sites, do not be fooled by the borderless attributes of the Internet. Geography still counts, and you will have more success setting up the venture in populated areas that boast a far larger pool of local investors, many of whom will want to visit your site and meet you in person — or at least know that they can.

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Authors

Institutions

Source

Idea conceived

  • January 2016

Idea posted

  • April 2016

DOI number

10.13007/593

Subject

Real Time Analytics