New ventures are sources of economic growth, employment, and innovative products and services. To reach scale, even the best new idea needs funding, and that’s where the venture capital industry comes in. But there are concerns about homogeneity in venture capital. Venture capital investors tend to have similar backgrounds, and most venture capital investing occurs in just a few geographical areas. In fact, in 2015, 75% of VC funding went to companies located in just three states: California, Massachusetts, and New York. In recent years, crowdfunding platforms, like Kickstarter, have promised to break the logjam.
Recent research by Olav Sorenson, the Frederick Frank ’54 and Mary C. Tanner Professor of Management, and four colleagues at Yale and the University of California, Berkeley, finds that not only does funding through Kickstarter reach areas with little or no venture capital activity, but successful crowdfunding campaigns can also draw subsequent support from venture capital. The paper, “Does the crowd promise to fund more innovation?,” was published in Science.
The researchers analyzed data from Kickstarter, which is the largest crowdfunding site, over the period from 2009 to 2015. Since crowdfunding sites will see many more types of startups than venture capital typically funds—they are used to fund philanthropic efforts and the creation of artwork or music, for example—the group used a “word-based distance metric” to narrow the pool of endeavors to 55,005 for Kickstarter and then compared them to 17,493 similar venture capital investments. The results showed that crowdfunding reaches areas with little or no venture funding and is far less concentrated. According to the paper, “[T]he crowd allocates a much larger share of its resources than professional investors do to the interior of the country, away from the coastal population centers and the traditional technology hubs. Even within the innovation hot spots of Boston and Silicon Valley, moreover, crowdfunding investments end up concentrated in different parts of those regions.”
In addition, where there are successful crowdfunding campaigns, venture capital funding increases over the next two to three years. When the pool was restricted to just tech-based campaigns (the most likely investment for venture capital), the relationship becomes even stronger.
According to Sorenson, this effect most likely results from two factors. “The funding that is raised through the Kickstarter campaigns may allow the entrepreneurs to develop their ideas further, maybe actually put a product out on the market, which could help them to attract venture capitalists,” he said. “The other thing that could happen is venture capitalists are also able to monitor these platforms. They can look at the platforms and see what the top crowdfunding campaigns are. This could give them some ideas of which companies could be interesting to invest in.”