Venture Capitalists in the Entrepreneurial Ecosystem and Fitness-reducing Competition
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Although the role of venture capital (VC) in entrepreneurship is undeniable, we address possible risks associated with the over-dependence of the ecosystem on VC firms. In particular, we examine whether the supply of VC promotes or undermines the creation of entrepreneurial value in a community even when VC firms serve as an effective selector of such value. With an agent-based model of entrepreneurship where entrepreneurs are uninformed of the capabilities of the potential business partners, we suggest that the local efficiency of VC firms in the matching process may lead to the information-cascade type of herding behavior among entrepreneurs, which undermines paradoxically the overall efficiency of the ecosystem. With this implication, we seek to contribute to the literature on entrepreneurship by highlighting the possibility that competition-promoting institutions may destabilize the market itself such that VC firms as the efficient selector of entrepreneurial opportunities may induce uninformed, non-VC-backed startups to imitate the investments of VC firms, thereby reducing the diversity of entrepreneurial activities and thus the stability of the entrepreneurial ecosystem.
Abstract
Although the role of venture capital (VC) in entrepreneurship is undeniable, we address possible risks associated with the over-dependence of the ecosystem on VC firms. In particular, we examine whether the supply of VC promotes or undermines the creation of entrepreneurial value in a community even when VC firms serve as an effective selector of such value. With an agent-based model of entrepreneurship where entrepreneurs are uninformed of the capabilities of the potential business partners, we suggest that the local efficiency of VC firms in the matching process may lead to the information-cascade type of herding behavior among entrepreneurs, which undermines paradoxically the overall efficiency of the ecosystem. With this implication, we seek to contribute to the literature on entrepreneurship by highlighting the possibility that competition-promoting institutions may destabilize the market itself such that VC firms as the efficient selector of entrepreneurial opportunities may induce uninformed, non-VC-backed startups to imitate the investments of VC firms, thereby reducing the diversity of entrepreneurial activities and thus the stability of the entrepreneurial ecosystem.
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