Abstract
Research Summary: We develop a two-step selection model between entrepreneurial ventures and venture capital (VC) investors in a thin VC market. The model predicts that in a thin VC market, the availability of VC reduces the propensity of firms to self-select into the market for VC (demand-side selection) but not the probability that firms entering the market for VC will receive financing (supply-side selection). We test these predictions using survey-based data on 190 new technology-based firms in Italy during the late 1990s and early 2000s. The empirical evidence supports the predictions of the model. Managerial Summary: Venture capital (VC) is an important ingredient of an environment that is conducive to the birth and the growth of entrepreneurial ventures, but VC markets are often highly local and thin in terms of participants. We show that the scarcity of VC supply may cause a drop in the demand for VC because entrepreneurs, anticipating that competition for VC money will be tough, will not seek VC in the first place. The more a market is thin, the more the demand-side selection is likely to become more important than the supply-side selection of VC investors. Demand-side selection may involve a significant number of otherwise good targets for VC investment, which will not be in the radar of VC investors. In turn, this may deter new VC investors from entering the local market, thus creating a vicious cycle that raises concerns for both policy makers and VC general partners.
