Sequential Fundraising and Mutual Insurance

Abstract

Seed fundraising for ventures often takes place by sequentially approaching potential contributors, whose decisions are observed by other contributors. The fundraising succeeds when a target number of investments is reached. When a single investment suffices, this setting resembles the classic information cascades model. However, when more than one investment is needed, the solution is radically different and exhibits surprising complexities. We analyze a setting where contributors' levels of information are i.i.d. draws from a known distribution, and find strategies in equilibrium for all. We show that participants rely on social insurance, i.e., invest despite having unfavorable private information, relying on future player strategies to protect them from loss. Delegation is an extreme form of social insurance where a contributor will unconditionally invest, effectively delegating the decision to future players. In a typical fundraising, early contributors will invest unconditionally, stopping when the target is "close enough", thus de facto delegating the business of determining fundraising success or failure to the last contributors.