The Role of Trust in the Informal Investor’s Investment Decision: An

Exploratory Analysis

Objective of Research• To explore the relevance of the concept of

trust to the analysis of the informal venture capital market

• Explored as a part of a wider study of information sources, networks, and reliance structures

ENVC_GROUP7

Trust• Trust: A means of speeding decision-making and

negotiations by reducing transaction costs under conditions of risk

• Trust plays a major role in analysis of informal venture capital market

• In the entrepreneurial context, trust has been identified as a major lubricant for cooperation to arise

ENVC_GROUP7

Situational Domains in the Informal Investment Decision-

Making ProcessDOMAIN DESCRIPTIONScreening Decision to pursue initail awareness of opportunity

Review of business planDecision to reject/follow up

Assessment Evaluation of merits, Degree of confidenceEvaluation Reaction to entreprenuer team,Decision to reject or

enter negotiations,Increase in financial return factorsNegotiations To invest or not to invest,Issue of deal structure and

pricingInvolvement Decision to become involved or remain hands-

off,Decisions on level of involvement

ENVC_GROUP7

Swift Trust• Emergence of trust relations in situations where – the individuals have a limited history of working

together & limited prospects of working in future– are involved in tasks that are often complex and

involve independent work & have deadlines– tasks are non-routine and not well understood

• Exists in temporary group situations• Made possible in presence of a contractor

ENVC_GROUP7

Importance of a Coordinator• Coordinator knows the other individuals in group• Already formed a trusting relation to each

member in group in advance• Swift trust to come about as a result of

assessment of the trustworthiness of the coordinator– Only non-situation specific link between

individuals in the group– A rather ‘stronger’ swift trust

ENVC_GROUP7

Other Trust Types• Calculus Based Trust:– Formed on the basis of what one sees to get out of the

relationship - difference

• Knowledge Based Trust:– Formed on the basis of shared knowledge of product or market

situation - agreement

• Identification based Trust:– Formed on the basis of high degree of identification with the

wishes of the other party – mutual sharing of values

ENVC_GROUP7

The Relation: Swift Trust & Other Trust Types

Swift Cooperation CriteriaIndividual’s perception of:

1. Utility: Potential economic value2. Importance: Potential non-economic

value3. Risk: Potential loss4. Competence: Professional Ability5. Coordinator Judgment: Coordinating

Party’s ability

ENVC_GROUP7

Propositions• P1: The greater the perception of utility, the greater the

possibility of trusting, cooperative behavior

• P2: The greater the perception of importance, the greater the possibility of trusting, cooperative behavior

• P3: The greater the perception of risk, the less the possibility of trusting cooperative behavior

• P4: The greater the perception of competence, the greater the possibility of trusting, cooperative behavior

A Protocol for Indentifying Trust and Cooperation

• Data was collected as part of wider study of decision making process of business angels.

• Focus of study was on the initial screening stage when business angels become aware of investment opportunity.

• The study used verbal protocol analysis methodology

• And capture decision making in real time.

Verbal Protocol Frequency Analysis

Trust and Investment Decisions

• Nine in ten investors rejected the proposal as an investment opportunity.

• Shows (93% investment proposals received by business angels are rejected)

• These decisions were based on time spent on reviewing the proposal.(Avg time – 11.25 minutes)

• The result of verbal protocols analysis can be summarized under: Evidence of cooperation Evidence of trust Nature of the statement type

Evidence of Trust• All references to trust issues by investors

in this sample refer to calculus-based trust• Calculus based trust as most common form

of trust in business relationship.• In this stage investors look for reason to

reject and opportunity

Evidence OF Cooperation• Three quarters of the thoughts segments coded in this

analysis relate to five dimensions Utility Importance Risk Competence Coordinator judgment

• Thoughts segments are classified to reflect the specific context of the investor comments.

• Investors thoughts are dominated by comments about the low perceived competence of entrepreneur team.

• Risk account for almost 15% of thought segment coded and 20% of the swift cooperation comments in particular.

• The issue of coordinator judgment is of considerable importance in the initial screening stage

• Judgment is made on basis of inferences and questioning based of the proposal document itself.

Nature of Statement Type• Informal investors make decision in the situational domain

primarily on basis of preconceptions and inferences.• Informal investors are not systematically seeking out

additional information to assist in coming to a decision in this stage

• Preconceptions are more likely to be negative than positive at early stage.

• Investors perception of market related factors may play a particular role in this process.

Swift trust and the Role of coordinator

• The evidence suggest that investor or prospective investees do place as considerable reliance on the coordinator providing them with information of a kind and in a way that enables them to from judgments and indentify cooperation thresholds.

• The role of the coordinator in the informal investment decision therefore requires the development of trust in two sets of actors:

1. trust in promoters of the investment

2. trust in source of information on this

(with realization that the latter will itself influence the former)

Implications of further Research

The exploratory research discussed in this paper does suggest that it is possible to extend the current conceptualization of swift trust to incorporate three advances.

1. The formal distinction between trust and cooperation as separately identifiable influences on business behavior

2. The identification of swift trust and swift cooperation bases for decision making in time constrained and only indirectly inter personal contexts.

3. Identification of specific roles of coordinator judgment in shaping trust and cooperation thresholds in these investment decision-making domains.

Based on the initial exploration of the application of the swift trust concepts to informal investment

decision making domains, we can identify a number of key propositions around which to structure further

more research.

• PR1: Calculus based trust will dominate investor investee relationships in all decision making process.

• PR2: knowledge based trust and identification based trust will become relatively more important in later situational domains of the decision making process as investor entrepreneur relationships develop.

• PR3: The relative importance of each of the three trust types in investor coordinator relationships will vary according to the type of coordinator: informal referral sources such as family friends and business associates will be relatively more likely to depend on knowledge or identification based trust than formal referral sources such as business angel networks.

• PR4: Calculus based trust will be relatively less important than knowledge- or identification-based trust in situations where an investment opportunity is considered than where it is rejected.

• PR5: Even in the situational domain 1, where calculus based swift trust dominates, the decision to proceed with an opportunity to the next domain will be relatively more reliant on knowledge based trust.

• PR6: Measures of utility (upside potential) will become relatively more important than the measures of risk (downside potential) as the investment opportunity movies from early to later situational domains.

• PR7: while coordinator judgment is important in early situational domains, its importance will fall once the initial reject/proceed decision has been made by the investor

• PR8: investor preconception and inferences which dominate in early situational domains will be replaced in a relative importance by questioning an action statement types in later situational domains.

Conclusion(The Role of Trust in the Informal investor’s Investment decision)

• The building of trust relationship between the entrepreneur and the informal investor appears to be essential for successful capital investments.

• Business angels trust in the entrepreneur is determined in the first instance by an assessment of the proposal.(be it any of the 3 trust types)

• Numerous factors are taken into account by Business Angels when assessing investment opportunities are 1. Risk 2. utility 3. importance of opportunity 4. perceived competence of entrepreneurs

• Swift trust may or may not develop in a context mediated by a coordinators preceptions of the judgement and ability of coordinating itself investment decisions

• Overall therefore, the swift trust framework proposed here appears to allow accurate Identification of different trust types and appears to provide the basis for uncovering the interplay between cooperation and trust in the informal investment decision making process.