Attracting Early‐Stage Investors: Evidence from a Randomized Field Experiment

• Author: ARTHUR KORTEWEG,KEVIN LAWS,SHAI BERNSTEIN
• DOI: http://doi.org/10.1111/jofi.12470
• Date: 01 April 2017
• Published date: 01 April 2017

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 2 •APRIL 2017

Attracting Early-Stage Investors: Evidence

from a Randomized Field Experiment

SHAI BERNSTEIN, ARTHUR KORTEWEG, and KEVIN LAWS∗

ABSTRACT

This paper uses a randomized field experiment to identify which start-up characteris-

tics are most important to investors in early-stage firms. The experiment randomizes

investors’ information sets of fund-raising start-ups. The average investor responds

strongly to information about the founding team, but not to firm traction or existing

lead investors. We provide evidence that the team is not merely a signal of quality,

and that investing based on team information is a rational strategy. Together, our

results indicate that information about human assets is causally important for the

funding of early-stage firms and hence for entrepreneurial success.

EARLY-STAGE INVESTORS PROVIDE financial capital to young entrepreneurial

firms, enabling their birth and development and thus contributing to innova-

tion and growth in the economy (Solow (1957)). Start-up firms are particularly

difficult to finance because their prospects are highly uncertain, they lack tan-

gible assets that can be used as collateral, and they face severe information

problems (Hall and Lerner (2010)). Given these problems, how do investors

choose which start-ups to fund, that is, what factors drive their selection pro-

cess? While this question is often debated among academics and practitioners

(e.g., Quindlen (2000), Gompers and Lerner (2001)), systematic evidence on

the selection process of early-stage investors is scarce. This stands in sharp

contrast to the wealth of evidence on investment decisions in public equity

∗Shai Bernstein is from Stanford Graduate School of Business and NBER. Arthur Korteweg is

from the University of Southern California Marshall School of Business. Kevin Laws is from An-

gelList, LLC. The authors thank Michael Roberts (the Editor), the Associate Editor, an anonymous

referee, Jean-Noel Barrot, Doug Cumming, Wayne Ferson, Amir Goldberg, Steve Kaplan, Ross

Levine, Alexander Ljungqvist, John Matsusaka, Richard Roll, Rick Townsend, Danny Yagan, and

Xiaoyun Yu; seminar participants at Cornell, Harvard Business School, Northwestern University,

UC Davis, UCLA, University of Illinois at Urbana-Champaign, University of Maryland, University

of Southern California, University of Texasat Austin, the joint Stanford-Berkeley seminar, the 7th

Coller Institute of Private Equity symposium, the 2015 Western Finance Association meetings,

and the 2015 SFS Cavalcade; and brown bag participants at the UC Berkeley Fung Institute and

Stanford for helpful comments and suggestions. The authors obtained IRB approval from Stanford

University (protocol # 28088) before conducting the field experiment. Arthur Korteweg and Shai

Bernstein have no potential conflicts of interest as identified in the Journal of Finance policy.Kevin

Laws is the COO of AngelList, which ran the test in this paper to optimize email contents.

DOI: 10.1111/jofi.12470

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510 The Journal of Finance R

markets by institutional and retail investors.1In this paper we provide, to the

best of our knowledge, the first experimental evidence of the causal impact of

start-up characteristics on investor decisions.

Based on competing theories of the firm, we focus on three key character-

istics of start-ups: the founding team, the start-up’s traction (such as sales

and user base), and the identity of current investors. The founding team is

important if human assets are the critical resource that differentiates one

start-up from another, as argued by Wernerfelt (1984), Rajan and Zingales

(2001), and Rajan (2012), especially if experimentation at the earliest stages

of the firm is important (e.g., Schumpeter (1934), Kerr, Nanda, and Rhodes-

Kropf (2014), Manso (2015)). Alternatively, if the nonhuman assets are most

important, as suggested by the property rights theories of Grossman and Hart

(1986), and Hart and Moore (1990), among others, then investors should re-

act most strongly to firm traction in identifying early signs of an underlying

idea’s success. A third possibility is that investors prefer to rely mostly on

the behavior of other, earlier investors rather than on their own informa-

tion, especially when earlier investors are high profile and successful. Such

behavior may arise in settings with information asymmetry and may lead

to information cascades (Bikhchandani, Hirshleifer, and Welch (1992), Welch

(1992)). In these cases, investors pay most attention to the identity of existing

investors.

Testing these hypotheses is challenging because it is difficult to separate

the causal effects of different start-up characteristics. For example, are serial

entrepreneurs more likely to attract financing due to their past experience, or

because they tend to start companies that look attractive on other dimensions

known to the investor but not to the researcher, such as the underlying business

idea? This omitted variables problem is exacerbated by the fact that existing

data sources for start-ups contain only a small fraction of investors’ information

sets at the time of funding. Moreover, existing data sets include only completed

deals rather than the entire pool of start-ups considered by investors. Without

data on the characteristics of companies that were turned down by investors,

it is difficult to learn about investors’ decision-making process.

To address these problems, we conduct a randomized field experiment on

AngelList, an online platform that matches start-ups with potential investors.

AngelList regularly sends emails to investors featuring start-ups that are rais-

ing capital. Besides broad information about the start-up idea and funding

goal, the emails provide specific information on the founding team, the start-

up’s traction, and the identity of current investors, but only if the specific

information passes a disclosure threshold set by AngelList. Investors therefore

perceive a given dimension of the firm (team, traction, or current investors) as

of low quality if the corresponding information category is missing from the

email.

1See, for example, Falkenstein (1996), Wermers (2000), and Gompers and Metrick (2001)for

evidence on the investment behavior of mutual funds, and Barber and Odean (2000) and Ivkovi´

c

and Weisbenner (2005) for individual retail investors.