Sorting and Equilibrium Fund Size in The Venture Capital Market
56 Pages Posted: 8 Apr 2019 Last revised: 5 Dec 2019
Date Written: November 29, 2019
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: Suggested Citation