How Venture Capital Thwarts Innovation

Abstract

Venture capital funding has increasedtwelve-fold over the last decade. This essay examines whether this fundingactually resulted in a decrease in the amount of technological innovations.Only companies with fundamentally new technologies were considered for thisstudy. Data consisting of 823 electronic high-tech initial public offeringsfrom 1992-2002 was obtained from the New York Stock Exchange andNASDAQ. Findings reveal that the number of firms producing technically fundamentalinnovations for that period was unexpectedly low, anddecreased steeplyafter 1996, even though the amount of venture funding continued toincrease. This trend is attributed to the risk aversion of venture capitalists.Venture capitalists generally tend to invest in multiple companies, allottingeach firm a time limit to return the investment made on their product. Venturecapitalistsalso tend to consider the business perspective of a projectmore significantly than the technical aspect, and invest according to economiccycles. It is concluded that the redistribution of venture funds couldpotentially induce a greater level of fundamental innovation. (SRY)

Keywords: Experimental/primary research, Firm financing, Startups, Venture capital, Technology innovation, Business cycles, R&D, Risk orientation