The Crowdfunding Effects on Venture Capital Investments
Posted: 17 Jan 2020
Date Written: January 1, 2020
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 investments in a startup. Our economy consists of one startup, one crowdfunding platform, and two VCs with heterogeneous prior beliefs on the startup's probability of success. The startup first approaches both VCs for funding, which is modeled as a second-price auction between the VCs, and then turns to the crowdfunding platform if rejected by both. After the crowdfunding, the VCs update their beliefs on 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 VCs raise the expected amount of VC investments. Moreover, crowdfunding raises the chance of a startup getting VC funding only for those deemed unfavorable by both VCs, but for those debatable startups with divergent VCs' views, crowdfunding may reduce their chance of receiving VC investments. We then examine how the relationship between crowdfunding and VC investments is shaped by the informational characteristics of the startup and the crowdfunding platform. For instance, when the more optimistic VC holds a moderate expectation on the startup and the investment risk is high (resp., low), this VC tends to invest before the startup seeks crowdfunding if the crowdfunding information is sufficiently accurate (resp., noisy). Finally, our main results are robust in several model extensions such as the startup is allowed to strategically decide on the timing to approach VCs, VCs can invest in any point of the time during the crowdfunding campaign, and as an alternative benchmark, VCs can observe private signals on the startup.
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