Startup Financing with Patent Signaling under Ambiguity

One of the most important challenges for startup companies is securing financing. Indeed, it is crucial for startups to demonstrate their projects’ profitability to potential investors. We develop a model of single-stage startup financing with signaling under ambiguity. Nature determines the ability of a technology entrepreneur (startup), who strategically chooses a costly patent level to signal his ability to potential investors. Because the project undertaken by a startup may involve highly innovative technology and may not be well known to agents, they might face ambiguity about the value of the project. To examine ambiguity effects on startup financing, we provide three different financing models in view of the degree of ambiguity: (i) no ambiguity; (ii) only investors face ambiguity; (iii) all agents face ambiguity. In each model, we derive perfect Bayesian equilibria and refine them into a unique equilibrium by imposing the Intuitive Criterion of Cho and Kreps (Quarterly Journal of Economics, 102, 1987, 179) or its extension. We analyze the refined equilibria from the perspectives of agents’ equity shares and expected profits, and equilibrium patent levels.