We develop a theoretical model of two-stage startup financing with signaling. In our model, the nature determines the technology entrepreneur’s ability and he strategically chooses a costly patent level to inform his ability to potential investors. Angels participate in investment for seed money in the first-stage after observing the patent level and venture capitals offer investment to the entrepreneur based on angels’ behavior in the second-stage. We derive a unique equilibrium in view of the Intuitive Criterion of Cho and Kreps (1987). In the equilibrium, as the expected project return increases, the entrepreneur can reveal his ability with a less patent cost. Furthermore, a higher expected project return leads to an increases share of the entrepreneur and thus he gains more profit. Since investment markets are competitive, investors bid lower shares as their portion when the project returns of their investment increases.
KEYWORDS: startup financing; signaling; Intuitive Criterion; angel; venture capital
JEL CLASSIFICATION: G14, G24, D82
