Venture capital investment selection: do patents attract investors?

Venture capital is appropriately referred to as risk capital. It is notorious for its high failure rate. Thus selection criteria used by venture capitalists (VCs) for screening and evaluating investment opportunities are of utmost importance. They define chances of success. Scholars have argued that tighter protection of intellectual property rights reduces expropriation risks and encourages venture capitalists to finance technology projects. Few empirical studies however have examined the influence of patented innovation on investment decisions by venture capitalists. This study seeks to address this specific knowledge gap in venture capital research and practice. It builds on resource-based view (RBV) theory which argues that technological innovation is a strategic resource of the firm that can provide competitive advantage and draws upon the concept of information asymmetry to model the interplay of signaling and screening and alleviate the risk of adverse investment selection. This research paper is based on matched data compiled from VentureXpertTM, DelphionTM and NBER/USPTO databases. The resulting unique and proprietary dataset consists of 1020 U.S. VC-backed IPO firms across 7 technology sectors and 16 Metropolitan Statistical Areas (MSAs) in the 20 years from 1980-2000. The relation between venture capital selection and the technological innovation of VC-backed firms is examined. As predicted by RBV theory technology firms engaged in patenting activity attracted more VC investors on their successful journey from initial selection to exit.