The Role of Venture Capital Investments for Innovation in Young Technology-based Firms

Financing is a crucial but scarce factor especially in technology-oriented industries where the risk of failure is high and information asymmetries are substantial, e.g. because the marketplace for the new and innovative products is unclear. Particularly young technology-based firms are often perceived to lack capital. Hence, debt investors may generally be reluctant to invest in this type of firm so that entrepreneurs often need to rely on equity financing, e.g. on venture capital (VC).

This paper tries to shed light into the link between venture capital financing and fims' innovation activities. We reflect innovation activities by using two different variables: Patent counts and an index on firm's innovativeness of the technology applied. The data set was generated by a computer-assisted telephone survey for which over 1,000 young firms in technology-oriented service and manufacturing sectors were called. The firms have been founded between 1996 and 2005. The data contains information on the characteristics of the founder team, the firm and innovation indicators.

Analyzing the role of VC for financing innovative young firms has to deal with potential endogeneity of VC financing. In order to account for endogeneity we use full-information maximum likelihood (FIML) methods which simultaneously handle the objective function and an endogeneity-correcting equation. We confirm that VC financing positively contributes to young firms’ innovation activities in high-tech industries.

Heger, Diana (2013), The Role of Venture Capital Investments for Innovation in Young Technology-based Firms, ZEW Discussion Paper No. 13-077, Mannheim.