A new theoretical model of government backed venture capital funding

Abstract

Government involvement in the venture capital (VC) market has become an important catalyst of the entrepreneurial ecosystem of young and innovative firms. There is an extensive literature describing the VC model, but the models of its government backed variants are not comprehensively discussed. The article focuses on the model of purely government backed venture capital (GVC) and hybrid venture capital (HGVC). The conclusion of this article is that, by the logic of their models, GVCs are destined to underperform than private VCs. Many articles see HGVCs as a step forward compared to GVCs, as they involve private participants. The novelty of the current article lies in bringing out the drawbacks deriving from the system of hybrid venture capital funding by creating a complex theoretical framework of the HGVC model. We show that due to the crowding in of private participants, this scheme creates a two-goal system where the private profit maximising interests conflict with the economic policy goals. The complex system of HGVC is exposed to increased moral hazard issues that might lead to higher distortions than GVC. The conclusions are especially relevant in the case of developing industries.