Does Crowdfunding Benefit Entrepreneurs and Venture Capital Investors?

Abstract

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: While extant literature has mainly focused on predicting crowdfunding campaign outcomes and optimal campaign design, the broader questions of how crowdfunding affects entrepreneurs and how crowdfunding platforms fit in with traditional startup financing sources, such as banks and VCs, have received relatively little attention. Methodology: We model a bargaining game, with a moral-hazard problem between an entrepreneur and a bank, and a double-sided moral-hazard problem between the entrepreneur and a VC, with respect to their non-contractible efforts. 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. Moreover, crowdfunding can help to overcome the agency problems. 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 VC operational expertise (operational support, access to supplier networks, etc.). Managerial Implications: 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.