Abstract
I introduce a model where entrepreneurs self-select into venture capital funds and value-added from venture capitalists (VCs) (i) decreases as their funds grow and (ii) complements entrepreneurs' quality. Aiming to commit high value-added, thereby attract high-quality entrepreneurs, (too many) VCs raise small funds. By doing so, they worsen the pool of entrepreneurs who select in the low value-added segment of the venture capital market: aggregate fundraising is inefficiently small. Subsidizing entry of less skilled VCs, by affecting entrepreneurs sorting, induces a Pareto-improvement. The model also rationalizes the emergence of limited partnerships, independently of whether they are the efficient fund structure.
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