Competition in the Venture Capital Market and the Success of Startup Companies: Theory and Evidence

Abstract

We examine the effect of a competitive supply of venture capital (VC) on the exits (IPO or M&A) of startups. We develop a matching model with double-sided moral hazard, and identify a novel differential effect of VC competition on the success of startups. Using VC data, we find evidence for this differential effect. For example, when the VC market becomes more competitive (HHI decreases from its mean 0.08 to 0.04), the absolute likelihood of success increases by 2.8 percent for startups backed by less experienced VC firms, but it decreases by 3.6 percent for startups backed by the most experienced VC firms.

Keywords: entrepreneurship, venture capital, matching, double-sided moral hazard, exit, IPO and M&A

JEL Classification: C78, D86, G24, L26, M13