The Market for Venture Capital: Entry, Competition and the Survival of Start-Up Companies

Abstract

Over the last two decades the number of venture capital (VC) firms actively investing in start-up companies in the US has more than tripled. In this paper we examine (i) the response of incumbent VC firms to increased competitive pressure from less experienced entrants, and (ii) the implications for the funding and survival of start-up companies. We first develop an equilibrium model of the VC market with heterogenous entrepreneurs and VC firms. Each VC firm matches endogenously with an entrepreneur, offering capital in exchange for an equity stake. Our theoretical model predicts that entry of new VC firms has a ripple effect throughout the entire market: All start-ups then receive more capital in exchange for less equity (implying higher pre-money valuations), and become more likely to survive. We then test these predictions using VC data from Thomson One, and find strong empirical support.