Selection of entrepreneurs in the venture capital industry: An asymptotic analysis

We study a model of entrepreneurs who compete in an auction-like setting for venture capital (VC) funding in a setting where limited capital dictates that the VC can only finance the best entrepreneurs. With asymmetric information, VCs can only assess entrepreneurs by the progress of development, which, in equilibrium, reveals the quality of the new technology. Using an asymptotic analysis, we prove that in attractive industries having a large number of entrepreneurs competing for VC funding could lead to underinvestment in technology by entrepreneurs as the effort exerted by losing entrepreneurs is wasted. The study then proceeds to characterize the conditions under which a greater number of competing entrepreneurs is better. The model also demonstrates that VCs could possibly increase their payoff by concentrating on a single industry. In addition, the study also provides some insights on the effects of multiple investments by VCs and the effects of competition among VCs on the same investments.

► We use an all-pay auction model to analyze competition for venture capitalists (VC) funding.
► A large number bidders vying for VC funding in attractive industries could be detrimental to VCs.
► We characterize when would a large number of entrepreneurs competing for VC funding is better.
► We also show that VCs could possibly increase their payoff by focusing on a single industry.