The Deregulated VC Boom

• In Event: Reconfiguring State–Market Relations in Contemporary Capitalism

Abstract

Why did venture capital investment surge in the decade following interstate banking deregulation, precisely when bank credit became more accessible to small firms? Standard substitution logic predicts the opposite: cheaper bank financing should crowd out equity investment. This paper resolves the puzzle by shifting attention from demand to the supply-side ecology of financial intermediaries. Drawing on resource partitioning theory, we conceptualize entrepreneurial finance as a three-tier organizational field — large banks, community banks, and VC firms — competing over funding niches. Deregulation concentrates generalist banks and erodes the community bank sector, vacating relationship-intensive lending markets and releasing resources for specialist VC firms to occupy. Using county-level VC investment data from 1994 to 2005 and instrumenting banking structure with state-level deregulation timing in a two-stage least squares framework, we find that both greater top-5 bank concentration and declining community bank share independently increase VC fund entry and investment volume. Heterogeneity analyses show effects are strongest for private equity and buyout activity where bank-VC niche overlap is greatest and negligible for early-stage VC. These findings suggest deregulation shifted moderate-risk ventures from liquid bank debt to illiquid equity capital, concentrating systemic risk in ways that amplified the dot-com bust.

Authors

• Bo-Wei Hu, Princeton University

• Olav Sorenson, University of California-Los Angeles