Equity Investors and Entrepreneurs: The Signals that Matter

Wednesday, March 14, 2018

It’s a harsh truth about the tech industry: Most ideas rarely come to fruition. For every iPad, Alexa, or Spotify, there are hundreds of competitors that never made it. You can point to plenty of reasons why, but one typically stands out: The founders failed to secure funding.

How can tech entrepreneurs boost their chances of obtaining capital? Research by Assistant Professor Sofia Bapna offers insights by examining the question through a randomized field experiment (similar to the methodology used in clinical trials), in partnership with an equity crowdfunding platform. As Bapna notes, there is often significant “information asymmetry” between equity investors and entrepreneurs. There is also high uncertainty about the future prospects of ventures. While investors look to pinpoint ventures with the highest expected ROI, entrepreneurs don’t always know what to focus on in their pitches.

In such contexts, investors often look for key signals, signs that an entrepreneur can deliver. “Entrepreneurs must know what signals they should focus on developing—and leveraging later in their pitches,” says Bapna. “In particular, it is important for them to know which signals are complements. Signals are complements when the effect of the combined signals is greater than the sum of the effects of individual ones.”

She discovered that signals of product characteristics (such as ones that suggest a protected or differentiated product) and market characteristics (ones that suggest market acceptance or need), and signals of product characteristics and investment characteristics (such as ones that indicate exit potential or high ROI) are complements. “A signal of product characteristics is the key to unlocking the value of a market or investment-related signal,” she says. “Investors who viewed a signal of product characteristics with a signal of market characteristics were 72 percent more likely to indicate interest in investing than those who received neither signal.

“Similarly, investors who viewed a signal of product characteristics with a signal of investment characteristics were 65 percent more likely to indicate interest in investing,” she adds. “Moreover, that interest is positively associated with actual equity investments.”

These results provide clear guidelines for technology entrepreneurs looking to raise capital from private equity investors: The calculus of a winning pitch involves using the right combination of signals.

Entrepreneurs can increase their chances of tapping investment capital if they use specific combinations of key signals in their pitches.