Crowdfunding and bank financing: substitutes or complements?

In this paper, we analyze a firm choice between crowdfunding and bank financing. For many entrepreneurs, it is an important issue. We analyze a model where the choice of financing is affected by moral hazard problem regarding the choice of production scale that favors bank financing, and by the uncertainty about market demand that favors crowdfunding. We argue that long crowdfunding campaigns or campaigns with large targets usually are less efficient in mitigating moral hazard problem than small/short campaigns. We also argue that high-quality firms and firms with potentially large markets will tend to select bank financing while projects with largest amount of investment should select mixed financing where the firm uses a short crowdfunding campaign and a bank loan. Most of our model empirical predictions have not been directly tested so far while they are indirectly consistent with available evidence. Plain English Summary A financing strategy where crowdfunding and bank financing complement each other can be an optimal choice for entrepreneurs as compared to pure crowdfunding or pure bank loan strategy. In this paper we analyze a firm choice between crowdfunding and bank financing. For many entrepreneurs it is an important issue. We argue that long crowdfunding campaigns or campaigns with large targets usually are less efficient in mitigating moral hazard problem than small/short campaigns. We also argue that high-quality firms and firms with potentially large markets will tend to select bank financing while projects with largest amount of investment should select mixed financing where the firm uses a short crowdfunding campaign and a bank loan. These findings should help entrepreneurs with selecting an optimal financing strategy. The government should limit the size of reward-based crowdfunding campaigns. This should increase the extent of its usage by entrepreneurs. It may be appropriate in current conditions given that the amount of bank loans by far exceeds that of crowdfunding.