How Resilient is Venture-Backed Innovation? Evidence from Four Decades of U.S. Patenting

Abstract

Despite theoretical predictions to the contrary, corporate innovation is strongly pro-cyclical. In this paper, we compare innovation in the economy as a whole to that of firms backed by venture capital (VC), a source of capital associated with the most impactful young firms. We show that (1) patents filed by VC-backed firms are of significantly higher quality and economic importance than those in the broader economy, (2) venture-backed innovation is even more procyclical than innovation in general, and (3) that the deterioration of venture innovation in downturns appears driven by shifts in the types of startups that these investors finance. Our findings suggest that during recessions, venture capitalists perceive a need to conserve capital both due to demand for financing from struggling companies already in their portfolios and due to a more challenging fundraising environment. Therefore, they shift funding to less innovative firms that are closer to profitability. Rather than countering the pro-cyclicality of innovation in the broader economy, VC finance appears instead to amplify this pattern.