Crowdfunding or bank financing : innovation with the threat of downstream imitation and market uncertainty

Abstract

We consider a startup seeking external financing such as crowdfunding and bank financing. Public information disclosure may incur downstream imitation under crowd­funding, and demand uncertainty creates an additional burden on profitability under bank financing. We study how the startup can mitigate downstream imitation via information disclosure and what is the optimal funding choice in the presence of downstream imitation and demand uncertainty. Reward-based crowdfunding has experienced dramatic growth in recent years. However, crowdfunding is a double-edged sword: on the one hand, releasing more information can induce more contributors to pledge and increase the chance of surviving in the campaign; on the other hand, more public information lowers the barrier to entry and attracts opportunistic entrepreneurs. We explore how a startup might mitigate this threat via information disclosure and discuss the benefits of two financing strategies. We employ a game-theoretical model where the startup can either choose the bank financing strategy and start the business activity without demand information or elect the crowdfunding strategy in the presence of downstream imitation. We find that the startup may accommodate imitation in the presence of a small or large crowdfunding market. The information disclosure can be used as a weapon to mitigate downstream imitation, i.e., the startup may strategically hide crowdfunding information to weaken or expel the imitator. We show that the startup should choose bank financing if the commercial risk is low and crowdfunding otherwise. That is, the complementary relationship between the risk of downstream imitation and commercial risk appeals for bank financing. We show how startups can strategically reveal product information on the public crowdfunding platform, thus guiding startups for deterring potential downstream imitation. We also show that the commercial risk of projects affects startups' funding choice, which in turn is of interest to crowdfunding platforms aiming at high-quality projects.