Description
Abstract: This chapter presents a search model of venture capital, in which the number of successful matches of entrepreneurs and venture capitalists at any moment in time is a function of the number of entrepreneurs searching for funds, the number of venture capitalists searching for entrepreneurs, and the number of vacancies posted by each venture capitalist. The model is used to examine the implications of imperfect matching for the level of employment and the level of frictional unemployment. The optimal policy in this model involves correcting for inefficiencies created by entrepreneurs' employment decisions, VC companies' decisions in screening projects and advising entrepreneurs, and the occupational choices of individuals to become workers or entrepreneurs. The model shows that in the market equilibrium, the level of advice offered by VC companies is inefficiently low compared with the social optimum. Furthermore, the number of vacancies, the level of employment, and the number of potential entrepreneurs are generally either too low or too high relative to their socially optimal level. Policy to achieve the social optimum consists of a capital gains subsidy, an employment tax or subsidy, and an investment tax or subsidy.