Venture capitalists (VCs) not only finance but also add value to start-up companies. Advising firms is time consuming and creates a trade-off between intensity of advice and portfolio size. We jointly determine the optimal number of portfolio companies and the intensity of managerial advice. Diminishing returns to advice per firm call for a larger portfolio. With progressively increasing managerial effort cost, however, a larger number crowds out advice to each individual firm. As they receive less support, entrepreneurs request a larger profit share, making further portfolio expansion eventually unprofitable. Comparative static analysis shows how optimal portfolio size responds to venture returns and other parameters.

Venture capitalists, representing informed capital, screen, monitor and advise start-up entrepreneurs. The paper reports three new results on venture capital (VC) finance and the evolution of the VC industry. First, there is an optimal VC portfolio size with a trade-off between the number of companies and the value of managerial advice. Second, advice tends to be diluted when the industry expands and VC skills remain scarce in the short-run. The delayed entry of experienced VCs eventually restores the quality of advice and leads to more focused company portfolios. Third, as a welfare result, VCs tend to provide too little advisory effort and to invest in too few companies. Testable implications are also discussed.