Working Paper | HBS Working Paper Series | 2012

Investment Cycles and Startup Innovation

by Ramana Nanda and Matthew Rhodes-Kropf

Abstract

We find that VC-backed firms receiving their initial investment in hot markets are more likely to go bankrupt, but conditional on going public are valued higher on the day of their IPO, have more patents, and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is true even for the most experienced VCs. Furthermore, our results suggest that the flood of capital in hot markets also plays a causal role in shifting investments to more novel startups—by lowering the cost of experimentation for early stage investors and allowing them to make riskier, and more novel, investments.

Keywords: venture capital; innovation; Market Cycles; Financing Risk; Business Startups; Venture Capital; Initial Public Offering; Investment; Innovation and Invention; Patents; Risk and Uncertainty;

Citation:

Nanda, Ramana, and Matthew Rhodes-Kropf. "Investment Cycles and Startup Innovation." Harvard Business School Working Paper, No. 12–032, December 2012. (Forthcoming, Journal of Financial Economics.)