Venture Funded Entrepreneurship: the Impact on Wealth Inequality and Mobility

Abstract: This paper develops a novel model to study the role of venture capital (VC) in shaping US wealth inequality and mobility. In our model, households choose entrepreneurship entry and the source of external funds (bank or VC) based on project quality and household wealth. The model has three distinct features: 1) VC offers synergy with entrepreneurs through unobservable effort, while entrepreneurs incentivize VC through a profit-sharing contract. The non-contractible nature of VC effort implies expertise and funding must be combined if VC is involved. 2) VC is chosen endogenously only when project quality is high, making entrepreneurship depend more on project quality compared to wealth. 3) Internal capital of a business is more mobile for entrepreneurs compared to external funding, leading to a lower internal capital cost than external cost. This difference creates a strong saving motive for households, which is particularly relevant for wealthy entrepreneurs. The model can quantitatively match the income distribution and wealth distribution in the United States. When calibrated to occupational transitions and entrepreneurs? equity shares, the model generates that the VC sector: 1) increases the wealth share of the top 0.1% households by 1 percent points and the wealth share of the top 1% households by 2.1 percent points, 2) increases the probability that the households at the bottom 99% move to the top 1% after a generation by 1.4 percent points.