The Crowdfunding Effects on Venture Capital Investment
49 Pages Posted: 17 Jan 2020 Last revised: 20 Apr 2022
Date Written: February 26, 2020
We study how crowdfunding, as a source of public information, affects competing venture capital (VC) firms' investment decisions, as well as their profitability. Our economy consists of one startup, one crowdfunding platform, and two VC firms with private prior beliefs about the startup's probability of success. The startup first approaches both VC firms for funding, which is modeled as a second-price auction or a bargaining process, and then turns to the crowdfunding platform if rejected by both. After the crowdfunding, the VC firms update their assessments of the startup's success based on the information collected from the crowdfunding platform, and the startup seeks funding from them again. As a benchmark, we first show that with a monopolistic VC firm, although crowdfunding provides another investment opportunity to the startup, it also leads the VC firm to strategically delay its investment after seeing the crowdfunding outcome. That is, the VC firm chooses to delay investment even if investing at the pre-crowdfunding time is profitable, which may hurt the startup. Meanwhile, the additional investment opportunity can also hurt the VC firm itself depending on the information accuracy of crowdfunding. With the VC firms' competition in presence, due to the nature of public information disclosure by crowdfunding, both VC firms enjoy the informational value of crowdfunding which raises their investment cost at the post-crowdfunding stage. In anticipation of this, both VC firms make no strategic delay in investment and wait only if they find it unprofitable to invest before the crowdfunding. Thus, crowdfunding always increases the likelihood and amount of investment in the startup but may hurt the VC firms.
Keywords: crowdfunding, public information, venture capital, competition
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