The Effect of Market Structure on Specialization Decisions in Venture Capital

In making its investment decisions, a venture capital firm must consider whether to specialize exclusively in one sector or to spread its investments across several sectors. While spreading investments across sectors has benefits – such as diversifying the firm’s holdings and opening up a larger pool of investment opportunities – it reduces the benefits of specialization, namely that a specialist has greater access to its sector’s most promising ventures, either because it can more accurately assess a project’s value or because the venture is more likely to accept an investment from a VC with specialized knowledge of its sector. In addition, competition from other VC firms will affect a firm’s specialization choice in the sense that its relative standing among competitors will influence a startup’s decision to accept its investment. We find empirical evidence suggesting that firms alter their specialization decisions in response to competitors and market structure using a panel dataset of VC investments from 1975 2003. ∗Kellogg School of Management, Northwestern University, [email protected] †Kellogg School of Management, Northwestern University, [email protected] ‡Department of Economics, Northwestern University, [email protected]