Does crowdfunding help firms obtain venture capital and angel
finance?
Massimo G. Colombo
Department of Management, Economics, and Industrial Engineering
Politecnico di Milano
Piazza Leonardo da Vinci, 32
20133 Milan, Italy
Phone: +39 02 2399-2748
Email: [email protected]
Kourosh Shafi a
Department of Management, Economics, and Industrial Engineering
Politecnico di Milano
Piazza Leonardo da Vinci, 32
20133 Milan, Italy
Phone: +39 328 558 9043
Email: [email protected]
a
Corresponding author
Keywords: crowdfunding, venture capital, angel investment
I like to thank Andrea Nespoli for his data collection efforts.
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ABSTRACT
In this paper, we ask whether crowdfunding complements or substitutes venture
capital/business angel. To answer this question, we follow 300 projects, which is the
population of all hardware projects before the end of 2013 launched on Kickstarter and
Indiegogo that raised at least one hundred thousand US dollars. We find that substitution or
complementarity between crowdfunding and VC depends on the information produced on the
campaign and the post-campaign performance of entrepreneur in delivering their product on
time. Hardware firms in general benefit from demand information and crowd feedback in
resolving information asymmetry faced by potential VC investors. Moreover, only non-VCbacked firms appear to have interactions between financing and the performance of
entrepreneur in delivery of product according to his announced estimated delivery. Non-VCbacked firms that show delay in delivering their product are less likely to receive initial
external financing unless there is positive crowd feedback. Additionally, non-VC-backed
firms that successfully ship their product are less likely to receive initial external financing,
owing to initiation of the bootstrapping process by entrepreneurs. As a result of successful
delivery of promised product, entrepreneurs feel confident in their self-efficacy, which
renders the coaching of VC unnecessary and can allow entrepreneurs to avoid dilution costs
and the loss of control ensuing VC investments.
1
1. Introduction
In spite of the importance of access to adequate financial resources for survival and growth of
new firms (Gilbert, McDougall, and Audretsch, 2006; Lee, Lee, and Pennings, 2001), it is
well-recognized that raising external finance is often difficult because prevalent information
asymmetries create adverse selection risk and moral hazard problems for investors (Sanders
and Boivie, 2004; Hall, 2002; Carpenter and Petersen, 2002). Scholars have argued that
unlike traditional financial intermediaries like banks, venture capital (VC) investors can
overcome some of these problems by relying on their expertise both to select promising
startups and to deter entrepreneurs’ opportunistic behavior after the investment has been made
(e.g., Amit et al., 1998; Lerner and Gompers, 2001; Baum and Silverman, 2004).1 Moreover,
VCs help build “winners” by coaching portfolio firms (Sapienza, 1992; Barney, Busenitz,
Fiet, and Moesel, 1996; Sapienza et al. 1996).
Although research has extensively highlighted the upside of obtaining support from
VCs, substantial costs entail pursuing VC for entrepreneurs. First, issue of new equity in an
early stage of firm’s life may lead to a substantial dilution of entrepreneurs’ ownership shares.
Second, potential loss of entrepreneurs’ control over his firm might ensue from VC
investments (Wasserman, 2003) because VCs often require contractual control rights
specially to take charge of firm if things take a turn for the worse; Control rights reduce
principal-principal agency costs that are potentially generated by conflicts of interest between
entrepreneurs and VCs given few formal governance structures in place for early-stage firms.
Thus, these costs might discourage entrepreneurs to seek VC. More broadly, previous studies
that have tested the pecking order hypothesis (Myers, 1984; Myers and Majiluf, 1984)
highlight higher costs of external capital compared to internal capital due to information
asymmetry, which is prevalent for new firms. As a result, many new firms never receive any
outside financial backing (Kerr and Nanda, 2009), perhaps by opting out of VC market
(Eckhardt, Shane, and Delmar, 2006).
New firms use internal capital to finance their
operations, and only resort to external equity capital when there is a need for large capital
infusion (see e.g. Cassar, 2004; Vanacker and Manigart, 2010). Likewise, the financial
bootstrapping literature (e.g., Winborg and Landström, 2001; Ebben and Johnson, 2006;
Vanacker et al., 2011) shows that firms use several creative mechanisms to avoid resorting to
expensive external sources of finance, including practices to minimize capital held in stock
and the use of advance payments by customers to finance working capital.
1
To this latter end, VCs resort to different mechanisms (see e.g., Kaplan and Strömberg, 2004) such as
staging. Staging consists of the stepwise provisions of several rounds of VC finance instead of
providing portfolio companies with an upfront infusion of all required capital (Gompers, 1995; Wang
and Zhou, 2004; Tian, 2011). Staging creates efficient incentives for entrepreneurs, as VCs may stop
financing the venture at each financing round if agreed-upon milestones are not met. More importantly
for the purpose of the present paper, staging allows VCs to learn about the entrepreneur and the
venture’s operations over time and use the information acquired between each round to make better
investment decisions (Bergemann and Hege, 1998).
2
More recently, the development of crowdfunding has opened new financing channels
for entrepreneurs2. Crowdfunding consists of launching an open call, mostly through
dedicated platforms on the Internet, for the provision of financial resources, either in the form
of donation or in exchange of a future product or some form of reward (Belleflamme et al.,
2013, p. 7). There are different types of crowdfunding depending on what individuals who
support the project (backers) expect to receive in exchange for their contributions (Marom
and Dushnitsky, 2013). Backers may receive equity shares (Ahlers, Cumming, Günther, and
Schweizer, 2015), an interest rate (Zhang and Liu, 2012), gratification from the achievement
of a mutually desired goal (Kappel, 2009), or a reward in the form of product or service. In
this paper, we focus only on the category of crowdfunding in which most of the backers
pledge in exchange of a promised reward (so called, reward-based crowdfunding,
Belleflamme, Lambert, and Schwienbacher, 2013).3 The few previous studies on rewardbased crowdfunding have mostly focused attention on the antecedents of the success of
crowdfunding campaigns (e.g. Ordanini et al, 2011; Agrawal et al, 2014; Kuppuswamy and
Bayus, 2013; Mollick, 2013; Colombo et al., 2015), and have left open questions regarding
post-crowdfunding outcomes. Mollick and Kuppuswamy (2014), for an exception, have
conducted a survey to assess post-crowdfunding outcomes, yet they leave unanswered when
reward-based crowdfunding complements or substitutes VC.4 We attempt to fill this
important gap for the following conceptual and practical reasons5.
On the one hand, the money raised through a successful crowdfunding campaign allows
entrepreneurs to initiate the process of bootstrapping and may make VC financing
superfluous. In addition, success in crowdfunding may bolster entrepreneurs’ confidence in
firm’s prospects and in their own execution ability, reducing the expected benefits from
coaching by VCs. It may also re-enforce entrepreneurs’ optimistic belief (Dushnitsky, 2010)
in re-using crowdfunding as a viable alternative to VC to raise larger amounts of money. For
all these reasons, crowdfunding may be an alternative financing channel to VC, for instance
being extremely valuable in countries or regions where there is limited supply of VC. On the
other hand, crowdfunding may be complementary to VC because successful crowdfunding
2
The emergence of crowdfunding is argued to be due to imbalances between the supply and demand
for capital or a consequence of improvements in technology (Bruton, Khavul, Siegel, and Wright,
2014). However, in our opinion further research is warranted looking into antecedents of accelerated
growth in crowdfunding across world.
3
For the sake of simplicity, in this paper we use the term “crowdfunding” to refer to “reward-based
crowdfunding”.
4
Magdalena and Clarysse (2015) administer a survey to crowd-funders (about their motivations) and
inquire whether individuals who already made equity investments in a project would be more or less
likely to keep a reward-based pledge (or equity) if presented both options of equity and reward. In our
study, we don't consider equity crowdfunding; rather we focus on later financing by VC or business
angels. For detailed discussion of differences and similarities between VC and equity crowdfunding,
see Mohammadi and Shafi (2015) and Ahlers et al. (2015).
5
For instance, Bruton, Khavul, Siegel, Wright 2014: p. 17 note that “heterogeneity within particular
forms of alternative finance and how this influences success at raising initial finance are questions
worth asking.”
3
campaign enables entrepreneurs (a) to test market demand for their (prototypes of) products,
and (b) to generate valuable information on the quality of the focal firm to potential investors,
with attendant consequences of rendering the firm more attractive to VCs; in this sense,
crowdfunding alleviates substantial information asymmetry between new firms and investors
and investors can rely on crowdfunding-associated information for improved quality
judgments and reduced uncertainty in valuation of new firms (Certo, Daily, Cannella, and
Dalton, 2003; Higgins and Gulati, 2006; Lounsbury and Glynn, 2001; Rindova, Petkova, and
Kotha, 2007).
We argue that whether crowdfunding and VC finance are complements or substitutes
depends on the status of VC-backing of firm prior to crowdfunding and process-related
outcomes of the crowdfunding campaign. We analyze separately firms based on VC-backing
before the end of campaign because the financial resource needs and objective of VC-backed
firms in pursuing various benefits associated with crowdfunding could vary compared to non
VC-backed ones. Regarding VC-backed firms that opt into crowdfunding, we claim that their
successful crowdfunding campaigns will provide (subsequent) VCs with additional evidence
about the quality of focal firm. Accordingly, we find that good news generated by a larger
amount of raised capital, a larger number of backers, and more positive feedback by backers
make the provision of an additional round of VC more likely. For non-VC-backed firms, the
same relationship holds true; however, more nuanced picture of determinants of initial VC
financing is obtained when we investigate performance of entrepreneur in product delivery
and its relation with the crowd feedback. After successful completion of crowdfunding
campaign, entrepreneurs are uncertain about their execution ability to deliver a high-quality
product, and only over time they update their self-efficacy beliefs (e.g., with achievement of
further progress on promised product). Therefore, on-time delivery to customers of the
promised products (or services) offers positive posterior information of their ability. Having
observed their ability conditioned on product delivery, we find these entrepreneurs will be
less likely to look for costly expertise and financing of VC and will probably rely on the
capital provided by backers to initiate financial bootstrapping. Conversely, delays in product
delivery may indicate that entrepreneurs are encountering unexpected problems (e.g.,
technical or managerial issues). Being less self-confident, these entrepreneurs will find
coaching by VCs more valuable and will be more likely to look for VC. Nonetheless, we find
the bad news associated with delayed product delivery will make their firms less attractive to
VCs. However, this negative effect of delay in delivery of product on the probability of the
focal non-VC backed firm to obtain initial VC will be weakened the more positive are the
feedbacks that entrepreneurs receive from the crowd; therefore, we find positive feedbacks
from crowd render VCs more inclined to provide capital and expertise necessary to accelerate
the product development of an entrepreneur missing on-time delivery of product.
4
To test our predictions, we use data from the population of hardware startups that
completed successful crowdfunding campaign before 1st January, 2014 in two major U.S.based platforms, namely Indiegogo and Kickstarter, and raised more than one hundred
thousand US dollars. The hardware industry is capital-intensive and entrepreneurs are
inclined to look for VC (perhaps with higher propensity than other high-tech industries such
as software). We track all these startups up to the 1st January, 2015 to see whether (and
when) they obtained a round of VC financing after completion of the crowdfunding
campaign. We split our sample based on whether startups were VC-backed or not at the end
of the crowdfunding campaign, and separately on the two sub-samples we estimate survival
models. Our results support our predictions and broadly indicate that crowdfunding not only
provides entrepreneurs with financial resources, but also generates valuable information on
these firms. Depending on firms’ VC-backed or non-VC-backed status, crowdfunding
differently informs the financing decisions of both entrepreneurs and VCs.
2. Theoretical background
2.1. Benefits and costs of VC for entrepreneurial firms
There is common consensus among scholars and practitioners that VC is one of the most
suitable financing options for young innovative firms to access external capital (e.g. Gompers
and Lerner, 2001, 2004; Denis, 2004). VC investors provide value-adding benefits in addition
to financial resources to their portfolio firms. They coach entrepreneurs in various domains
with most perceived lack of entrepreneurs’ expertise including finance and control, strategic
planning, and the recruitment of managers and other skilled personnel (Gorman and Sahlman,
1989; Sapienza, 1992; Sapienza et al., 1996; Hellmann and Puri, 2002; Colombo and Grilli,
2013). They also help portfolio firms establish strategic partnerships such as alliances (Hsu,
2006; Lindsey, 2008; Hochberg et al., 2007; Colombo et al., 2015). It is therefore no surprise
that several previous studies have documented a positive impact of VC on portfolio firms'
economic performance and likelihood of going public (e.g., Chemmanur et al., 2010; Bertoni
et al. 2011; Chemmanur et al., 2011; Puri and Zarutskie, 2012; Croce et al., 2013).
In spite of the aforementioned benefits to seeking VC, there may also be serious
drawbacks for entrepreneurs, which discourage recourse to VC financing as the best choice.
First, by raising new equity from VCs, entrepreneurs’ equity is diluted and they will forgo a
substantial fraction of future profits (Kaplan and Strömberg, 2002). “Venture capitalists, for
their part, generally seek to provide their entrepreneurs with only the minimum of cash
required" (Gorman and Sahlman, 1989: 238) to own (some minimum level of) shares of new
firm, recognizing that higher the ownership amount entrepreneurs are willing to surrender to
VCs, the more successful they are likely to obtain VC (Hustedde and Pulver, 1992: 367).
Additionally, when VCs invest in early stage firms compared to late-stage ones, dilution is
even greater. VCs require a higher rate of return when investing in early stage as they incur
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higher risks. Increased information asymmetry of early-stage investing entails a larger “lemon
premium” for investors. Second, retention of control is an important consideration for many
entrepreneurs (Sapienza, Korsgaard, and Forbes, 2003; Manigart and Struyf, 1997).
Entrepreneurs often have strong psychological attachments along with their identity tightly
linked to the firm they founded (Dobrev and Barnett, 2005). Given high level of uncertainty
involved in investing in an early-stage firm, VCs frequently ask for control rights such as the
right to replace founder executives with seasoned professional managers to reduce uncertainty
relating to the founders’ managerial ability. As was noted by a VC, “our default assumption
when we first look at a company is that the Founder-CEO can’t lead this company going
forward” (cited in Wasserman, 2003, p. 154-55). Even if the entrepreneurs are not replaced,
conflicts of interests between VCs and entrepreneurs may arise, leading to principal-principal
agency costs. As VCs foresee the possibility of circumstances in which there will be likely
disagreement with the entrepreneurs, and given the uncertainty about the abilities of
entrepreneurs and the difficulties of observing their actions post-investment (Kaplan and
Strömberg, 2004), VCs usually structure investments with contractual provisions including
board rights, voting rights, and other control rights which allow them active involvement in
their portfolio firm’s management (Fried, Bruton, and Hisrich, 1998). These provisions could
allow VCs to gain full control if the firm performs poorly or fails to meet specific milestones
(Kaplan and Strömberg, 2004). VC contracts also frequently include non-compete clauses,
which prevent entrepreneurs from starting another venture in the same industry (Barney et al.
1994; Hoffman and Blakey, 1987), and vesting clauses, which allow VCs to repurchase
departing entrepreneurs’ shares at low price (Sahlman, 1990). Viewed from entrepreneurs’
perspective, these contractual provisions could be perceived as non-friendly and clearly limit
entrepreneurs’ decision autonomy.
Resource dependency theory (Pfeffer and Salancik, 1978) argues that a party (i.e., an
entrepreneur) is less likely to seek and depend on the resources from another party (i.e., a VC)
that would seek control over the former’s resources (Emerson, 1962; Santos and Eisenhardt,
2009); In this context, the dependence generated in exchange of access to resources that VCs
control will lead to undesirable power imbalance disfavoring entrepreneurs. In accordance
with this view, we expect entrepreneurial firms not to be inclined to enter into exchange
relationships with VCs and to refrain from costs related to loss of control explicated above
unless they cannot generate internally the necessary capital and/or regard the coaching and
the other non-financial benefits provided by VCs as extremely valuable.
Finally, pecking order theory, which claims cost preference of internal financing to
external financing for firms (Myers, 1984; Myers and Majluf, 1984), supports the view that
privately held firms in general (Brav, 2009; Cosh et al., 2009), and new firms in particular
(Cassar, 2004; Vanacker and Manigart, 2010), are quite reluctant to raise external equity
6
finance. Only when new firms need a great capital infusion (e.g., to build a fabrication plant),
it becomes worthy to take courses of action intended to overcome barriers such as information
asymmetry, which are hypothesized to drive the wedge between external and internal cost of
financing.6 Overall, we conclude this section by the following quote from Christian Chabot,
CEO of Tableau Software:
“I would say the biggest thing I learned working in venture capital for two years and
being exposed to it is — avoid venture capital at all costs. That’s what I learned…. I
think it is very important for young missionary, driven entrepreneurs to avoid venture
capital as long as they can, and if you can. Now, if your idea is to create some kind of
chip and you need a fab plant, OK, that’s not going to work out. But, if you have
software or media or something that could be bootstrapped, bootstrap it for as long
as you can.”
2.2. Financial bootstrapping
Scholars and practitioners alike emphasize financial bootstrapping as an alternative
option to raising external finance (Bhide, 1992; Winborg and Landstrom, 2001; Ebben and
Johnson, 2006). Financial bootstrapping is defined as a range of “highly creative ways of
acquiring the use of resources without borrowing money or raising equity financing from
traditional sources” (Freear, Sohl, and Wetzel, 1995). For instance, these mechanisms include
delaying payments to external parties, minimizing resources tied up in the business (e.g.,
stock or accounts receivable), owner financing, and the use of entrepreneur’s personal
network for sharing and/or borrowing resources (Winborg and Landstrom, 2001: p. 249).
Financial bootstrapping is beneficial to resource-constrained firms because it promotes
efficient and creative use of their scarce resources (Baker and Nelson, 2005) and the
development of new skills (e.g., cash management skills). Furthermore, bootstrapping allows
for the flexibility necessary for changes in the strategic direction of firms without requiring
permission from outside stakeholders (Bhide, 1992).
In spite of previous favorable introduction of bootstrapping as an attractive source of
financing, there are difficulties associated with this mode of financing and it is viewed as a
feasible option only when certain conditions are met. Bootstrapping is desirable for profitable
firms and entrepreneurs with high ability who are confident to be able to develop their firms
without resorting to VC. Entrepreneurs generally are uncertain ex ante about their
entrepreneurial abilities, and only learn about their “true” ability over the course of time
(Jovanovich, 1982) after encountering managerial or technical challenges. The upward
revised assessment of their self-efficacy is followed by success in resolving these challenges;
in which case, high-ability entrepreneurs find the coaching offered by VCs as unnecessary
and view financial bootstrapping as a valid substitute for costly VC financing (Amit et al.,
6
Brav (2009) also shows that among private firms, those that have fewer shareholders who
allegedly value control rights more, are less likely to issue new equity and are more likely to
prefer debt over equity when external capital is required.
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1998). In other words, the successful use of bootstrapping is conditional on the ability of
entrepreneurs such that only high-quality entrepreneurs view this option as viable. We further
develop and apply these arguments in hypothesis development for the specific context of
crowdfunding.
2.3. Reward-based crowdfunding
Reward-based crowdfunding is a financing mechanism that exhibits several peculiarities.
First, unlike VC, the crowd provides funding without asking for equity in exchange; that is,
there is neither dilution of entrepreneurs’ ownership nor contractual provisions, which limit
the control rights of entrepreneurs. The reward-based funding comes from listing a
prototype/product, soliciting pre-orders, and receiving payment from the crowd in advance of
shipping the product. Financing is often used to complete a prototype and build a product. In
this sense, reward-based crowdfunding can be considered as a bootstrapping technique, which
allows entrepreneurs to “obtain payment in advance from customers” (Winborg and
Landstrom, 2000: p. 241). Second, in addition to advanced payments, through a
crowdfunding campaign entrepreneurs obtain valuable information on (a) the demand for
their products, (b) product suggestions, and, (c) their ability to successfully solve
technical/managerial problems to deliver the product to customers successfully. Through the
crowdfunding campaign, entrepreneurs can find out about market demand for their product by
observing the quantity pre-ordered. This information helps reduce the ex-ante uncertainty
about the size of the market and alleviates concerns of firm failure related to lack of productmarket fit. Crowd also provides feedback on product, design feature suggestions, price inputs,
etc. There are other additional benefits from crowdfunding campaigns including engagement
of a community of early adopters (beta/lead users), promotion of the product, and marketing it
through word of mouth or media. Finally, a host of information on the performance and effort
of entrepreneur is visible to public from post-campaign webpage in the form of updates on the
progress of campaign or responses to backers. Overall, crowdfunding provides information to
the entrepreneurs, but also to investors; in this sense, we expect crowdfunding to help resolve
some of the information asymmetry between new firms and investors and reduce adverse
selection problems. Third, crowd might possess the wisdom to select promising firms
(Mollick and Nanda, 2015) (to some extent, or bear little risk by making mistakes and if the
crowd doesn't fall into the trap of non-rational herding) but cannot provide value-adding
services in a level compared to traditional investors. Although after the campaign the
entrepreneurs often inquire about various strategies such as manufacturing partners, sales, and
distribution suggestions from the connections available in the community of backers, this is
perhaps not comparable to the capability and the commitments of VCs with financial
incentives, specialized portfolios of firms in related industries, and other value-adding
abilities such as upgrading managerial capabilities of firms; all of which could contribute
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positively to the success of the portfolio firm. In light of these differences, the decision to
choose alternative forms of financing is non-obvious and we set out to highlight when
entrepreneurs favor crowdfunding or view crowdfunding as a complement to traditional
sources of (seed) financing.
2.4. Hypothesis Development
In what follows, we separate the hypothesis development for non-VC-backed and
VC-backed firms. We have reasons to believe that these two types of firms are heterogeneous
in their financial resource needs, capabilities, and the objectives to enlist their
prototype/product on crowdfunding. More specifically, we propose conditions that delineate
when crowdfunding complements or substitutes VC for these two sub-sample of firms.
2.4.1 VC backed firms.
Turning our attention to VC-backed firms before end of crowdfunding campaign, we
suspect that entrepreneurs and their existing investors might be interested majorly only in the
money from crowd (or less likely for financial bootstrapping reasons in case they are worthy
of further investment) because these firms have had the initial endowment of financial
resources from these investors and potentially are at a later stage of development than nonVC backed firms. Having said that, we argue that crowdfunding produces additional
information that could help resolve information asymmetry faced by subsequent investors,
and thereby, enhance the likelihood of subsequent financing by VC.
VC backed firms benefit majorly in two ways from launching a crowdfunding
campaign: (a) market validation of their product and demand assessment and (b) feedback
from an engaged community. VC-backed firms might seek market-validation of a product in
the crowdfunding to persuade subsequent VCs. Danae Ringelmann, co-founder of Indiegogo7
observes that:
We don't see crowdfunding and venture capital as mutually exclusive. We're seeing
Indiegogo become an incubation platform for traditional financiers to come in and
discover new ideas … A successful crowdfunding campaign helps prove to VCs,
angel investors and banks that there is a demand for a product in a marketplace,
removing some of the risk from the equation.
Crowdfunding can also provide valuable feedback on the project. This point is clearly
reflected in the following quote by James Proud – the creator of Hello, a Hardware company
that after receipt of venture capital turned to crowdfunding with a product:
A lot of companies when looking at Kickstarter see it as a source of funding, I think
that’s the wrong way to look at it. The real magic of Kickstarter is that it has an
engaged community ready to back or communicate with companies about their
projects.8
7
http://www.techrepublic.com/article/funding-your-startup-crowdfunding-vs-angel-investment-vs-vc/
http://www.forbes.com/sites/ryanmac/2014/08/06/backed-with-millions-startups-turn-tocrowdfunding-for-marketing/.
8
9
Overall, as positive news on demand and positive feedback from the community
become available, it accelerates the time to raise subsequent VC. Furthermore, this anecdotal
evidence is consistent with prior research on factors that enable a new venture to obtain a
subsequent round of financing conditional on having received prior funding. Performance is a
key indicator of additional VC financing9 as the provision of subsequent round of financing
often accompanies achievement of milestone-based performance of new firms (so called
“Equity milestones” are common in U.S. style VC contracts (Kaplan, Martel, and Strömberg,
2007: 291) and are designed to increase pay-performance sensitivity for entrepreneurs). In
line with this idea, we hypothesize that (a) market-validation as revealed by the amount of
money raised in the campaign, and (b) positive feedback from the community are two factors
that likely accelerate securing acquisition of subsequent resources from follow-on investors
for VC-backed firms.
Hypothesis 1. VC-backed firms with larger amount of pledged money from the crowd
are more likely to receive subsequent round of VC.
Hypothesis 2. VC-backed firms with positive feedback from community are more
likely to receive subsequent round of VC.
2.4.2 Non-VC backed firms.
Like VC-backed firms, non-VC-backed firms could also benefit from the
crowdfunding campaign to reduce information asymmetry faced by their initial investors.
Initial external finance is particularly fraught with information asymmetry compared to
subsequent financing (Hsu and Ziedonis, 2013) and, even the same quality signals produced
by non-VC backed firms (in comparison to VC-backed firms) might be clouded with noise
(Plummer, Allison, and Connelly, 2015), perhaps because of the larger number of new firms
seeking initial funding. We hypothesize that it is unlikely that information produced in
crowdfunding campaigns such as amount of money raised remain relatively unnoticed, albeit
with a weaker effect owing to the noisy environment of initial external financing, thus
increasing the likelihood of receiving initial external capital.
Hypothesis 3. Non-VC -backed firms with larger amount of pledged money from the
crowd are more likely to receive initial round of VC.
Hypothesis 4. Non-VC-backed firms with positive feedback from community are more
likely to receive initial round of VC.
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Guler (2007) presents an alternative view, and suggests that obtaining additional financing is likely to
be an escalation of commitment by VC firms for low performing firms and she suggests that intraorganizational politics, as well as coercive and normative pressures from co-investors and limited
partners might influence this decision.
10
In what follows, we set out to investigate how events surrounding the delivery of
product affect the likelihood of getting an initial round of financing. Entrepreneurs almost
always disclose when they plan to ship their products (i.e., the estimated delivery date) on the
crowdfunding platform; from the announced date of product delivery and the actual date of
shipping the product (if shipped), two critical periods (i.e., “delay in delivery period” and
“after-delivery period”) can be constructed to evaluate more nuanced understanding of initial
VC financing. To motivate this choice, we quote Mr. Casey Hopkins, the creator of the
iPhone holder Elevation Dock10, as one example of how the timeline of product delivery in
the community of crowdfunding matters:
I had this vision: If we ship late or people don't like it, the entire Internet will be
outside my house with pitchforks and torches. I can't even articulate the pressure. It's
not for the faint of heart.
Period with delay in delivery of product. Although successful crowdfunding alleviates the
ex-ante uncertainty about latent demand of a new product and its market acceptance, the
uncertainty about feasibility depends on the entrepreneur’s ability (talent, skill, experience,
etc.) to combine available resources and deploy them to meet customer needs. After the
estimated delivery date arrives, if entrepreneurs have not managed to successfully ship the
product and backers experience delay, then it appears that entrepreneurs are facing difficulty
in keeping with pre-planned timeline (schedule) of shipping. This might be perceived as
negative news to potential investors, possibly indicating over-optimism in the time estimation
of new product development (due to unforeseen technical challenges) or low managerial
capability of entrepreneurs. Although at this stage, as a response to the pressures from
community of backers, entrepreneurs might intensify searching for solutions such as seeking
investment from VC, VCs might be reluctant to provide funding to these projects
unconditionally. Overall, ceteris paribus, the negative information associated with the delay in
delivering products as calculated based on the pre-planned announced schedule on the
campaign day adversely affects VC’s decisions about providing initial funding.
Hypothesis 5. Non-VC backed firms after having delayed the delivery of product are
less likely to receive initial round of VC.
Although we previously argued that entrepreneurs might be more likely to engage in
looking for initial funding in the period with delay in delivery because “venture capital is
associated with reduction in the time to bring a product to market” (Hellmann and Puri 2000:
959), entrepreneurs might have difficulty in persuading investors for various reasons
including their potential managerial and technical problems to reach their milestones preannounced to the crowd. However, we propose that positive feedback generated from
10
http://money.cnn.com/2012/12/18/technology/innovation/kickstarter-ship-delay/
11
interactions of entrepreneurs with the community might still attract VCs and signal an
attractive investment opportunity worth pursuing.
Positive feedback from community entails great business opportunity and can tip the
balance in favor of firms struggling to deliver their products. VCs not only evaluate the
entrepreneur’s ability but also the attractiveness of business opportunity (e.g., potential
business size or strong technology) because VCs possess the expertise to get involved, for
instance by changing management if necessary, and add managerial and technical capabilities
to firms they back to put them on the success path. We assert that positive feedback from
community reassures VCs that there is an attractive business opportunity (e.g., strong
technology) worth pursuing despite the risk; As Baum and Silverman (2004) also note that
“VCs finance startups that have strong technology, but are at risk of failure in the short run,
and so in need of management expertise” (p. 411). Therefore, we take the positive reaction of
crowd to the campaign over time (and specially during the period with delay) as indicative of
the attractiveness of business opportunity and hypothesize:
Hypothesis 6. The negative relationship between delay in the delivery of product of
non-VC backed firms and initial round of VC financing is weaker when there is
positive feedback from community.
Period after delivery of product. Successful delivery of product is an important
milestone indicating that much of the uncertainty about the technical feasibility of the product
is resolved and documents the execution ability of entrepreneurs.
We argue that non-VC firms that have successfully shipped their promised product to
customers are more likely to rely on financial bootstrapping, and thus, are less likely to seek
VC for two major reasons. First, entrepreneurs have been able to use efficiently the financial
resources obtained from the crowd to develop a product and deliver it to customers. Shipping
proves the viability of the product with customers and makes entrepreneurs more selfconfident about their execution ability, thereby rendering coaching by VC less attractive
(Ehrenberg, 2013)11. Second, having experienced the viability of crowdfunding as a financing
option, entrepreneurs are more inclined to resort to using crowdfunding campaign another
time to raise additional financial resources. In line with this view, there is evidence that
successful
first-time
crowdfunding
entrepreneurs
launch
subsequent
(follow-up)
crowdfunding campaigns and often manage to raise larger amounts successfully12. This
strategy of serial product-launch by the same firm is also appealing to backers because the
crowd can now trust the competence of entrepreneurs above and beyond the good intentions
of entrepreneurs to deliver on their promise. In turn, the availability of this financial
bootstrapping mechanism makes entrepreneurs less inclined to incur the ownership dilution
11
12
http://fortune.com/2013/04/03/venture-capital-vs-crowdfunding-lets-get-real/
https://www.kickstarter.com/blog/by-the-numbers-when-creators-return-to-kickstarter
12
and loss of control cost inherent in VC finance. Therefore, we propose that conditional on
shipping their promised product, entrepreneurs are less likely to seek costly external financing
and view bootstrapping empowered by crowdfunding as an effective financing strategy.
Hypothesis 7. Non-VC backed firms after having successfully delivered the product
are less likely to receive initial round of VC.
3. Data and Methods
3.1 Data. We track all the hardware firms with successful crowdfunding campaigns raising at
least one hundred thousand US dollars in the platforms of Indiegogo and Kickstarter in the
period from the beginning of these platforms until 12/31/2013. We highlight the motivations
behind these choices. First, Indiegogo and Kickstarter are currently the largest U.S.
crowdfunding platforms and have large community attractive for the hardware entrepreneurs;
for instance, one hardware entrepreneur noted that “we talked to both [Indiegogo and
Kickstarter] and I would say both are helpful and we could not have gone wrong either
way”13,14. Second, we zeroed in on hardware campaigns because this industry is capitalintensive15. Third, we applied a threshold of $100,000 after our interviews16. Specifically, we
consulted with one venture capitalist active in investing in hardware companies in U.S. with
crowd-funded portfolio companies, and also the founder-CEO of a VC-backed hardware
company having gone through crowdfunding; all of which provided a picture for both sides of
the VC financing table. Although this threshold might seem large for crowdfunding
campaigns in general (for example, about 98.5% of Kickstarter crowdfunding campaigns fail
to reach this threshold17), this threshold appears to begin the appropriate size-range for
potential consideration attractive to venture capitalists (and angel investors) in hardware
industry. Lastly, we limited the sample to the period before the end of calendar year of 2013
13
https://www.youtube.com/watch?v=zDlavV9-La0?t=51m
Indiegogo
even
has
curated
a
hardware
handbook
for
entrepreneurs
(http://landing.indiegogo.com/hardwarehandbook/). It is also noteworthy to mention that in 2012,
Kickstarter tightened its requirements due to delays of product delivery, and rejected an increasing
number
of
projects
especially
hardware
projects
(Hurst,
2012)
(http://www.wired.com/2012/12/kickstarter-rejects/). Hardware entrepreneurs turned more frequently
to indiegogo as their favorite platform.
15
Beyond capital intensity of hardware, as the quote goes “there is a reason they call it hardware—it is
hard”. Hardware companies (compared to software ones) are dealing with the particular following
challenges: (1) Hardware products take a longer development time due to larger specialist teams with
diverse backgrounds such as mechanical, electrical engineers, industrial designers, etc., (2) iteration of
products is difficult and mistakes and changes are more costly after the initiation of manufacturing, (3)
tools are more expensive, and figuring out (4) distribution channels and (5) how many units to make
could be hard, and finally (6) software is need to make the hardware work. All these factors combine to
make hardware hard and require entrepreneurs to demonstrate high levels of skill to be able to deliver
their promises without resorting to VC.
16
Industry experts suggest that for a product aiming for 100k USD, a rough breakdown is that 30k for
bill of material and 20k USD for tooling on average, only leaving 50k salary for a team
(http://techcrunch.com/2014/10/11/8-things-about-hardware-crowdfunding-we-learned-from-20campaigns/).
17
https://www.kickstarter.com/help/stats
14
13
so that we allow about at least one year for the companies to receive venture capital after the
finish of the campaign, taking into consideration that our data collection on funding activities
took place at the end of calendar year of 2014. More specifically, all variables on VC funding
were obtained from various data sources: Crunchbase database (accessed at 7 October 2014),
AngelList online dataset accessible at “https://angel.co”, and VentureXpert database
(accessed at January 2015). In addition to these datasets, we used manual searches for all the
companies not found in the previous sources such as news, website of firms, or investors’
blog-posts, etc. As a final step in this process, we contacted several project creators on the
crowdfunding platforms for a few cases with missing or confusing information about their
financing status. It is noteworthy to mention that in hindsight one-year cutoff is a reasonable
timeframe to observe financing given that (a) the average number of days for firms ever
receiving a round of financing after campaign is 289 days, and (b) on average, entrepreneurs
estimate to ship within 112 days and actually deliver in 275 days.
In Table 1, panel A we also present the distribution of projects on several other
dimensions. The number of hardware campaigns grows rapidly over time. 84% (16%) of
campaigns are funded in Kickstarter (Indiegogo). 88% of campaigns use all-or-nothing model
(i.e., fixed funding) and 77% are located in US. In terms of exit, one goes public, 12 get
acquired, 8 stop operations, and the rest are operating. To simplify the presentation of results,
we refer to any type of professional investment either from business angels and VCs as VC.
Following this categorization, as shown in Table 2 panel B, 247 (82%) projects are from nonVC backed firms at the end of crowdfunding campaign and 53 (18%) are from VC-backed
firms. Of the projects launched by non-VC backed firms, 55 projects later achieve initial VC
(22%), and of the projects launched by VC-backed firms, 32 to achieve subsequent VC after
the end of campaign (i.e., 60%). We perform Pearson's Chi Square test, which tests whether
unpaired observations on two variables of VC-backing status before and after the campaign
are independent of each other, and reject the null hypothesis of no difference between the
distributions (p<0.01). We postpone later description of sample to descriptive statistics.
3.2. Variables.
Dependent variable. The dependent variable represents the hazard of successful achievement
of VC financing for a firm at time t. The time variable (t) measures the time in days from a
firm’s end of crowdfunding campaign until the initial/subsequent financing date. Firms that
didn't receive VC by the end of December 2014 were considered at risk for subsequent
financing and right-censored. Firms that stop operation, get acquired, or IPO exit the analysis
at that time and are no more at risk of VC.
Independent variables.
14
Delay in delivery represents the period after the date of pre-announced/estimated date of
delivery on the crowdfunding campaign and before shipping. It is a time-varying dummy
variable equal to one in the period after the estimated delivery time announced by
entrepreneur on the crowdfunding platform and the actual date of shipping, otherwise, zero.
We always used the earliest date of estimated delivery date, so called “early-bird” product
offering, noting that these dates were most often very close to each other.18
Shipped. It represents the period after the firm manages to ship his product. It is time-varying
dummy variable equal to one after actual shipping date, and zero otherwise. In this sense,
whereas crowdfunding as a bootstrapping technique allowing entrepreneurs to “obtain
payment in advance from customers” (Winborg and Landstrom, 2000: p. 241), shipping the
product enables the firm to generate revenue in an accounting sense19.
Review. It represents the extent to which backers post positive comments in the campaign
page. We follow several steps to create this variable. First, we scraped all the comments for
each project (1,187 comments on average). Each comment has a timestamp. We did sentiment
analysis of each comment after excluding the project creators’ responses (130 responses on
average) in the comments. For this purpose, we used the Sentiment Analysis API service
provided by “https://indico.io”. A more positive comment receives a higher score; the values
range between zero as the most negative comment, 0.5 as neutral one and 1 as the most
positive. Last, we took the cumulative average of the scores up to t-1 as our final measure of
Review.
Raised capital. It is the amount pledged in US dollars in the crowdfunding campaign. We log
this variable to alleviate skewness concerns.
Control variables.
We control for age of the firm (Age), calculated as the number of days from the foundation of
the company and log this variable. Given that entrepreneurs have richer endowment of social
capital from their home country (Dahl and Sorenson, 2012), we control for location of the
Kickstarter posted on their blog that “As Kickstarter has grown, we've made changes to improve
accountability and fulfillment. In August 2011 we began requiring creators to list an "Estimated
Delivery Date" for all rewards. This was done to make creators think hard about when they could
deliver, and to underline that Kickstarter is not a traditional shopping experience. In May 2012 we
added additional guidelines and requirements for Design and Technology projects. These include
requiring creators to provide information about their background and experience, a manufacturing plan
(for hardware projects), and a functional prototype. We made this change to ensure that creators have
done their research before launching and backers have sufficient information when deciding whether to
back these projects.” https://www.kickstarter.com/blog/accountability-on-kickstarter
19
The accounting notion means that revenue is earned when goods are delivered. Our interviews
suggested that one of the main concerns facing delayed projects is cancelling of pre-orders by the
crowd; for instance, founder-CEO of a company tailoring solutions to hardware companies to manage
fulfilling orders post-crowdfunding campaign highlighted this issue. Currently, entrepreneurs are
obliged to give back money in case of failure to delivery only ethically, though not legally.
18
15
firm and set U.S. location (U.S. location) to one if they are located in U.S., otherwise zero;
the crowdfunding platforms of Indiegogo and Kickstarter, which hosted the hardware
campaigns, originally started in U.S. We control for the number of eventually granted patents
(Patents) dated at the time of application as is common in studies using this innovation
variable; this data is collected using Thomson Innovation database. Patents represent the
technical capabilities of research staff and signal the quality of new firms’ technological
resources, discounting lemon premium asked by potential investors (Haussler, Harhoff and
Muller, 2012; Hsu and Ziedonis, 2013). Sales channel is a dummy variable and is equal one
when the estimated delivery of product as promised by entrepreneur is within three month
after the end of campaign. We control for this variable because short duration of announced
estimated delivery could indicate that either (a) entrepreneurs are probably using the platform
as an online store with the goal to pre-sell an already almost built-product or (b) a simple
project (e.g., with few components) is offered. (Our results are also robust to two-month
period.)
3.3. Descriptive statistics
Panel B of Table 1 shows a set of variables separated by the status of VC of firms launching
the projects before the end of campaign and present univariate analysis; All the continuous
variables are logged due to skewness before performing t-tests (with the exception of Patents)
and for the dummy variables, we perform Chi-squared tests. Projects of VC-backed firms
have larger goals (p<0.05), raise more money (p<0.01), have more backers (p<0.05), about a
year younger as observed at the end of campaign (p<0.1), and have more patents as calculated
at the end of campaign (p<0.01), slightly longer promising duration to deliver (p<0.05), yet
slightly shorter waiting duration to actual shipping from the end of campaign (n.s.). Between
projects of firms with VC and without, there appears to be no significant difference about
whether the projects finally ship or the use of sales channel (both, n.s.). On the financing side,
projects of VC-backed firms are more likely to get post-campaign financing (p<0.01), with
lower mean time to achieve subsequent financing (n.s.).
Table 2 shows descriptive statistics and correlation of variables used in multivariate
analysis. Old firms have more patents, and raise more money, which might suggest that old
firms have had more time to establish a track record necessary to alleviate information
asymmetry faced by crowd investors (Mohammadi and Shafi, 2015; Ahlers et al., 2015). The
correlation between Raised capital and Delay in delivery is positive; this is consistent with
anecdotal evidence that projects that exceed their goals by large amounts often deliver later
because of difficulties in adjusting to demand. Take Oculus Rift, a virtual reality headset
designed by 20-year-old Palmer Luckey. He planned to make a few hundred headsets by
hand, however, backers pre-ordered 7,500 units. Oculus CEO Brendan Iribe recounts that “In
16
the first 24 hours, everyone is happy and slapping your hand. And 48 hours later, the reality
sets in. There's a bit of fear: We're going to have to make all of these.”20
Except the obvious high correlation between Shipped with Delay in delivery and
Sales channel, there seems to be no serious concerns. We enter these variables separately and
simultaneously in our models, and results don’t change.
3.4. Method.
We estimated the hazard of receiving a round of VC financing post crowdfunding-campaign.
We perform an event-history analysis using Cox models, which do not require the distribution
of time dependence of the hazard to be specified. The Schoenfeld residuals don't suggest
violation of the proportional-hazards assumption. Specifically, none of the non-time varying
variables violated the proportional hazard assumptions, however, time-varying variables
violate this assumption and this does not cause concern because time-varying variables are by
definition non-proportional (Allison, 1984). The data were organized so that each campaignday is a spell. A spell is treated as censored if it does not result in a round of financing event.
Multiple observations for the same firm may create correlations between the error structure
and the independent variables and lead to underestimation of the standard errors. We thus
estimated all models with the Huber-White-sandwich estimator of variance to yield robust
standard errors, clustered on firms.
3.5. Results
We split the sample based on the status of VC-backing before the end of campaign
and report the results of the models estimating the hazard of success in Table 3.
Panel A of Table 3 shows the estimates for sample of VC backed firms. Model I is
the baseline regression including control variables. With respect to control variables, only the
coefficient of Sales channel is significantly positive (p<0.05); Sales channels increases the
hazard by 178%. The coefficients on theoretical independent variables of Review and Raised
capital are both positive and significant (respectively, p<0.05 and p<0.1), providing support
for H1 and H2. In terms of economic magnitude, the increase of one S.D. of Review increases
the hazard by 61% and one S.D. increase in the log of Raised capital increase the hazard by
32%. To have symmetrical presentation of results compared to non-VC backed firms, in
Model II, we insert Delay in delivery and Shipped, and their interactions with Review variable
in Model III and IV. None of these models suggest any improvement over the baseline Model
I.
Panel B of Table 3 shows the estimates for sample of non-VC backed firms. In Model
V, we test H3 and H4. With respect to control variables, one S.D. increase in log of age in
days decreases the hazard by 38 % (p<0.01) and one S.D. in log of patent application
increases the hazard by 22% (p<0.1). Sales channel and U.S. location are not significant.
20
http://money.cnn.com/2012/12/18/technology/innovation/kickstarter-ship-delay/
17
Raised capital is not significant, and thus, we fail to reject the null of H3. However, In line
with H4, Review is positive and significant (p<0.1); and one standard deviation increase of
Review increases the hazard by 26%. Figure 1 plots the hazard of financing event over time in
days for different samples and Figure 2 plots the survival function obtained from Model I and
V of Table 3. The hazard multiplier of VC-backed firms monotonically increases, however,
for non-VC backed it is an inversed u-shaped. In model VI, we add two dummy variables
related to product timeline: Delay in delivery and Shipped. Delay in delivery and Shipped
decrease the hazard by 56%, and 73% (respectively, p<0.1, and p<0.01), providing support
for H5 and H6. Finally, in Model VII we interact Review with Delay in delivery, and the
coefficient of interaction term is positive and significant (p<0.01). Consistent with H7, the
effect of negative relationship of Delay in delivery on the hazard of financing is weaker when
there is positive feedback. At mean (mean plus one S.D.) of Review, the hazard decreases by
%58 (31%) for a switch of Delay in delivery from zero to one. We plot the relative hazard
(i.e., hazard multiplier) of interaction term in Model VIII in Figure 3. Model IIX adds an
interaction term between Shipped and Review (n.s.), and the results of H7 remain intact.
We perform a series of robustness tests. First, we include variables related to human
capital of founders in Table A1 because the quality of team and their human capital is viewed
important to investors (Colombo, Delmastro, Grilli, 2004; Kaplan, Sensoy, Strömberg, 2009;
Beckman, Burton, O'Reilly, 2007; Kirsch, Goldfarb, Gera, 2009; Franke et al. 2008). More
specifically, we collected several strata of information about the 578 founders of the firms.
This information includes the number of years spent in university education, whether founder
is CEO in the current firm, work, and managerial experience (both in years). Given that some
firms have multiple founders, we take the average of experience and education to arrive at
firm-level variables. The results largely hold despite the reduced sample size. Second, we
substitute the log of number of backers with log amount raised and obtain similar results.
Third, we perform shared-frailty Cox survival models to check for the presence of unobserved
heterogeneity (Gutierrez, 2002); a shared-frailty survival model is analog to regression
models with random effects. In most models, we don't find a significant frailty effect,
meaning that the correlation within new firms can be ignored; the results of shared-frailty
estimates are very similar to those reported earlier in Table 3.
4. Conclusion and Discussion
We set out to understand the contingencies affecting the complementarity or substitutability
between (reward-based) crowdfunding and VC. Having separated the sample of firms based
on their VC status before the end of crowdfunding campaign – a research-design strategy
mirroring potential differences in initial endowment of financial and capability resources, we
report similar and different anteceding determinants of new firm’s receipt of VC. For VCbacked firms, the higher amount of money raised in the campaign and more positive feedback
18
from community accelerate securing subsequent round of financing; This result indicates that
crowdfunding plays a complementary role to VC because it serves as a medium of
information production enhancing the precision of quality judgment of VCs that often believe
past performance is the best indicator of future performance. Similarly, non-VC backed firms
enjoy the same benefits albeit at a lower magnitude, perhaps due to more noisy environment
of initial (compared to subsequent) external financing (Plummer et al., 2014); interestingly,
only for non-VC backed firms there is product-financing interactions. If an entrepreneur
misses on-time delivery of product (e.g., technical or managerial reasons), the bad news
makes the provision of initial capital of VC less likely unless the entrepreneur receives
positive feedback from the community. The crowd feedback often encompasses reactions to
updates on project progress posted by founders or the behavior of founders in response to
questions of backers, and we interpret this evidence as a signal of an attractive business
opportunity or technology in need of support in order to accelerate the development of
product (Hellman and Puri, 2002; Baum and Silverman, 2004). Finally, we present evidence
of substitutability between crowdfunding and VC when non-VC backed firms manage to ship
their products; plausible explanations could be that entrepreneurs gain confidence in their
abilities to pursue bootstrapping financing, or view coaching of VC unnecessary, potentially
expensive due to loss of control or dilution reasons, and their financial resources fungible–
perhaps replaceable from returning to crowdfunding for subsequent financing.21
It is noteworthy to discuss several points. First, we didn't hypothesize on the role of
product reviews after shipping event for non-VC backed firms. There seems to be two
opposing forces at work. On one hand, high-ability entrepreneurs who manage to offer better
quality products (with positive reviews) might re-enforce their beliefs that bootstrapping is
effective and a cost-saving solution to their financial needs and perhaps resort again to
crowdfunding. On the other hand, entrepreneurs who successfully ship but receive negative
feedback (e.g., low quality product) might look for VC but fail to attract VCs who can
evaluate better the investment opportunity given the product quality. Our empirical attempts
fail to disentangle the dominating effect, maybe due to multi-collinearity issues arising from
21
One might argue that average size of investments for VC investments is larger than crowdfunding
campaigns and hence, the question of substitutability is irrelevant based on size of capital infusion. We
intentionally don't involve in comparisons of investment sizes. Crowdfunding is growing in size and
legitimacy and has the potential to surpass the size of VC market. Our study design also focused on
earlier rounds of investment with higher risk and lower required amounts of financing, whereas it is
correct that at this point in time, VCs clearly have deeper pockets even to provide development and
expansion stage investments. For instance, Pebble Watch raised about 10 million USD after being
rejects by VCs in spite of the fact that the founder had production experience with a previous watch,
had raised seed capital, and pedigree from a high-profile incubator (Y-combinator)
(http://www.forbes.com/sites/anthonykosner/2012/04/19/who-needs-venture-capital-pebble-smartwatch-raises-over-5-million-on-kickstarter/). Indeed, having demonstrated customer demand, Pebble
raised a next round of financing of 15 million USD of series A round (led by Charles River Ventures).
Recently, in another attempt at reward-based crowdfunding, Pebble raised about 20 million USD
(http://techcrunch.com/2015/03/29/pebble-times-20m-kickstarter-campaign-by-the-numbers/).
19
including multiple interactions terms. Second, one might argue that shipping a product might
contribute as a positive signal to potential investors, especially for non-VC backed firms
lacking affiliation endorsements of prior investors. Then, we should expect that shipping of
product accelerates VC financing; and the interaction of Shipped with Review in Model IV
becomes negative (suggesting substitution of this two sources of information). In addition to
lack of empirical support for this view, we assert that working products allow for additional
and more accurate information assessment on whether a new firm or entrepreneurs are an
attractive investment target, reducing the further need to use other signals of quality often
used in absence of real product or tangible sales. Therefore, our view resonates with the
findings of Plummer et al. (2015: p.12) that “a new product could be good or bad, so there is
ambiguity associated with the new product signal by itself”.
Our paper has several theoretical contributions and managerial implications. First, we try
to uncover the interconnection between crowdfunding as a new form of financing and
traditional sources of financing (VC and business angel). In this sense, we contribute to the
growing stream of literature on crowdfunding by showing that crowdfunding and VC finance
may be complements or substitutes depending on firms’ characteristics (notably, their VCbacked or non-VC-backed status) and the information the process related outcome of the
campaign conveys to both entrepreneurs and investors. More generally, we contribute to the
literature that has analyzed the trade-offs between different financing modes for
entrepreneurial firms by highlighting under what circumstances the predictions of the pecking
order theory are generalizable to crowdfunding. In addition, our attempt is similar to the twostage selection model of VC proposed by Eckhardt, Shane, and Delmar (2006); which
encourages inclusive consideration of both the entrepreneurs’ as well as investors’ decision
(i.e., first stage is the entrepreneur’s decision to seek VC and second stage, VC’s decision to
provide capital to the entrepreneur). Second, we contribute to the literature investigating the
determinants of VC selection; which attempts to understand how VCs assess new firms
(Amit, Brander, Zott, 1998; Baum and Silverman, 2004; Kirsch, Goldfarb, and Gera, 2009;
Shane and Cable, 2002; Dushnitsky and Shaver, 2009). Given the prominent role of
information asymmetry and the assumption that entrepreneurs have incentives to exaggerate
their prospects or to withhold or temper information when presenting their firms to VCs, we
suggest crowd-feedback as a new source of reliable information for investors. Third and
relatedly, we present evidence that there is concordance between how crowd perceives the
opportunity (i.e., wisdom of crowd) and professional investors (following the footsteps of
Mollick, 2013). In this sense, we complement evidence of Mollick and Nanda (2015), who
compare the opinion of experts and crowd in the context of theatrical arts. However, this
evidence should be taken with cautious as Matthew Witheiler, general partner at FlyBridge
Capital who invests in hardware firms, notes:
20
Backers are buying a product. Investors are buying a vision. Some products may
generate tons of demand (like the Coolest Cooler) but may not be great venture
investments.22
In terms of managerial implications, entrepreneurs need to evaluate carefully
development plans of their product as these might have consequential implications in their
follow-up attempts to seek external financing. Perhaps, the optimal strategy could be to hold
off launching a campaign until a working prototype exists because this not only likely
increases their success chances in fundraising, but it also makes sure they have an
appreciation of required capital and effort before mass production. Overall, crowdfunding can
help with higher rate of success among launched products, to some extent because
crowdfunding reduces the noise of demand prior to the investing in building a product. For
the professional investors, crowdfunding is a source of information on the demand and
performance of entrepreneurs, and can be an attractive source of quality deal flows, possibly
enlarging the opportunity set of high-return and portfolio-fit investments (Gompers and
Lerner, 2004) often constrained by their geographical location (e.g., Cumming and Dai,
2010). Last, our research has the policy recommendation of devising regulations that help
encourage growth of crowdfunding, which serves as a path to innovation. Crowdfunding not
only has the potential to fill early-stage investing gap but also can be important in countries
with less developed VC financial market or countries lacking wide presence of early-stage
risk-taking non-governmental VCs; Overall, crowdfunding, enabled by the wisdom and
pocket of crowd, increases the overall efficiency of resource allocation much needed for
innovation and competitiveness.
Our research has certain limitations. We have not dealt with endogeneity of VC selection;
though we are careful to perform separate analysis on each sample and formulate our
hypothesis taking this issue into account. It seems daunting to find an instrumental variable
that correlated with the likelihood of initial round of financing and not correlated with later
financing. Furthermore, we grouped VC and business angels into one category of traditional
investors, and label them VC. VC and business angels are very different investors in terms of
investment size, stage of investment, and value-adding capabilities (Kerr, Lerner, and Shoar,
2014); however, our intention in this aggregation was to contrast more traditional sources of
22
http://techcrunch.com/2014/10/11/8-things-about-hardware-crowdfunding-we-learned-from-20campaigns/). For instance, Index Ventures mentions that few things are important when looking for
investing in a hardware company: “The first is it [product] must be more than just a connected device.
There have been a lot of things that just connect to your phone. That is not very exciting. It is easy to
copy and commoditize. We look for things that may be embodied in hardware, but have a very
significant software component. The second thing we look for is that it is not a single unit, but a system
of some kind. The business model that follows from that is that the more of them you buy, the better
off the system is. We are looking for a platform, not a one-off buy. The last thing we look for is some
kind of cloud-based service that sits behind it. The way we think of it is that the hardware is our
monetization method—where you get the charge, but a lot of the virtues of the product actually come
from the software.” (http://blogs.wsj.com/tech-europe/2013/06/17/hardware-is-hard-thats-why-theycall-it-hardware/). These criteria altogether don't seem to list the priorities of users/consumers or
backers.
21
financing with crowdfunding and it was not feasible to separate these two groups of investors
because of small sample size.
Future research can contribute to our understanding of the interconnection between other
forms of crowdfunding such as equity crowdfunding and VC. With introduction of each new
financial innovation (reward-based crowdfunding, equity crowdfunding), various questions
come to the fore including ownership, governance, and potential outcomes. Unlike rewardcrowdfunding without offering ownership, equity crowdfunding introduces new shareholders,
a number of whom (maybe none) could ask for voting rights (impacting governance structure,
redistribution the allocation of incentives, possible complications of a fragmented private
investor-base, etc.). The ownership by crowd also creates economic incentives for backers
(who are not necessarily professional investors) to contribute to the success of their portfolio
firm. Given recent attention to regulation of equity crowdfunding in large countries such as
U.S. and its increased legitimation, it is interesting to investigate to what extent
complementarity and substitutability between equity crowdfunding and VC might occur and
more precisely, the boundary conditions influencing this relationship. Agrawal et al. (2013)
argues that if the entrepreneur is able to raise capital through a reward-based crowdfunding
and avoids dilution of equity crowdfunding, then it can raise perhaps later-stage capital from
established investors well positioned to add value and capability to perform due diligence
offering lower cost of capital than equity crowdfunding. Therefore, the interconnection of
equity-crowdfunding and VC might need considerations of reward-based crowdfunding.
Relatedly, performance outcomes of various crowdfunding initiatives are also interesting to
explore. For instance, given the substitution between reward-based crowdfunding and VC in
the special case of non-VC backed firms after shipping the product, one might wonder about
the long-term performance of this situation because entrepreneurs forgo value-adding services
of VCs such as valuables industry knowledge, network resources such as partners and status
that increase the performance of their portfolio firm (Hochberg et al., 2007). One could
subscribe to the view that direction of innovation might change because entrepreneurs might
find ways to tap into user-driven innovation (Von Hippel, 1998; Baldwin, Hienerth, and von
Hippel, 2006; Chatterji and Fabrizio, 2014) by sourcing solution information (e.g., ideation
and product design) available from crowd expertise beyond demand information23.
Furthermore, being less interested in financial returns and ability to diversify risk, crowd can
also support more risky and radical innovations.
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Table 1 – Presentation of crowdfunding projects
Panel A
Presentation year
2011
2012
2013
Freq.
17
82
201
Website
Indiegogo
Kickstarter
47
253
Funding type
Fixed Funding
(All-or-nothing)
Flexible Funding
(Keep-it-all)
Panel B
No.
Percentage (%)
Financing
Post-campaign VC
financing (No.)
Post-campaign VCfinancing (%) c
Time to receive VC d
Non-VCa
247
82
55
22
300
VC
53
18
All
32
6***
29
269
289
Firm characteristics
266
34
Age of firm (days) b
No. of patents
1,356
0.4
1,079*
1.08
1,307
***
0.52
Campaign
Location of campaign
US located
231
Non-US located
69
Raised (USD) b
348,106
690,539***
408,603
Goal (USD) b
81,425
100,755**
84,840
2,426
4,264**
2,751
Exit status
IPO
M&A
Out of business
Operating
Sales channel (%) c
Product timeline
1
12
8
279
No. of total backers b
Days before shipping b
Estimated delivery time
pre-announced (days) b
On-time delivery (%) c
Shipped or not (%)c
22
15
21
276
268
275
108
129**
112
13
13***
13
82
89
83
a
VC refers to projects launched by firms that are VC-backed before the end of
crowdfunding campaign. All time units are in days.
*
p<0.10, ** p<0.05, *** p<0.01 t-test in difference in means between VC-backed and
non-VC backed sample after logging continuous skewed variables denoted by
superscript b and Pearson's Chi square test of proportion difference between VCbacked and non-VC-backed sample for binary variables denoted by superscript c.
d
Only for the subsample that receive ever financing after post-campaign.
27
Table 2 – Descriptive statistics and correlation matrix
Variable
Mean
S.D.
(1)
1. Delay in delivery
0.256
0.437
1
2. Shipped
0.543
0.498
-0.64
1
3. Review
0.504
0.049
-0.12
-0.06
1
4. Age
6.935
0.928
0.012
0.147
-0.109
1
12.416
0.751
0.013
-0.067
-0.049
-0.031
1
6. Patents
0.231
0.482
0.01
-0.031
0.069
0.223
0.172
1
7. US location
0.784
0.412
-0.026
0.078
-0.139
0.078
0.058
0.058
1
8. Sales channel
0.217
0.412
-0.281
0.374
0.041
-0.067
-0.163
-0.041
0.12
5. Raised USD
(2)
(3)
(4)
(5)
(6)
(7)
28
Table 3 – Cox Regression results predicting the hazard of obtaining VC a
(A) VC-backed sample
Model I
Review
Raised capital
**
9.865
(4.178)
0.271*
(0.149)
Delay in delivery
Shipped
Model II
**
10.350
(4.449)
0.313**
(0.158)
0.602
(0.790)
-0.125
(0.903)
Review × Delay in
delivery
Model III
*
8.925
(4.774)
0.319*
(0.163)
-3.461
(6.365)
-0.225
(0.914)
7.544
(11.551)
Review × Shipped
Age
Patents
U.S. location
Sales channel
No. of observations
No. of firms
No. of firms receiving post-VC
-0.072
(0.254)
-0.174
(0.295)
0.002
(0.406)
1.022**
(0.410)
0.002
(0.253)
-0.240
(0.314)
0.011
(0.385)
1.241**
(0.507)
0.018
(0.252)
-0.260
(0.325)
-0.034
(0.401)
1.258**
(0.503)
(B) non-VC-backed sample
Model IV
Model V
**
*
14.328
(6.028)
0.313**
(0.157)
-0.414
(6.775)
6.283
(5.138)
4.754
(2.634)
0.264
(0.171)
Model VI
*
4.672
(2.619)
0.218
(0.163)
-0.823*
(0.453)
-1.326***
(0.480)
2.267
(12.195)
-12.179
(9.867)
-0.009
(0.245)
-0.296
(0.326)
-0.049
(0.386)
1.364**
(0.533)
19,572
19,572
19,572
19,572
53
53
53
32
32
32
-0.508***
(0.144)
0.454*
(0.259)
0.461
(0.351)
-0.484
(0.361)
-0.519***
(0.151)
0.444*
(0.257)
0.490
(0.347)
-0.136
(0.404)
Model VII
Model IIX
-2.038
(3.618)
0.144
(0.170)
-8.100***
(3.022)
-1.474***
(0.499)
-2.220
(7.527)
0.144
(0.175)
-8.195*
(4.707)
-1.604
(4.689)
14.011**
(5.728)
14.195
(9.023)
-0.490***
(0.153)
0.487*
(0.259)
0.585
(0.373)
-0.119
(0.406)
0.255
(9.060)
-0.489***
(0.152)
0.488*
(0.262)
0.584
(0.372)
-0.120
(0.407)
132,692
132,692
132,692
132,692
53
247
247
247
247
32
55
55
55
55
-105.728
-104.669
-104.413
-103.600
-277.763
Log likelihood
10.441
11.097
12.576
12.812
23.284
Likelihood ratio χ 2
*
p<0.10, ** p<0.05, *** p<0.01. a Robust standard errors appear in parentheses clustered around firms.
-274.416
-271.469
-271.468
31.117
38.076
38.604
29
Table A1 – Robustness of Cox Regression results predicting the hazard of obtaining VC a
Review
Raised capital
Model I
2.715
(6.374)
0.237
(0.148)
Delay in delivery
Shipped
Review × Delay in delivery
(A) VC-backed sample
Model II
Model III
2.897
0.403
(6.792)
(6.906)
0.295*
0.309*
(0.160)
(0.164)
0.523
-5.876
(0.834)
(7.491)
-0.178
-0.299
(0.990)
(1.011)
11.972
(13.893)
Review × Shipped
Age
Patents
U.S. location
Sales channel
Team size
CEO-founder
Av. Education
Av. Management Experience
Av. Work Experience
No. of observations
No. of firms
No. of firms receiving post-VC
Log likelihood
Likelihood ratio χ 2
-0.075
(0.316)
0.022
(0.304)
-0.154
(0.442)
1.080**
(0.474)
0.114
(0.161)
0.646
(0.663)
0.192**
(0.078)
0.111*
(0.061)
-0.079
(0.056)
19,572
53
32
-101.361
29.026
-0.012
(0.313)
-0.044
(0.318)
-0.143
(0.424)
1.325**
(0.647)
0.105
(0.157)
0.487
(0.624)
0.180**
(0.078)
0.122*
(0.067)
-0.080
(0.059)
19,572
53
32
-100.474
36.457
-0.016
(0.307)
-0.048
(0.328)
-0.240
(0.440)
1.341**
(0.645)
0.090
(0.163)
0.449
(0.619)
0.199**
(0.083)
0.123*
(0.067)
-0.077
(0.060)
19,572
53
32
-99.937
36.811
Model IV
8.686
(8.149)
0.280*
(0.159)
-1.469
(8.110)
8.472
(5.537)
4.345
(14.746)
-16.196
(10.305)
-0.016
(0.315)
-0.041
(0.321)
-0.308
(0.419)
1.390**
(0.631)
0.075
(0.167)
0.404
(0.629)
0.236***
(0.087)
0.117**
(0.059)
-0.077
(0.058)
19,572
53
32
-98.588
47.060
Model V
4.563
(3.119)
0.236
(0.205)
-0.554***
(0.200)
0.446
(0.296)
0.754**
(0.342)
-0.466
(0.416)
0.426***
(0.126)
1.113***
(0.427)
0.029
(0.057)
0.065
(0.041)
-0.049
(0.033)
109,979
208
53
-247.500
46.436
(B) non-VC-backed sample
Model VI
Model VII
4.110
-2.871
(3.180)
(3.980)
0.197
0.152
(0.202)
(0.201)
-0.685
-9.586***
(0.469)
(3.414)
-1.115**
-1.308**
(0.505)
(0.529)
17.079***
(6.373)
-0.573***
(0.201)
0.427
(0.296)
0.785**
(0.336)
-0.141
(0.456)
0.411***
(0.125)
1.064**
(0.432)
0.013
(0.057)
0.067
(0.042)
-0.050
(0.033)
109,979
208
53
-245.266
52.061
-0.538***
(0.198)
0.486*
(0.292)
0.856**
(0.346)
-0.092
(0.452)
0.474***
(0.131)
1.037**
(0.428)
0.017
(0.055)
0.063
(0.042)
-0.049
(0.034)
109,979
208
53
-241.689
61.683
Model IIX
-11.054
(9.786)
0.137
(0.199)
-13.773**
(5.780)
-6.588
(5.564)
25.257**
(11.162)
10.375
(10.859)
-0.537***
(0.197)
0.487*
(0.294)
0.846**
(0.344)
-0.110
(0.457)
0.477***
(0.130)
1.051**
(0.428)
0.020
(0.055)
0.067
(0.042)
-0.050
(0.034)
109,979
208
53
-241.161
64.143
p<0.10, ** p<0.05, *** p<0.01. a Robust standard errors appear in parentheses clustered around firms.
30
Figure 1. Survival function of firms separated by their VC-backing status before
the end of campaign (from Model I and V).
Figure 2. Hazard function of the firms separated by the VC-backing status of
firms before the end of crowdfunding campaign (from Model I and V).
31
Figure 3. The hazard multiplier for the sample of non-VC backed firms obtained
from Model VII
32