Self-Selection and Advice in Venture Capital Finance

In nancing start-up \u85rms, venture capitalists carefully select among alternative projects, design incentive compatible \u85nancial contracts and support portfolio com-panies with value enhancing managerial advice. This paper considers how venture capitalists can induce self-selection among entrepreneurial \u85rms with di¤erent quali-ties and growth potential by designing appropriate contracts and o¤ering managerial support. We study the e ¢ ciency of the competitive market equilibrium with respect to the level and quality of entrepreneurship and the level of e¤ort by entrepreneurs and venture capitalists. We also provide comparative static results with respect to basic preference and technology parameters