Abstract
ABSTRACTI model positive sorting of entrepreneurs across the high and low value‐added segments of the venture capital market. Aiming to attract high‐quality entrepreneurs, inefficiently many venture capitalists (VCs) commit to provide high value‐added by forming small portfolios. This draws the marginal entrepreneur away from the low value‐added segment, reducing match quality in the high value‐added segment too. There is underinvestment. Multiple equilibria may emerge, and they differ in aggregate investment. The model rationalizes evidence on VC returns and value‐added along fundraising “waves” and when the cost of entrepreneurship falls, and generates untested predictions on the size and value‐added of venture capital.
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