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

We study a model of entrepreneurs who compete for venture capital (VC) funding in a setting where the VC can only finance the best entrepreneurs because of limited capital. 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 an abundance of entrepreneurs competing for VC funding could lead to underinvestment in technology by entrepreneurs as the effort exerted by losing entrepreneurs is wasted. We then analyze under what conditions a greater number of entrepreneurs competing for VC funding would be better, and show how this depends on the shape of the distribution of entrepreneurs quality. The model also demonstrates that VCs could possibly increase their payoff by concentrating on a single industry.