Problem Definition: We study how a new development in entrepreneurship—crowdfunding—interacts with more traditional financing sources, such as venture capital (VC) and bank financing.
Academic/Practical Relevance: The growth of the crowdfunding industry has been remarkable. By 2015, crowdfunding accounted for $2.7 billion of financing for early-stage ventures in the US. Such growth has inspired multiple studies of crowdfunding. The majority of them focus on predicting crowdfunding campaign outcomes and on the optimal campaign design. However, the broader questions of how crowdfunding affects entrepreneurs and how crowdfunding platforms fit in with the traditional startup financing sources, such as banks and VCs, have received relatively little attention.
Methodology: We model a multi-stage bargaining game, with a moral-hazard problem between entrepreneurs and banks, and a double-sided moral-hazard problem between entrepreneurs and VCs with respect to the efforts of the entrepreneur and the VC.
Results: We decompose the economic value of crowdfunding into cash gains or losses, costs of bad investments avoided, and project-payoff probability update. This economic value is generally shared between entrepreneurs and investors, benefiting both. However, crowdfunding can also harm the entrepreneur and the VC. Competition from other investors reduces value to VC investors, who may walk away from the deal entirely. This can hurt entrepreneurs who lose out on valuable VCs’ operational expertise (operational support, access to supplier networks, etc.). The model provides a theoretical underpinning for recent empirical observations that some projects lose VC financing after successful crowdfunding campaigns. Our results complement earlier studies in Operations Management by demonstrating that the entrepreneurs’ objectives are more complex than simply maximizing the payoffs from crowdfunding campaigns.
Managerial Implications: For entrepreneurs and investors, we explain which projects should be crowdfunded and which ones should not be. For policy makers, we highlight how the development of crowdfunding platforms can benefit or hurt projects, entrepreneurs, and investors.