A forthcoming issue of the Journal of the European Economic Association will carry a study arguing that crowdfunding in the absence of liquidity constraints is a superior method of equity financing–superior to “traditional financing forms,” that is, unless those traditional financiers are fully competitive and perfectly informed.
By one estimate, global crowdfunding reached $195 billion in 2017. Of that, $13 billion was equity- or reward-based.
The JEEA article is by Hans Peter Gruener of the University of Mannheim, and Christoph Siemroth, University of Essex. It is titled “Crowdfunding, Efficiency, and Inequality.”
Gruener and Siemroth ask the reader to consider a company that requires new funding to produce and market a new consumer product. From a social welfare perspective, and all else being equal, we (the public, policy makers, disinterested philosophers, etc.) should want the company to get a lot of funding for this product if and only if there is going to be a lot of demand for it. If on the other hand there isn't going to be a lot of demand, and the product will end up gathering rust in a warehouse … a lot of funding doesn't sound allocatively efficient. If on the third hand there will be some demand for it, but it will remain a niche … the efficient (or Pareto optimal) result involves enough funding to supply that niche.
The Point of a Crowd
What is the novelty of funding the new product through a cybercrowd? Precisely this, in the words of Gruener and Siemroth, “a representative sample of potential customers of the new product may participate in the funding decision of the firm” as opposed for example to VC financing, where “a select few decide on funding products that they might never consume themselves.”
One of the case studies on which Gruener and Siemroth focus involves a craft beer brewery known as Mine Shaft Brewing (MSB). MSB used the US platform Crowdfunder to get the funding to expand its production capacity. In their pitch, MSB's entrepreneurs cited a distributor who had said that its customers “would want you in UT, WY, NM.” The suggestion was that profits were limited by the limits on production capacity.
