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Sorting and Equilibrium Fund Size in The Venture Capital Market

Venture capitalists (VCs) add value to the projects they finance. In a matching model where VCs span their attention over multiple entrepreneurial projects, the entrepreneurs direct their search at different VCs. VCs' attention is diluted as their funds grow. Complementarities generate positive sorting over VC attention and project quality. Anticipating this, VCs raise excessively small funds. The entry of unskilled VCs feeds back into equilibrium sorting, increases returns of top-performing VCs - consistently with empirical evidence - and leads to a Pareto-improvement. In a multi-period extension, funds organized as limited partnerships emerge in equilibrium even when they are not the optimal configuration.