Who Funds You, Baby? New Study Shows VCs Outpace Other Innovation Backers

These days, organizations across the board claim to be focused on innovation. But when you look at how well different types of entities responsible for bringing new products and services into the world actually do so, some are better than others.

The most obvious type of organization that helps launch new products is a venture capital firm, which funds entrepreneurs and often works with them to bring their concepts to market. Another is corporate venture capitalists, who typically work within a larger corporate structure and seek to acquire innovative startups that can be folded into the parent company. A third entity is government, which supports innovation by issuing grants for groundbreaking research and for early-stage development of entrepreneurial ventures.

Among those three flavors of funding partners, traditional venture capitalists (VCs) fueled the most innovation, according to a recent study by entrepreneurship researchers from the Stanford Technology Ventures Program (STVP), the entrepreneurship center in the university’s Department of Management Science & Engineering (MS&E).

Their study, “Who Takes You to the Dance? How Partners’ Institutional Logics Influence Innovation in Young Firms,” is published in the journal Administrative Science Quarterly. The study’s co-authors include STVP-affiliated faculty Riitta Katila and Kathleen Eisenhardt, both professors in MS&E. The lead author is Emily Cox Pahnke, an assistant professor of management at the University of Washington, and a graduate of STVP’s Ph.D. program.

“We attribute these differences to VCs having a closer advisor relationship with the venture,” said Pahnke, whose dissertation provided the data for this study. She added that traditional venture capitalists are driven by better-paced and more motivating milestones than either corporate VCs or government agencies.

The authors studied almost 200 ventures in the United States, over a 22-year period, that make minimally invasive surgical devices, counting which ones received the highest number of patents and FDA approvals. The ones that worked with VC firms performed the best, primarily because their professional norms and practices made them more nimble and nurturing funding partners than corporate VCs or government agencies.

Regardless of the type of funding partner — venture capitalists, corporate VCs or government agencies — all proved to be good at selecting innovative ventures and having valuable technical and commercial resources on hand. The problem, the researchers concluded, was that the latter two were less involved during the relationship.

Traditional VCs, especially those in boutique firms, are deeply engaged with the entrepreneurs they fund, serve as advisors and sit on the boards of their startups, the co-authors explained.

Corporate VCs, on the other hand, turned out to be less effective partners because the complex division of labor within corporations, and broader strategic goals, seem to hinder progress and slow the decision-making process.

Meanwhile, the entity with perhaps the most altruistic reasons for seeing society advance through scientific and technological innovations proved to be the least effective funding partner. The effort on the part of government agencies to be fair and treat all private ventures equally resulted in particularly passive relationships, cookie-cutter approaches and “one size fits all” resources, according to the study.

In the field of surgical devices, the primary government agency that funds firms is the National Institutes of Health (NIH), which issues grants to support both technical breakthroughs that advance science, and commercial innovations that can improve public health. However, despite the NIH’s immense technical and informational resources, they remain largely out of reach because of the agency’s hands-off approach.

“So, then the question becomes whether it should be the government’s role to support startup innovation,” said Katila, whose research is at the intersection of technology strategy and organizational learning.

Given how important innovation is for society, she admits that she and her co-authors were disappointed to see government not outperform the other types of funding partners. But on a positive note, Katila said that their findings can show the public sector how to be better backers of innovation by identifying what works best in the private industry.

The government is beginning to catch on: The U.S. Patent and Trademark Office recently opened a regional office in Silicon Valley to save entrepreneurs on the West Coast a trip to Washington, D.C. And over the last few years, several government agencies — including the NIH — have trained their scientists and researchers in the “lean startup” methodology that has fueled much of the current tech boom.

“Government and Silicon Valley have much to learn from one another to boost innovation,” Katila said.