Note: The observations are relative to average employment (normalized to 1) for VC-funded startups in the year of first VC funding, t=0.
Not every new business venture hits the big time; indeed, most begin small and stay small through their lifecycle. Critically, for the aggregate economy, most new firms also do not make breakthrough innovations that spur productivity growth beyond their business. What sets the game-changers apart from the pack? A number of factors can put a new venture on a path to growth, including the presence of a patent or a trademark, R&D activity, and initial firm size.
However, this research adds another factor to the mix: It turns out that venture capital (VC) backing during the early stages of a start-up is a key ingredient of firm success. More than that, the authors find that such firms are also key contributors to aggregate innovation and productivity growth; that is, these individual firms introduce technological advances that not only benefit the firms’ bottom line, but that also disperse into the broader economy.
Note: The observations are relative to the average patent stock (normalized to 1) for VC-funded firms in the year of VC funding, t=0.
Following are the key empirical observations of this research:
- Like all start-ups, VC-backed firms are subject to the slings and arrows confronting fledgling businesses—many fail and many remain small. However, VC-backed firms are much more likely to grow and attain “superstar” status than non-VC-backed firms. Further, such firms are increasingly dominating markets within their industries.
- The second and third points emphasize that the relationship between a VC and an entrepreneur matters—a lot. And those relationships do not begin randomly. It turns out that VCs select the most promising startups to support. The authors’ empirical analysis shows strong evidence of assortative matching between entrepreneurs and financiers (including banks and others); those firms with promising innovation and growth prospects are more typically funded by VCs.
- Further, not all VCs are created equal: those with more experience and with higher funding capabilities tend to ensure greater success for start-ups. Again, those start-ups backed by more experienced VCs engage, on average, in more innovative techniques. Moreover, as measured by patent citations, these more innovative technologies have the largest positive impact on the rest of the economy.
The authors’ empirical analysis revealed the following results:
- Employment at VC-funded firms grows, on average, by about 475 percent over the time the VC is involved with the firm, compared with employment growth of about 230 percent for non-VC-funded firms.
- Similarly, VC-funded firms experience much higher growth in patent stock: VC-funded firms’ patent stock grows by about 1,100 percent vs. about 440 percent for non-VC-funded firms.