Dr. Alexander Huber, Director Finance at Unternehmertum Venture Capital Partners, has written two research papers with his fellow scholars on the relationship between crowdfunding and venture capital investments. We’ve asked him to share their insights.
Together with your co-authors Dr. Ferdinand Thies, Prof. Dr. Carolin Bock, and Prof. Dr. Alexander Benlian, you’ve analyzed reward-based crowdfunding through platforms like kickstarter. Many founders in the B2C segment are using this form of financing. What is important in a crowdfunding campaign and what is its added value?Crowdfunding allows founders to fund their product or service idea relatively quickly and easily. Depending on the legal framework, investors receive company shares, bonds, or simply the product that is being developed.
In essence, crowdfunding isn’t different from other financing forms like through business angels or venture capital (VC). The team, their product, and its development have to suit the investors and be pitched convincingly. However, crowdfunding makes it easier for many founders to reach many potential supporters because large platforms like kickstarter have a global outreach.
It also allows the team to test their solution on the market before developing it further, making it easier to estimate the demand for it. After all, the so-called “backers” often are the customers! Vice versa, this means you can take a successful crowdfunding campaign as a synonym for positive market entry or potential demand. It’s also a sign of future success.
How else is crowdfunding different from venture capital?
As I previously mentioned, it depends on the framework. But essentially, we can summarize: with crowdfunding, many investors contribute small amounts - with venture capital, few investors contribute large amounts. In addition, crowdfunding lacks a substantial component: so-called “smart money”. This means that venture capitalists (or business angels, for that matter) don’t just invest financial resources but also support founders with their network, their entrepreneurial experience, and much more.
In your first research paper, you’ve analyzed how crowdfunding affects subsequent venture capital investments. What are your findings?
We’ve empirically proven that a successful crowdfunding campaign increases the probability of an ensuing VC investment significantly. We have also observed that so-called “platform endorsement” - a crowdfunding site highlighting specific campaigns - has a positive impact on subsequent venture capital funding.
This means that start-ups with successful crowdfunding have better chances for a VC investment?
Yes. However, the correlation only applies up to a certain limit. From then on, the probability actually decreases. We’ve called this an inverse U-shaped correlation.
One of our explanations is that the capital collected is sufficient after reaching a certain amount - making a subsequent VC funding simply not necessary anymore. Another reason could be that the founding team’s demands increase due to their great success. From a VC perspective, that doesn’t look “profitable” enough anymore.
Is there an incentive for venture capitalists to look out for start-ups with successful crowdfunding and invest in these?
Following a crowdfunding campaign, there are often several funds contributing venture capital for a start-up - making up a syndicated round. What are the pros and cons here?
A pro for a syndicate is that the evaluation of the start-up is distributed among several players. Not every party has the same information before they conclude the investment - four eyes see more than two. In addition, the funds can pool their resources that way - both tangible and intangible ones.
At the same time, the cooperation of different venture capitalists causes “frictions”, including different fund durations and return expectations. In the end, the parties are on a journey of three to seven years together and have to get on well with one another.
How does the fact that a start-up has previously completed their crowdfunding affect VC syndication?
Our second analysis showed that a successful crowdfunding campaign makes it generally less probable for a start-up to be funded by several VCs. The results also confirm that these syndicates turn out to be smaller and, at the same time, more international. That being said, we could not register a difference in the level of experience or professionalism of the supporting funds, measured by the number of exits, etc.
Thank you for your insights!
You can find both research papers by Dr. Alexander Huber and his fellow scholars linked below.
- Paper no. 1: Following the Crowd—Does Crowdfunding Affect Venture Capitalists’ Selection of Entrepreneurial Ventures? (Account or institutional access necessary)
- Paper no. 2: Trusting the Crowd: Effects of Crowdfunding on Venture Capital Syndicates (Account or institutional access necessary, free download possible)