Sorting and Equilibrium Fund Size in The Venture Capital Market

56 Pages Posted: 8 Apr 2019 Last revised: 5 Dec 2019

See all articles by Francesco Sannino

Francesco Sannino

Frankfurt School of Finance & Management, Finance Department

Date Written: November 29, 2019

Abstract

Venture capitalists (VCs) add value to the projects they finance. In a matching model where VCs span their attention over multiple entrepreneurial projects, the entrepreneurs direct their search at different VCs. VCs' attention is diluted as their funds grow. Complementarities generate positive sorting over VC attention and project quality. Anticipating this, VCs raise excessively small funds. The entry of unskilled VCs feeds back into equilibrium sorting, increases returns of top-performing VCs - consistently with empirical evidence - and leads to a Pareto-improvement. In a multi-period extension, funds organized as limited partnerships emerge in equilibrium even when they are not the optimal configuration.

Keywords: Venture Capital, Directed Search, Adverse Selection, Fund Size, Span of Control

JEL Classification: G24, G31, D82, D83

Suggested Citation

Sannino, Francesco, Sorting and Equilibrium Fund Size in The Venture Capital Market (November 29, 2019). Available at SSRN: https://ssrn.com/abstract=3353233 or http://dx.doi.org/10.2139/ssrn.3353233

Francesco Sannino (Contact Author)

Frankfurt School of Finance & Management, Finance Department ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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