The Crowdfunding Effects on Venture Capital Investments

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.