Does Reward-Based Crowdfunding Help Firms Obtain Venture Capital and Angel Finance?

Abstract

This paper examines when successful reward-based crowdfunding campaigns increase the likelihood of obtaining external financing (e.g. venture capital and business angel financing). Two diverging perspectives are offered. On the one hand, pre-orders of a prototype/product offered in reward-based crowdfunding can allow entrepreneurs to obtain payment in advance from customers. Besides financing, crowdfunding enables the entrepreneur to evaluate his own managerial ability without resorting to exchange of equity that ensues costs such as loss of control and dilution for entrepreneurs. On the other hand, crowdfunding resolves demand uncertainty about new products and generates information on entrepreneurs’ ability (to ship the product). This information alleviates the adverse selection risk and moral hazard problems for external providers of financing. Given these views, we develop a theoretical model, derive propositions, and empirically test hypothesized relationships between crowdfunding and external equity financing on the population of all hardware projects that raised at least $100,000 prior to the end of 2013 in Kickstarter and Indiegogo. Our findings reveal that in the sample of firms with no prior external equity before the end of crowdfunding campaign, the hazard of external financing increases with (a) the target fundraising goal and (b) the ability of entrepreneurs in delivering a positively reviewed project with less time delay. However, in the sample of firms with external equity prior to the end of campaign, the hazard of subsequent financing increases with the pledged amount of money in excess of the amount of target fundraising goal. Overall, our paper tries to sketch a possible mechanism that links the performance of crowd-funded projects during the campaign and after the campaign to ability of entrepreneurs to receive outside capital.