A Price Theory of Silicon Valley

I develop a model of Silicon Valley engineer labor and venture capital (VC) markets. Software engineers choose between joining an established software company or founding a venture-backed startup. In equilibrium, they are indifferent between entrepreneurship and employment. The model predicts equilibrium markets wages, the terms of VC investments (i.e., the fraction of equity retained by the entrepreneur) and the minimum “quality” of the ideas pursued by startups, as represented by the VC funding “standard”. This funding standard I inversely related to the number of new startups per period. When direct startup costs fall—e.g., as a result of technological advances or lowered interest rates—engineer wages rise and entrepreneurs can obtain better terms from VCs; VC funding standards drop, increasing the number of startups. Increases in the supply of engineers reduce wages, decrease retained equity and lower the VC funding standard. Increases in the supply of ideas raise wages, increase retained equity and raise the VC funding standard. Increases in demand in the product market for software raise wages, raise retained equity and lower the VC funding standard.