Wednesday, January 2, 2019

Erin McGuire: Can Equity Crowdfunding Close the Gender Gap in Startup Finance?

As I have previously explained, there is growing interest in gender and racial gaps in patenting from both scholars and Congress—which charged the USPTO with studying these gaps. But I don't think it makes sense to study these inequalities in isolation: patent law is embedded in a larger innovation ecosystem, and patents' benefit at providing a strong ex post reward for success comes at the cost of needing to attract funding to cover R&D expenses until patent profits become available. It may be difficult to address the patenting gap without also addressing inequalities in capital markets.

In particular, there is a large and well-documented gender gap in the market for early-stage capital. For example, this Harvard Business Review article notes that women receive 2% of venture funding despite owning 38% of U.S. businesses, and that even as the percentage of female venture capitalists has crept up from 3% in 2014 to 7% in 2017, the funding gap only widened. Part of the explanation—explored in the fascinating study summarized in the HRB piece—may be that both male and female VCs ask different kinds of questions to male and female entrepreneurs: in actual Q&A sessions, VCs tended to ask men questions about the potential for gains and women about the potential for loses, with significant impacts on funding decisions.

Economist Erin McGuire, currently an NBER postdoc, has an interesting working paper on one partial solution to this problem: Can Equity Crowdfunding Close the Gender Gap in Startup Finance? Non-equity crowdfunding through sites like KickStarter and Indiegogo have grown in popularity in the past two decades; equity crowdfunding differs in that funders receive shares in the company in exchange for their investments. The average equity crowdfunding investment is $810—over ten times the average investment on Kickstarter. Equity crowdfunding was illegal in the United States before the JOBS Act of 2012, which allowed equity crowdfunding by accredited investors in September 2013. McGuire hypothesized that the introduction of this financing channel—with a more gender-diverse pool of potential investors—as an alternative to professional network connections would have a greater benefit for female entrepreneurs.

McGuire used Crunchbase to obtain financing information for U.S. startups operating during each month between September 2011 and September 2015, and she used determine the founders' likely gender (restricting to names over 80% likely to be either male or female). She dropped firms with a funding round over $10 million, which are unlikely to be in the early growth stage. Using a difference-in-differences model, she concluded that firms founded by women raise about 36% less external capital than those founded by men, and that the legalization of equity crowdfunding decreased this gap by 20 percentage points. The estimated gaps did not vary substantially when different probability thresholds were used to identify founder names as female.

As potential mechanisms to explain this effect, McGuire points to the higher proportion of women among equity crowdfunding angel investors than VCs (which benefits female entrepreneurs if women are more likely to invest in other women), angel investors' lower expected returns and thus perhaps greater willingness to invest in industries like clothing and apparel with a higher proportion of female founders, and the ability of female entrepreneurs to access investors outside their professional networks (which tend to be smaller for women). McGuire also shows that the JOBS Act does not seem to have increased the entry rate of female firms relative to male firms; rather, the main effect was to make it easier for female entrepreneurs to access external capital.

It's an intriguing result, and I look forward to more work on disentangling these different mechanisms. And perhaps identifying and correcting some imperfections in capital markets will also help address inequalities in the patent system.

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