Networking as a Barrier to Entry and the Competitive Supply of Venture Capital

Abstract

We examine whether networks among incumbent venture capital firms help restrict entryinto local VC markets in the U.S., thus improving VCs bargaining power overentrepreneurs. We show that VC markets with more extensive networking among theincumbent players experience less entry. The effect is sizeable economically and appearsrobust to plausible endogeneity concerns. Entry is accommodated if the entrant hasestablished relationships with a target-market incumbent in its own home market. In turn, incumbents react strategically to an increased threat of entry, in the sense that they freezeout any incumbent that builds a relationship with a potential entrant. Finally, companiesseeking venture capital raise money on worse terms in more densely networked marketswhile increased entry is associated with higher valuations.