Is Wisdom of Crowds a Positive Signal? Effects of Crowdfinancing on Subsequent Venture Capital Selection

Abstract

Venture capital investors, whose decisions are highly consequential for the survival and growth of new ventures, serve as gatekeepers for the diffusion of radical innovation. In recent years, crowdfunding – an innovation in the start-up finance arena – is emerging as a viable route for entrepreneurs to secure scarce early-stage financing. While venture capital remains the most important source of funding for young innovative firms in later stages, it is important to study the interactions between new and traditional forms of venture financing. This study examines the impact and signaling effects of prior (crowd-based) funding on subsequent venture capital funding rounds. Drawing on a choice experimental research design and data on 5,280 selection decisions by 120 venture investors, the results indicate that “the crowd” is generally seen as a negative signal, but that it can generate certain positive signals to which professional venture investors react in their decision making. We find causal evidence that young firms with a previous crowdinvesting (securities-based crowdfunding) are typically not selected by venture investors, whereas high pledges of (reward-based) crowdfunding, collected fast by start-ups with a B2C business model, can have a positive effect on VC managers’ funding decisions. Our findings also suggest that traditional forms of pre-funding, i.e., prior business angel investments, by contrast significantly increase the likelihood of subsequent financing rounds. Theoretical and managerial implications are discussed.