Venture capital firms limits on innovation – patent investment and short time horizons means won’t invest in the patents of the aff

[Josh, Ramana, 2020, “Venture Capital’s Role in Financing Innovation: What We Know and How Much We Still Need to Learn,” Journal of Economic Perspectives Jstor, p.244, vol.34, No.3, acc. 7-19-24, GDI-LI]

The growth of the venture capital market in the past decade should not blind us to its limitations as an engine of innovation. Indeed, the changes delineated in the previous section will likely exacerbate these challenges. We lay out three distinct areas of concern about venture capital and its ability to successfully spur innovations. While the discussion must be inherently more speculative, given the relatively [[TABLE OMMITTED]] limited work done in this area, we suggest that these questions would benefit from scholarly attention in the years to come.

Despite the substantial growth of venture capital in the four decades since the revision of the “prudent man” rule for pension fund investment in 1979, venture capital touches only a tiny share of firms in the American economy. The estimated $450 billion currently under management by US venture capital firms (NVCA 2020) remains small in comparison to the several trillion dollars managed by the broader asset class of all US private equity, not to mention the total of all US public equities, estimated at $42.9 trillion at the end of 2018 (SIFMA 2019). Only a few thousand new firms each year raise institutional venture capital for the first time, as compared to over 600,000 annual business starts in the United States. Even among high-potential firms engaged in innovation, Farre-Mensa, Hegde, and Ljungqvist (2020) found that only 7 percent of firms that filed for a patent went on to raise institutional venture capital. These disparities are likely even more extreme in other nations, where the venture industry is less mature.

One reason for this is structural. Venture capital investors typically raise funds for a specific (usually a ten-year) period. This time frame implies that venture capitalists are naturally drawn to investment opportunities where the ideas can be commercialized and their value realized through an “exit” within a reasonably short period. Sudden market downturns, as occurred in 2000, 2008, and 2020, may disrupt plans to exit investments, creating more pressure to sell when market conditions permit, even if earlier than optimal for the firm. These constraints imply that venture capital investors often exit their investments well before growth opportunities are fully realized. As a result, they are often drawn to sectors with large uncertainty about an idea’s potential that can nevertheless be resolved quickly. What leads to variation in the degree to which uncertainty about the prospects of a young firm can be reduced quickly? An important element appears to be the nature of uncertainty about demand for the new product or service. Put another way, can uncertainty about the viability of the offering and the market demand be resolved quickly? Software and service businesses—which are typically based on proven technologies, often have short development times and can benefit from quick market feedback—are amenable to this approach. Also, as noted above, technological changes over the past two decades have made it quicker and cheaper to learn about demand for a new software business. By way of contrast, many other sectors like clean energy, new materials, and others are less amenable to such rapid learning. The widespread interest among venture capital investors in the few exceptions, such as biotechnology startups, is tied to the drug approval and reimbursement system that enables investors to project the market value of a new drug accurately if it is successful in passing through clinical trials (Janeway 2018).