Can crowdfunding crowd out venture capital investment?

Gerry Tsoukalas, Operations, Information, and Decisions, the Wharton School, and Vlad Babich, Georgetown University

Abstract: In recent years, crowdfunding has emerged as a viable new platform for raising funds for new products and ideas. In this project, we ask: How does this new form of entrepreneurial financing interact with the more traditional financing sources, such as venture capital and bank financing? Under what terms and conditions do entrepreneurs, venture capital investors, and society, benefit or lose from this new platform? Is crowdfunding here to stay? There is evidence to suggest that the effect of crowdfunding on society can be ambiguous. On the one hand, crowdfunding can serve as an information revelation mechanism, allowing investors to sort out good projects from bad ones. This provides value to society by ensuring that funding is not wasted on bad projects. On the other hand, if a crowdfunding campaign is very successful, entrepreneurs will potentially attract more investors, intensifying competition between them. Increased competition may be good for the entrepreneur, but not so for all investors involved. Even more surprising, when there are issues of double-sided moral hazard, some VCs could lose incentives to provide effort following successful crowdfunding campaigns, and entrepreneurs and society could be made worse off in equilibrium.

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