The new research in behavioral economics comes from University of California – Riverside. This research reveals that a fear of missing out will often motivate investors to inject cash early into startups, especially those firms which offer a ‘disruptive vision’. However, this is balanced by caution. Often the types of backers who are most likely to get in early to invest in startups are also reluctant to invest too much money for unproven ideas that might never get anywhere. This means that the more potential disruptive power a startup offers the more likely it is to raise money. But such firms will receive smaller amounts from a typical investor than a startup that is offering a less disruptive product or service.
Startup disruptors
Startup disruptors are emerging firms with groundbreaking ideas, together with ambitious plans for bringing the idea to market. Many occupy the technology space and most are entering a space where ‘traditional’ companies are dominant. Taking two lists of disruptive startups, CNBC features TransferWise which is using machine learning to disrupt banks, wire-transfer services, financial services, currency exchanges. Inc.500 features Saildrone, which is developing unmanned autonomous boats to provide data on fish and wildlife populations, environmental health, ocean temperatures, weather, and climate change.
New research into investor behavior
These two examples have succeeded because they attracted investors early on. According to the new research, entrepreneurs weight up the value of a startup by using primary strategies. The first approach consists of examining the track records and past accomplishments, such as the startup’s initial market success, or its unique resources. The second involves evaluating what the venture will become and what the its founders will potentially achieve (the ‘disruptive vision’).
These insights were gained by a team led by Professor Ashish Sood. The researchers studied 918 Israeli startups that were seeking a fist round of funding. This showed that increases in the disruptiveness articulated by the startup’s portfolio improved the odds of receiving a first round of funding by 22 percent. However, disruptive visions received 24 percent fewer funds in the first round.
This meant investors appeared positively biased toward disruptive visions, but they opt for investing relatively little during the first round. To probe this further, the researchers proceeded to interview 203 investors. This revealed that investors are attracted to startups but they will not invest widely.
How should startups approach seeking investors?
As to what this means for startups, Professor Sood summarizes: “For entrepreneurs seeking early stage investments, we have the following simple but important advice: carefully craft your message. If you are looking to acquire large sums of money, perhaps you should keep your disruptive plans quiet.”
The new research has been published in the Journal of Management Studies. The research paper is titled “Do Disruptive Visions Pay Off? The Impact of Disruptive Entrepreneurial Visions on Venture Funding.”
