vc e patentes

8/4/2019 VC e patentes

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Paper to be presented at the DRUID-DIME Academy Winter 2009 PhD Conference

on

ECONOMICS AND MANAGEMENT OF INNOVATION, TECHNOLOGY ANDORGANIZATIONAL CHANGE

Hotel Comwell Rebild Bakker, Aalborg, Denmark, January 22 - 24, 2009

VC FINANCING AND PATENTING IN NEW TECHNOLOGY-BASED FIRMS: ANEMPIRICAL STUDY

Diego D'adda

Politecnico di [email protected]

Abstract:VC financing and patenting in new technology-based firms: an empirical studyDiego D'Adda Politecnico di Milano

Year of enrolment: 2007 Expected final date: [email protected]

The aim of this paper is to analyse empirically the impact of Venture Capital (VC) financing on the patentingactivity of new technology-based firms (NTBFs). In particular, we compare the patenting rates of VC-backedand non VC-backed NTBFs to investigate whether VC financing really spurs patenting activity of portfoliofirms. We further want to assess whether the typology of investors has a different influence on the patentingactivity of VC-backed firms.

Venture capital (VC) financing is generally considered by both academics and practitioners as a more suitablefinancing mode for NTBFs than bank loans. In fact, it is contended in the financial literature that this financingmode offers a fundamental contribution to the success of high-tech entrepreneurial ventures (see for instanceDenis 2004).

JEL - codes: D92, G24, O39


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** Corresponding author: Diego DAdda, Politecnico di Milano, Department ofManagement, Economics and Industrial Engineering, Piazza Leonardo da Vinci, 32,

20133, Milan, Italy. ph: +39-02-2399-3974; fax: +39-02-2399-2710. E-mail address:[email protected] .

VC financing and patenting in new technology-based firms: an empirical study

Fabio Bertoni, Massimo G. Colombo, Diego DAdda**Department of Management, Economics and

Industrial EngineeringPolitecnico di Milano

Abstract

The aim of this paper is to analyse empirically the impact of Ven-ture Capital (VC) financing on the patenting activity of new technol-ogy-based firms (NTBFs). In particular, we compare the patentingrates of VC-backed and non VC-backed NTBFs to investigate whether

VC financing really spurs patenting activity. We further want to assesswhether the typology of investors, i.e. Independent Venture Capitalists(IVCs) and Corporate Venture Capitalists (CVCs), has an influence onthe patenting activity of VC-backed firms. We expect the effect ofCVC financing to be greater than that of IVC financing, due to differ-ent objectives characterizing the two typology of investors. To testthese hypotheses, we consider a unique longitudinal dataset composedof 197 Italian NTBFs operating in manufacturing sectors. Samplefirms were established in 1980 or later, remained independent up tothe end of 2003, and are observed from 1994. To analyse the determi-nants of firm patenting activity, we estimate different panel data mod-els. The results show that Venture Capital financing positively affect

subsequent patenting activity and that VC-backed firms do not exhibitsuch a high patenting propensity before receiving VC. The findingsalso reveal that IVC and CVC financing does not seem to differentlyinfluence patenting propensity, but further investigation is necessarysince that these results could be determined by the dramatic decreasein the number of useful observation when distinguishing VC bysource.


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.Introduction

Since the seminal work by Jaffee and Russell (1976) and Stiglitzand Weiss (1981), the argument that there are frictions in capital mar-kets that make it difficult for firms to obtain external financing and

constrain their investment decisions has increasingly been gainingground in the economic and financial literature (see Fazzari et al. 1988and the studies mentioned by Hubbard 1998). New technology basedfirms (NTBFs) are those most likely to suffer from these capital mar-ket imperfections. In turn, the fact that poor access to external financ-ing may limit the growth and even threaten the survival of NTBFs isworrisome because of the key role these firms play in assuring dynam-ic efficiency and employment growth in the economic system (Au-dretsch 1995, Acs 2004).

The above arguments especially apply to bank loans (Carpenterand Petersen 2002). In fact, banks generally do not possess the compe-tencies required to evaluate ex ante and monitor ex post the invest-

ment projects proposed by young high-tech firms that lack a trackrecord. In principle, the above mentioned adverse selection and moralhazard problems can be alleviated through the recourse to collatera-lized loans (Berger and Udell 1998). Nonetheless most of high-techinvestments is in intangible and/or firm-specific assets that providelittle collateral value.

Venture capital (VC)1 financing is generally considered by bothacademics and practitioners as a more suitable financing mode forNTBFs than bank loans. In fact, it is contended in the financial litera-ture that this financing mode offers a fundamental contribution to thesuccess of high-tech entrepreneurial ventures (see for instance Sahl-man 1990, Gompers and Lerner 2001, Kaplan and Strmberg 2001,Denis 2004).

Nonetheless, whether access to VC financing fosters the innovativeactivity of portfolio companies is a matter of empirical test. Previousevidence, deriving mainly from industry level analysis (Kortum andLerner 2000, Tykvova 2000, Ueda and Hirukawa 2006), demonstratesa positive relation between venture capital financing and patenting

1 The term VC is referred here to equity (or equity-like) financingprovided by external investors to high-tech entrepreneurial firms in the earlystages of their life. It includes seed, start-up and expansion capital. Thesource of financing may be independent financial intermediaries, diversified

financial firms, and non-financial firms (i.e. corporate venture capital).


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activity. Fewer studies analyze the effect at firm-level and find mixedevidence (Engel and Keilbach 2002, Baum and Silverman 2004).

In this work we resort to a hand-collected 10 year long longitudinaldataset composed of 197 Italian NTBFs to analyze the effect of VCfinancing on firms patenting in the years that follow the first round offinancing. In addition, we distinguish VC-backed firms according towhether VC financing is provided by independent VC firms (i.e.IVC) or non-financial firms (i.e. corporate venture capital, CVC).2Italian NTBFs provide a very interesting testbed of the beneficial ef-fects of VC financing on portfolio companies as in Italy the VC indus-try is quite undeveloped and VC investors operate in a quite unfavora-ble environment. Sample firms were established in 1980 or later, sur-vived as independent firms up to January 2004, and are observed from1993 up to 2003. They operate in high-tech sectors of manufacturing.Most of them are privately held. In order to capture the effect of VCfinancing on firms innovative activity, we estimate econometricmodels that capture the propensity of the firm to patent.

The results of the estimates strongly support the view that VC fi-nancing has a dramatic positive effect on firms innovative activityeven though, contrary to our expectations, no difference arises be-tween IVC- and CVC-backed firms.

The paper is structured as follows. In the next section we surveythe literature on the effects of VC financing on firms performance;we also consider differences between IVC and CVC. In Section 3 wedescribe the sample of firms that are considered in the empirical anal-ysis. In section 4 we illustrate the empirical methodology. Section 5reports the results. Section 6 concludes.

2 In Italy US-style independent VC firms that exclusively focus onearly stage financing of high-tech start-ups are rare. So most firms includedin the IVC category operate both in the early stage and late stage equity capi-tal financing segments. Non financial firms invest in high-tech start-ups ei-ther directly or through affiliated subsidiaries. Both types of investment areincluded in the CVC category. Conversely, investments in high-tech start-upson the part of other financial intermediaries such as banks and insurancecompanies are almost inexistent in Italy. They are included neither in the IVC

nor in the CVC categories (while they are included in the VC category).


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.Literature review

In this section we review the literature on the effects of VC financ-ing on firms performance (Section 2.1) and, in particular, on firms

innovation (Section 2.2). Finally, in Section 2.3, we analyze how dif-ferent VC players (and in particular Independent Venture CapitalFunds and Corporate Venture Capital) might lead to dissimilar im-pacts on firms performance.

1. The value added of VC financing

The financial literature highlights several motives explaining whyaccess to VC financing stimulates the performances of invested com-panies.

First of all, intermediaries that provide external equity financing toNTBFs generally focus on specific industries (see among others

Gompers 1995, Amit et al. 1998, Bottazzi and Da Rin 2002). Due totheir sectoral specialization, these investors allegedly develop context-specific screening capabilities that make them capable to judge quiteaccurately the hidden value of entrepreneurial projects and the entre-preneurial talent of the proponents (Chan 1983, Amit et al. 1998).Therefore, they are able to deal effectively with the adverse selectionproblems that otherwise would prevent great hidden value firms fromobtaining the financing they need.3

Second, VC firms are no silent partners (Gorman and Sahlman1989, Barry et al. 1990). On the one hand, they actively monitor thebehavior of entrepreneurs of portfolio companies. For instance, Kap-lan e Strmberg (2003) show that VC firms control 41.4% of the seats

of the boards of directors of the US VC-backed companies that are

3 A rich stream of the empirical literature has examined the criteriathat VCs use to select portfolio companies. Generally these studies rely oninterviews with VCs and other qualitative methodologies (Tyebjee and Bruno1984, Mac Millan et al. 1985, 1987, Hall and Hofer 1993, Fried and Hisrich1994, Murzyka et al. 1996, Zacharakis and Meyer 1998, 2000, Sheperd et al.2000). For an analysis of the selection criteria of VCs based on documentedevidence see Kaplan and Strmberg (2004). It is important to emphasize thatVCs may prove unable to separate talented entrepreneurs from other entre-preneurs. Under these circumstances, NTBFs with great hidden value will beunlikely to obtain VC financing due to adverse selection problems (Amit et

al. 1990).


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considered in their study; in 25% of the companies they control themajority of board seats. Bottazzi et al. (2004) document that in 66% ofthe deals of European VC firms they consider the VC investor sat onthe board of the investee company. Moreover Lerner (1995) highlightsthat the number of VC investors who sit in the board of directors ismore likely to increase between two financing rounds if during thesame period the top manager of the participated firm is replaced, thatis in situations where monitoring is most important. On the otherhand, VCs make use of specific financial instruments and contractualclauses (e.g. stage financing) that protect their investments from op-portunistic behaviour on the part of entrepreneurs and create high po-wered incentives for them (Sahlman 1990, Gompers 1995, Hellmann1998, Kaplan and Strmberg 2003, 2004).

Third, VCs perform a key coaching function to the benefit of in-vestee firms (Gorman and Sahlman 1989, MacMillan et al. 1989, By-grave and Timmons 1992, Sapienza 1992, Barney et al. 1996, Sapien-za et al. 1996, Kaplan and Strmberg 2004)4. In fact, they provide

portfolio companies with advising services in fields such as strategicplanning, marketing, finance and budgeting, and human resourcemanagement, in which these firms typically lack internal capabilities.Accordingly, Hellmann (2002) documents that VCs favor the recruit-ment of external managers, the adoption of stock option plans, and therevision of human resource policies by invested firms, thus contribut-ing to their managerial professionalization. Bottazzi et al. (2004)show that European VC firms helped portfolio companies in recruitingoutside directors and senior managers in 40.8% and 48.4% of thedeals they analyze. Moreover, portfolio companies take advantage ofthe network of social contacts of VCs with potential customers, sup-pliers, alliance partners, and providers of specialized services like le-

gal and accounting services, head hunting services, and public rela-tions (Lindsey 2002, Hsu 2006).

Lastly, VC financing signals the good quality of a NTBF to thirdparties; therefore invested companies find it easier to get access toexternal resources and competencies that would be out of reach with-out the endorsement of the VC (Stuart et al. 1999). In accordance withthe existence of a certification effect, Megginson and Weiss (1991)find that VC-backed IPOs exhibit smaller underpricing than non VC-

4 Recent theoretical models on this issue are those by Casamatta

(2003), Inderst and Mller (2004), Repullo and Suarez (2004).


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backed ones that are matched by sector and IPO size.5 Moreover, Hsu(2004) suggests that NTBFs place considerable value on the certifica-tion effect and coaching services provided by high reputation inves-tors; accordingly, he shows that financing offers by VCs with highreputation are more than three times more likely to be accepted fromrecipient firms than other offers; in addition, these investors obtain adiscount on the purchase price of the participation ranging between10% and 14%.

Nonetheless, it is important to acknowledge that the agency rela-tion between the VC investor and the entrepreneurs of portfolio com-panies may engender conflicts, leading to a deterioration of the per-formances of these latter companies. In fact, entrepreneurs and exter-nal investors may have different strategic visions; disagreements mayabsorb the entrepreneurs effort and attention to the detriment of thepursuit of business opportunities (Dushnitsky and Lenox 2006). Evenif no conflict arises, the need of investors to monitor managerial deci-sions by the investor may increase bureaucracy and formalization of

decision processes, and hamper firms flexibility. Furthermore, asVCs are competent investors, they may be able to expropriate entre-preneurs of their innovative business ideas and exploit them also intheir absence (Ueda 2004). The associated appropriability hazardsmay induce entrepreneurs to take decisions that are detrimental tofirms performances.

2. The effect of VC financing on the innovation of portfo-lio companies: survey of empirical literature

A growing stream of empirical literature has analyzed the effects ofVC financing on the performances of investee companies. Here wefocus attention on the effects on innovative performances and patent-

ing activity.One of the first studies dealing with the impact of venture capital

on innovation is that one of Kortum and Lerner (2000). They analyzepatents data and venture financing across twenty manufacturing indus-tries between 1965 and 1992 in United States. They use a patent pro-

5 Wang et al. (2003) use the same methodology to study Singapore

IPOs and find similar results. Nonetheless, the literature is not unanimous onthis issue. For instance, Lee and Wahal (2004) analyse a large sample ofIPOs, more than a third of which are VC-backed. They differ from previouswork in that they control for the endogenous nature of VC financing (on thisissue see section 2.2); they highlight that underpricing is larger for VC-

backed firms.


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duction function at industry level, controlling for the arrival of tech-nological opportunities that could lead to a spurious relation betweenventure capital and patenting activity6. They find that VC does spurpatenting activity, even with more efficacy than traditional corporateR&D. They also conduct a firm level analysis between 122 VC-backed and 408 non VC-backed companies to control whether the ef-fect of VC derives only from change in patent propensity, i.e. to patentmore in lieu of relying on different appropriability mechanisms. Theresults suggest that VC-backed companies i) have patents that aremore frequently cited, i.e. their quality does not decrease, and ii) en-gage more in trade secret litigations than non VC-backed, i.e. theydont make less use of other innovations appropriability mechanismslike trade secrets.

In a similar study, Tykvova (2000) finds through a patent produc-tion function that venture capital has highly significant positive effecton patenting activity in a sample of ten industry sectors observed be-tween 1991 and 1997 in Germany. The effect of VC, in respect to cor-

porate R&D, seems to be lower than for Kortum and Lerner (2000),but Tykvova asserts that it could be underestimated due to the inclu-sion in the analysis of form of private equity financing different fromclassical VC.

Ueda and Hirukawa (2006) exploit the same methodologicalframework at industry level as well, extending data used by Kortumand Lerner (2000) up to 2001 to include also the NASDAQ bubbleperiod. Using patents as dependent variable they confirm Kortum andLerner (2000) results. However they argue that these results could beexplained by a different patent propensity between VC-backed andnon VC-backed companies, and that the use of total factor productivi-ty (TFP) growth, as a measure of innovative activity alternative to pa-

tents, may rule out this problem. They do not find support that venturecapital investments have a positive impact on productivity growth. Ina previous work, Ueda and Hirukawa (2003) address the causalityconcern between VC investments and innovations: they investigatewhether it is VC that spurs innovation or if it is an arrival of newtechnology that increases demands for venture capital by driving newstart-up firms. Using TFP as measure of innovation they find supportfor both of these hypothesis in computer and communication indus-

6 They use i) R&D expenditures to control for the arrival of technol-

ogical opportunities that could be anticipated only by economic actors at thattime and ii) a policy shift, that was unlikely to be related to the arrival of op-

portunities, in an instrumental-variable regression.


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tries, on the contrary they find a negative relation between VC andTFP growth in drugs and scientific instrument industries.

Unlike above mentioned studies that are conducted at industry lev-el, other scholars move to the firm level for a more in depth compre-hension of the relationship between venture capital and innovativeactivity and of the causality direction. Hellmann and Puri (2000) ana-lyze the type of financing, and its impact on product market behavior,of 173 start-up companies that are located in Silicon Valley. They findthat pursuing an innovator strategy7 positively affects the probabilityof obtaining venture capital financing; moreover VC financing reduc-es time to market especially for innovator firms, thus affecting its abil-ity to secure first-mover advantages.

Engel and Keilbach (2002) rely on a matched pair technique tostudy growth rates of employment and innovative output of a sampleof 142 German VC-backed companies that were established 1995 and1998. Focusing on the very early stage of venture capital investment,i.e. within one year since the foundation, they show with Probit esti-

mation that pre-foundation patenting behavior and human capital cha-racteristics do affect the probability of VC involvement. They thenresort to the propensity score method, based on the previous men-tioned estimation, to build their control sample; more precisely theyapply the nearest neighbor criterion with the additional constrain thattwin firms operate in the same sector and have been established in thesame year as the corresponding VC-backed firms. The test on the dif-ferences shows that the average number of patents is only weakly sig-nificant higher for VC-funded group in respect of the non funded con-trol group.

Baum and Silverman (2004) directly address the causality issue,i.e. whether venture capitalists really enhance innovation output and

patenting activity of investee companies or if the differences in inno-vation between VC-backed and non VC-backed companies can beexplained by the scouting ability of venture capitalists, that allowthem to select the more innovative firms. Their sample is composed of204 biotechnology start-ups in Canada. Relying on time series regres-sion techniques, they find that the amount of pre-IPO financing is po-sitively affected by patent applications and patents granted in the year

7 They measure innovator ex-ante strategy through interviews, tryingto capture if firms are introducing a new product or service that i) is not aclose substitute of a product/service already offered on the market, ii) is ex-pected to outperform product/services already offered in the market, or iii)

satisfies either of the two criteria above.


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before the financing, as well as by human capital characteristics andalliances. They argue that for biotechnology start-ups patenting is asignal of innovative capabilities and of the amount of probable futurereturns, given the strong appropriability regime surrounding biotechpatents. Furthermore they do not find support for the hypothesis thatpatenting activity, measured both by patent application and patentgranted, is positively related to the amount of VC financing in theprevious year.

To sum up, above mentioned studies are not unanimous as to thepositive effect of VC financing on firms patenting activity and to thecausality direction between the two. Industry level studies seem tofind a robust positive relation with patent activity (Kortum and Lerner2000, Tykvova 2000, Ueda and Hirukawa 2006) but not with anotherinnovation measure like productivity growth (Ueda and Hirukawa,2006), furthermore they find differences across different industries(Ueda and Hirukawa, 2003). At firm-level, studies show that patentingactivity positively affects VC involvement (Engel and Keilbach, 2002;

Baum and Silverman, 2004), but results of VC on innovation are con-troversial: Hellman and Puri (2000) and Engel and Keilbach (2002)find a positive relation, on the contrary Baum and Silverman (2004)do not find any significant influence.

Studies at firm level that rely on longitudinal datasets are rare, onlyBaum and Silverman (2004) estimate random effects panel data mod-els but they include lagged dependent variable among the regressors,that can be correlated with error term thus leading to distorted estima-tion, and moreover they do not resort to a distributed lags in order tocapture the influences of VC financing that go beyond the first year.Furthermore their sample is not cross sectorial, so their results maysuggest differences among different industries.

Another weakness of previous studies on venture capital financingis that they fail to take into account VC investors heterogeneity, thatmay moderate the subsequent effect on innovation. We will face thisissue in the next paragraph.

3. The role of the type of investor: IVC vs. CVC

Recently it has been argued in the literature that, especially in Eu-rope, there is great heterogeneity across VC investors (Bottazzi et al.2004). In turn, the different characteristics of VC investors differentlyaffect their behavior and the effect that VC financing has on the per-formances of portfolio companies. In this paper we focus attention on

the distinction between financing provided by independent financial


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intermediaries (IVC) and that provided by non financial firms (corpo-rate venture capital, CVC). As will be explained below, these two cat-egories of investors differ along several dimensions. As a result weexpect the effects on innovative performances of their presence asshareholders in the equity capital of portfolio companies to differ aswell.

First of all, IVC and CVC are likely to pursue different objectives.The aim of IVCs is to realize the greatest possible capital gain in theshortest possible time. For this purpose, they are interested in boostingthe growth of invested companies. Conversely, previous studies high-light that CVCs often pursue strategic objectives in addition to or evenin substitution of financial objectives (Chesbrough 2002, Dushnitskyand Lenox 2005a). In a pioneering work on CVC, Siegel et al. (1988)show that according to the surveyed parent corporations, exposure tonew technologies and markets is the most important motive for themto engage in CVC. Similarly, Ernst et al. (2005) document that CVCis used by large German firms for technology window purposes; in

fact, it allows parent companies to closely monitor the development ofpromising technological innovations related to their core business onthe part of young firms and then possibly to acquire them. In accor-dance with the view that CVC is mainly used by incumbent firms as atechnology learning device and it is not merely driven by financialobjectives, Dushnitsky and Lenox (2005a) while analyzing a largesample of US public firms observed over a 10 years period (1990-1999), show that CVC investment is mostly attracted by industrieswhich exhibit great technological ferment, weak protection of intellec-tual property rights, and an intermediate level of technology proximitywith the knowledge base of the corporate investor. Gompers (2002)highlights that in the USA, CVCs have increasingly oriented their in-

vestments towards industries that are related to the core business ofparent companies. Dushnitsky and Lenox (2006) find that CVC in-vestments creates value for the corporate investor, measured by thecontextual increase in the Tobins q, only if CVC is pursued for stra-tegic reasons (i.e. gaining a window on the novel technologies devel-oped by portfolio firms). Even more importantly for the purpose of thepresent work, Dushnitsky and Lenox (2005b) document that CVC in-vestments substantially boost the citation-weighted patent output ofthe corporate investor in the five years that follow the investment andthat this effect is more pronounced when the investor has both greatabsorptive capacity (Cohen and Levinthal 1990) proxied by the levelof R&D expenses, and an intermediate technology proximity with


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portfolio firms (see also Winters and Murfin 1988, Sykes 1986, 1990,Block and MacMillan 1993, Gompers and Lerner 1998, Chesbrough2000, 2002, Ernst and Young 2002). Dushnitsky and Lenox (2005b)results suggest moreover that different objectives lead to different in-vestment strategies, CVC financing is higher in industries characte-rized by low appropriability regimes due to their technology window-ing purpose8 (Dushnitsky and Lenox 2005a). In contrast whoever isinterested mainly in financial returns would look for investee firmsthat can appropriate of the larger part of returns from their innova-tions, thus increasing their value and financial returns of investors.

Second, as was explained in section 2.1, the alleged superior per-formances of VC-backed firms relative to their non VC-backed coun-terparts depend on the scouting, monitoring and coaching activitiescarried out by external investors and the certification effect engen-dered by reception of VC financing. We also mentioned that the agen-cy relation between the external investor and the entrepreneur maylead to inefficiencies. The extent of these positive and negative effects

on the innovation of portfolio firms is likely to depend on the type ofthe external investors and the different objectives they pursue (Hell-mann 1998).

Siegel et al. (1988) find that the strategic objectives of CVC inves-tors often diverge from those of the entrepreneurs of portfolio firms.This possibly leads to conflicts between entrepreneurs and CVC in-vestors that absorb entrepreneurs time and energy to the detriment offirm performances (Chesebrough, 2000). Appropriability hazards alsoare greater with CVCs than with IVCs, especially if the parent com-pany of the CVC operates in the same sector as the portfolio firm or ina closely related one (Block and MacMillan, 1993). Fear of expropria-tion may induce entrepreneurial firms with the most promising novel

technologies to look elsewhere for external financing.9

In addition,CVC may suffer from organisational deficiencies. Early stage financ-ing of high-tech firms is the core business of IVC firms, while it is anancillary activity for the parent company of CVCs. As a corollary,CVC investors are likely to benefit from learning by doing to a more

8 In weak intellectual property protection regimes, venture may notbe able to put a stop to knowledge spillovers to CVC investors, thus increas-ing returns from CVC investments (Dushnitsky and Lenox 2005a).

9 For the same reason, CVC investors may be disadvantaged in re-ducing information asymmetries relative to IVC investors, as high-tech start-ups looking for external financing may be less inclined to reveal proprietary

information (Dushnitsky 2005a).


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limited extent than IVC firms. It may also be rather difficult for CVCparent companies to design an incentive structure for managerial per-sonnel apt to attract highly qualified individuals (Block and Ornati1987). Hence the scouting, monitoring and coaching capabilities ofCVC investors are likely to be inferior to the those of IVC firms.

On the other hand, some empirical studies (Holmstrom 1989,Zwiebel 1995, Aghion et al. 1997, Czarnitzki and Kraft 2004) suggestthat firms controlled by managers have lower incentives to invest inR&D activities than companies controlled by the owners due to therisk aversion and the short-termism of managers, this is particularlyrelevant in case of an entrepreneurial NTBF involved in VC financing.Moreover, severe changes in internal control system may occur if VCsput more emphasis on financial rather than strategic control. This maystifle the incentives to innovate since it focuses more on short run ROItargets with less emphasis on long run projects (Hitt et al., 1996). Dueto the strict financial objectives, IVCs are likely to induct greaterchanges in management and internal control system of funded compa-

nies than CVC investors.Moreover, the presence of a CVC investor in the equity capital of ahigh-tech start-up may engender benefits that cannot be provided byIVC firms, with this leading to superior firm innovative performances.In fact, through the CVC invested firms may obtain access to the spe-cialised irreproducible resources and distinctive competencies of theparent company (e.g. distribution channels, brand, production capaci-ty, complementary technological competencies. See Block and Mac-Millan 1993, Dushnitsky 2004). In addition, portfolio firms can bene-fit from the network of industry-specific contacts with potential cus-tomers and suppliers of the parent company of the CVC investor. En-dorsement by a highly reputed firm also is very valuable and may help

portfolio firms establish business relations with third parties (Stuart etal. 1999, Maula 2001, Maula and Murray 2001).

To sum up, whether CVC financing has greater beneficial effectson portfolio firms than IVC financing is controversial. As far as weknow, no previous study has analysed differences between the effectsof IVC and CVC financing on firms patenting activity.


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.The sample

In this paper we use a unique, hand collected longitudinal da-taset relating to a sample composed of 197 Italian NTBFs that are ob-served over a ten years period (1993-2003) and operates in manufac-

turing sectors. Most sample firms are privately held. They were estab-lished in 1980 or later, were independent at founding time and haveremained so up to the end of 2003 (i.e. they are not controlled byanother business organization even though other organizations mayhold minority shareholdings). They operate in the following high-techsectors in manufacturing10: computers, electronic components, tele-communication equipment, optical, medical and electronic instru-ments, biotechnology, pharmaceuticals, advanced materials, robotics,process automation equipment.

The sample of NTBFs was extracted from the 2004 release of theRITA (Research on Entrepreneurship in Advanced Technologies) da-tabase. Developed at Politecnico di Milano, RITA is the most com-

plete source of information on Italian NTBFs. It was created in 2000and it is updated every two years. The development of the databasewent through a series of steps. First, Italian firms that complied withthe above mentioned criteria relating to age and sector of operationswere identified. For the construction of the target population a numberof sources were used. These included lists provided by national indus-try associations, on-line and off-line commercial firm directories, andlists of participants in industry trades and expositions. Informationprovided by the national financial press, specialised magazines, othersectoral studies, and regional Chambers of Commerce was also consi-dered. Altogether, 1,974 firms11 were selected for inclusion in the da-tabase. For each firm, a contact person (i.e. one of the owner-managers) was also identified. Unfortunately, data provided by offi-cial national statistics do not allow to obtain a reliable description ofthe universe of Italian NTBFs.12 Second, a questionnaire was sent to

10 In the total sample extracted from the 2004 release of RITA thereare 550 firms operating in high-tech sectors in manufacturing and services.We decided to consider only the 197 manufacturing firms in this study be-cause the dependent variable is based on patent that doesnt seem to be a va-lid indicator of innovative output for service firms.

11 Operating both in high tech sectors in manufacturing and services.

12 The main problem is that in Italy most individuals who are defined

as self-employed by official statistics actually are salaried workers with


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the contact person of the target firms either by fax or by e-mail. Thefirst section of the questionnaire provides detailed information on thehuman capital characteristics of firms founders. The second sectioncomprises further questions concerning the characteristics of the firmsincluding access to external equity financing, the identity of externalinvestors, and the evolution over time of firms employees and sales.Lastly, answers to the questionnaire were checked for internal cohe-rence by educated personnel and were compared with and supple-mented by published data (i.e. data provided by firms annual reportsand financial accounts) when they were available. In several cases,phone or face-to-face follow-up interviews were made with firmsowner-managers. This final step was crucial in order to obtain missingdata and ensure that data were reliable.13

The total sample consists of the 550 RITA firms that returned thequestionnaire. 2 tests show that there are no statistically significantdifferences between the distributions of the sample firms across indus-tries and the corresponding distribution of the population of 1,974 RI-

TA firms from which the sample was drawn (2(4)=1.085).The sample is large and as will be shown in section 4 quite hetero-geneous. Note, however that there is no presumption here to have arandom sample. First, in this domain representativeness is a slipperynotion as new ventures may be defined in different ways (see for in-stance, Birley 1984, Aldrich et al. 1989, Gimeno et al. 1997). Second,as was mentioned above, absent reliable official statistics, it is verydifficult to identify unambiguously the universe of Italian NTBFs.Therefore, one cannot checkex-postwhether the sample used in thiswork is representative of the universe or not. Third, as in most pre-vious studies, only firms having survived up to the survey date couldbe included in the sample. In principle, attrition generates a sample

selection bias that may distort the estimates. Some authors (see forinstance Manigart and Hyfte 1999) argue that the likelihood of bank-ruptcy of VC-backed firms may exceed that of their non VC-backedcounterparts. Under these circumstances lack of control for firms that

atypical employment contracts. Unfortunately, on the basis of official datasuch individuals cannot be distinguished from entrepreneurs who created anew firm.

13 Note that for only 3 firms the set of owner-managers at survey datedid not include at least one of the founders of the firm. For these firms infor-mation relating to the human capital characteristics of the founders waschecked through interviews with firms personnel so as to be sure that it did

not relate to current owner-managers.


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ceased activity would result in an upward bias of the effect of VC fi-nancing on firms growth. Conversely, suppose that more innovativefirms are more likely to become the target of an acquisition, loose in-dependence and exit the sample. Therefore, if VC financing spurredfirms patenting activity, the resulting sample selection bias wouldlead to a downward bias in the estimates. As a matter of facts, it isvery difficult to control for the selection bias. In order to check its ex-tent, we focused attention on the RITA 2000 sample. This sample iscomposed of 401 NTBFs (see Colombo et al. 2004) out of which 31where VC-backed at the beginning of year 2000. We examined theexit rate of these firms in the 2000-2003 period due to bankruptcy. 4VC-backed firms ceased activity in this period representing 12.9%.The corresponding percentages for non VC-backed firms is fairlyclose (12.2%). A

2 test shows that the difference between the twovalues is not statistically significant at conventional confidence level.Therefore, while it is fair to acknowledge that our sample suffers froma survivorship bias, we are quite confident that this does not greatly

influence the results of the estimates that will be illustrated in the fol-lowing sections.To sum up, the sample analysed in this work has several strengths

in comparison with previous studies. As far as we know this is the firststudy that relies on a large longitudinal dataset relating to privatelyheld NTBFs to distinguish the effects on firms innovative activity ofIVC and CVC financing. Second, Italy has a bank-based financial sys-tem and the VC industry is quite undeveloped (Bertoni et al. 2006).Hence, Italian NTBFs offer an interesting testbed of the alleged posi-tive effects of VC financing on firms performance even in an adverseenvironment.

Table 1 shows the sectoral distribution of the whole sample, of VC

backed firms (further distinguished by the identity of the investor,namely IVC and CVC) and of firm patenting at least one during theperiod of observation. Out of the 197 firms that are considered in thiswork, 22 obtained VC financing (i.e. 11.17%). Biotechnology, phar-maceutics exhibit the greatest share of VC-backed firms (18.18%),ICT manufacturing shows a lower percentage (11.38%), while firmsthat operate in robotics and automation are those that are less likely toobtain VC financing (7.69%).


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Table 1 - Distribution of sample firms by industry, typology of investors,

and patenting activity

Industry

Number of

firms

Total VC-

backed

firms

IVC-

backed

firms

CVC-

backed

firms

Total

Patenting

N % N % N % N %

ICT manufactur-ing 123 14 11.38 7 5.69 6 4.88 21 17.07

Biotechnology &

Pharmaceutics 22 4 18.18 1 4.55 2 9.09 6 27.27

Automation &

Robotics 52 4 7.69 1 1.92 1 1.92 3 5.77

Total 197 22 11.17 9 4.57 9 4.57 30 15.23

Table 1 highlights the geographical and sectoral distribution ofIVC- and CVC-backed sample firms: IVC- and CVC-backed firms areequal in terms of number and similar in terms of sectoral distribu-tion14. Table 1 also shows the sectoral distribution of number of firms

which apply and are granted at least one patent during the observationwindow. The average number of firms patenting is 15.23% with somesignificant difference across sectors: firms in Biotechnology andPharmaceutics are the most likely to patent (27.27%) while the oppo-site happens for firms in Robotics and Automation (5.77%).

As a preliminary evidence of the relationship between VC and pa-tenting it is interesting to check whether the likelihood to patent isequal between VC-backed and non VC-backed firms. Table 2 showsthat of the 175 non VC-backed firms 154 do not patent in the periodunder analysis while this happens for only 13 out of the 22 VC-backedfirms. The difference between the two distributions is statistically sig-

nificant (2=17.31). Moreover, among the 9 VC-backed patenting

firms only one deposited a patent before being invested by VC. Thissuggests that the increase in patenting activity of VC-backed firmsoccurs after the investment.

14 Of the 20 VC-backed firms, 4 are neither IVC- nor CVC-backedsince they receive financing from financial intermediaries (e.g. banks) or

non-independent (e.g. Public) VC funds.


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Table 2 Venture Capital financing and patenting activity

Non-VC-backed VC-backed Total

Not-patenting 154 13 167

Patenting 21 9 30

Total 175 22 197

Note however that this results do not check for firm-specific cha-racteristics (individual heterogeneity) that are likely to affect both thelikelihood to obtain VC and the patenting activity; such features canbe both observable (e.g. the sector in which they operate) or unob-servable (e.g. the quality of their R&D). Thus a more systematic anal-ysis is needed, as shown in the next section.


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.Methodology

In this work we study the relationship between innovative activity(measured as patenting) and VC financing.

We estimate two panel-data models to capture firms patenting ac-

tivity. Table 3 shows the dependent and explanatory variables in-cluded in the models.

Table 3 Dependent and explanatory variables of patenting activity

Variable Description

N. patents(t)

Number of patent applications of thefirm which are later granted by the pa-tent office

N. patents(t)>0

Dummy variable equal to 1 whenfirm applies for at least one patent inyear t

Patent stock(t-1)Firms patent stock in year t com-

puted as # patents(t-1)+0.85 Patentstock(t-2)

Employees(t-1)

Logarithm of the size of the firm att-1 measured by the number of em-ployees (including owners that have anactive role in the management of thefirm)

Age(t) Logarithm of firms age

VC-backed(t-1)

Dummy variable equal to 1 if firmreceived VC financing in or before year

t-1

IVC-backed(t-1)

Dummy variable equal to 1 if firmreceived IVC financing in or beforeyear t-1

CVC-backed(t-1)

Dummy variable equal to 1 if firmreceived CVC financing in or beforeyear t-1

The first two variables shown in Table 3 ( N. patents(t), N. pa-tents(t)>0) are the dependent variables of the econometric models thatwe estimate.N. patents(t) measures the number of patent applicationsof the firm in year twhich are later granted by the patent office. We


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estimate the conditional distribution ofN. patents(t) using a Popula-tion Averaged Generalized Estimating Equations (GEE) Logit modelwith Exchangeable correlation structure. Second, we estimate a Popu-lation Averaged Generalized Estimating Equations (GEE) NegativeBinomial model with Exchangeable correlation structurewith depen-dent variable N. patents(t)>0, that is a dummy variable equal to 1when firm applies for at least one patent in year t.

Control variables include measures of size and age alongside firm-specific effects (capturing time-invariant individual heterogeneity) andyear dummies (capturing time-variant common effects). Moreover weinclude in the regressions a variable that measures firms patent stock,Patent stock(t), and that captures, at least partially, unobservable hete-rogeneity between observations (see Blundell et. al. 1995). Previousstudies examining patenting rates have used similar measures (Ahujaand Katila 2001, Dushnitsky and Lenox 2005b). To test the effect ofVC on patenting activity we include a dummy variable, VC-backed(t-1), which is equal to 1 if firm received VC financing in or before year

t-1. Similarly we discriminate the effect of different types of VC re-placing VC-backed(t-1) with two dummy variables which capture re-spectively IVC, IVC-backed(t-1), and CVC, CVC-backed(t-1). To as-sess the difference between the effect of this two sources of VC wetest, in each of the three regressions, the null hypothesis of the twocoefficients being equal.


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.Results

Table 4 shows the results for the two econometric models analyz-ing the relationship between patenting activity and Venture Capital.

Table 4 Effect of Venture Capital on patenting activity

N. Patent apps(t) N. Patent apps(t)>0

Patent stock(t-1) 0.1185 (0.0608) * 0.4507 (0.12) ***

Employees(t-1) 0.5818 (0.2067) *** 0.5723 (0.2014) ***

Age(t) 0.0288 (0.3267) -0.1716 (0.2873)

VC backed(t-1) 1.3892 (0.5549) ** 1.2435 (0.4095) ***

Year dummies Yes Yes

Firm effect Yes Yes

Model Negative Binomial Logit

Observations 1314 1314

Groups 195 195

Note: ***, ** and * denote respectively significance level below 1%, 5% and10%. Negative Binomial and Logit regressions are estimated using GEE with exchan-geable correlation structure. All models are Population Averaged. Standard errors inbrackets.

In each model the coefficient associated to VC backed(t-1)is posi-tive and significant. When an average firm receives VC its patent-ing activity (measured as Number of patents applied and likelihood ofapplying for a patent) increases significantly even when controllingfor time-invariant heterogeneity and common exogenous shocks.

Table 5 shows the results for the three econometric models analyz-

ing the relationship between patenting activity and different sources ofVC, namely IVC and CVC. We do so by splitting the VC backed(t-1)dummy variable in two separate dummies that differentiate IVC andCVC-backed firms, respectively IVC backed(t-1) and CVC backed(t-1).

Table 5 shows that, overall both IVC and CVC have a significanteffect on firms patenting activity. However, contrary to our expecta-tions, their effect does not differ significantly: in both regression wecannot reject the hypothesis that IVC and CVC coefficient are equal.


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Table 5 Dependent and explanatory variables of patenting activity

N. Patent apps(t) N. Patent apps(t)>0

Patent stock(t-1) 0.111 (0.0832) 0.4617 (0.1185) ***

Employees(t-1) 0.6322 (0.2254) *** 0.6083 (0.2143) ***

Age(t) -0.0899 (0.3233) -0.2303 (0.2865)

IVC backed(t-1) 1.2805 (0.6577) * 1.2866 (0.4732) ***

CVC backed(t-1 1.5818 (0.6522) ** 1.168 (0.5476) **

Year dummies Yes Yes

Firm effect Yes Yes

Model Negative Binomial Logit

Observations 1314 1314

Groups 195 195

2(IVC=CVC) 0.13 0.04

Note: ***, ** and * denote respectively significance level below 1%, 5% and10%. Negative Binomial and Logit regressions are estimated using GEE with exchan-geable correlation structure. All models are Population Averaged. Standard errors in

brackets. Last row reports the 2 value of the Wald test on the null hypothesis thatIVC and CVC coefficient are equal.


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.Conclusions

In this work we analyze the effect of VC on innovative activity us-ing firm-level data on a sample of 197 manufacturing Italian NTBFs.We find significant evidence that VC increases firms innovative ac-

tivity measured by patenting. Firms propensity to patent increase sig-nificantly after they receive VC financing. Notably VC-backed firmsdo not exhibit such a high patenting propensity before receiving VC.We also analyze whether the identity of the VC matters, and IVC andCVC have different effect on firms innovative activity. Interestingly,previous evidence on Italian NTBFs showed that IVC-backed firmsgrow significantly more and are less financially constrained than theirCVC-backed counterparts. However no difference between IVC andCVC is found relative to their effect on patenting: we cannot reject thenull hypothesis that the two sources of VC do not differ to this extent.It should be pointed out that when distinguishing VC by source thenumber of useful observation decreases dramatically. Future research

will be aimed at extending the sample to a larger number of NTBFs,thus allowing more robust estimates on the differential effect of IVCand CVC.


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