The Crowdfunding Effects on Venture Capital Investments

52 Pages Posted: 17 Jan 2020 Last revised: 10 Mar 2020

See all articles by Ming Hu

Ming Hu

University of Toronto - Rotman School of Management

Yannan Jin

Shanghai University of Finance and Economics

Jussi Keppo

National University of Singapore - NUS Business School

Date Written: February 26, 2020

Abstract

We study how crowdfunding, as a source of public information, affects competing venture capital (VC) firms' investment decisions in terms of the timing, likelihood, and expected amount of VC investment in a startup. Our economy consists of one startup, one crowdfunding platform, and two VC firms with differing 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 between the two firms, 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. We find that crowdfunding and the competition between the VC firms raise the expected amount of VC investment. Moreover, crowdfunding increases the chance of a startup receiving VC funding only for those startups deemed unfavorable by both VC firms; for debatable startups about which VC firms' views diverge, crowdfunding may reduce their chance of receiving VC investment. We then examine how the relationship between crowdfunding and VC investment is shaped by the characteristics of the startup and the crowdfunding platform. For instance, when the more optimistic VC firm has a moderate expectation for the startup and the investment risk is high (resp., low), that VC firm tends to invest before the startup seeks crowdfunding if the crowdfunding information is sufficiently accurate (resp., noisy). Finally, we observe more nuanced crowdfunding effects in several model extensions, for example, if the startup is allowed to strategically decide on the timing to receive a VC investment, and if VC firms can observe private signals on the startup.

Keywords: crowdfunding, public information, venture capital, competition

Suggested Citation

Hu, Ming and jin, yannan and Keppo, Jussi, The Crowdfunding Effects on Venture Capital Investments (February 26, 2020). Available at SSRN: https://ssrn.com/abstract=3512638 or http://dx.doi.org/10.2139/ssrn.3512638

Ming Hu (Contact Author)

University of Toronto - Rotman School of Management ( email )

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Toronto, ON M5S 3E6
Canada
416-946-5207 (Phone)

HOME PAGE: http://ming.hu

Yannan Jin

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Jussi Keppo

National University of Singapore - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

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