Abstract
In this paper we analyze a firm choice between crowdfunding and bank financing. The interplay of these two important types of financing for entrepreneurial firms has not been extensively studied in existing literature while for many entrepreneurs it is an important issue. We analyze a model where the choice of financing is affected by moral hazard problem regarding the choice of production scale that favors bank financing, and by the uncertainty about consumer valuation of the product that favors crowdfunding. We show that a mixed financing where the firm uses a short crowdfunding campaign and a bank loan is optimal when the project is relatively large. Otherwise, traditional debt financing or crowdfunding without bank loan can be optimal. The model generates empirical predictions most of which have not been tested sofar.
Highlights
Crowdfunding is the method of raising funds from a large number of investors usually performed online
First we show that if the market limitations are soft, i.e., market limitations are not significant for the firm, crowdfunding may not be feasible due to moral hazard problems related to production scale choice during spot sales that in turn leads to low prices during spot sales and disincentivizes potential backers from participating in crowdfunding campaign due to no-arbitrage condition violation
Second when crowdfunding is feasible the trade-off between bank financing and crowdfunding depends on interplay of bankruptcy cost, investment size, the type of crowdfunding, the type of signal received etc
Summary
Crowdfunding is the method of raising funds from a large number of investors usually performed online. Banks have greater capacity compared to most other capital providers, banks managers are able to lend large sums of money to firms if they find them financially attractive while with crowdfunding the amount of funds that can be raised during the campaign is limited (see, e.g., Bernardino and Santos, 2020; Hui et al, 2014; Durkin et al, 2016) This is because not all potential customers have access to internet; not all of them like to use internet for purchases; not of all of them are comfortable with financing innovations etc.
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