Nº 22-39: Can the Government Be an Effective Venture Capital Investor?

In recent years, governments have allocated increasing capital to direct startup funding through Government-sponsored Venture Capital funds (GVC). In this paper, we study the role of GVCs in the venture capital market and their relationship with Private Venture Capitalists (PVC). Using European data, we find that GVCs invest consistently with their policy mandates, favoring specific industries, geographical areas, and firms with high innovation potential, but have lower average performances. These findings indicate that GVCs can identify innovative companies and prioritize positive externalities over profit maximization. We build an asset pricing model with heterogeneous preferences to study the role of GVCs in catalyzing PVC investments. We find that PVCs invest less in startups previously funded by GVCs, in line with empirical evidence. At aggregate level, GVC investments can crowd-in private ones if they focus on startups in VC hubs.