It may not always be rocket science, but that doesn’t mean companies with scientific or technologically sophisticated innovations have an easy time raising capital. New academic research might lead one to wonder: Should TBED policy makers provide training for angel and VC investors that improves their understanding of critical tech - or continue to focus primarily on funding gaps and teaching founders to speak the language of VCs?
Working with tech-based startups often involves helping them navigate difficult funding environments and witnessing their struggle to secure the resources to move their technology and businesses forward. While funding headwinds are common for startups, those focused on cutting-edge technology development face barriers not encountered by their less tech-heavy peers. New peer-reviewed research by Andrea Fosfuria and Jay Prakash Nagar, published in Research Policy, examines more than 10,000 companies and identifies a predictable link between science-based startups and delayed funding.
Using PitchBook data on 25 years of U.S. startups founded between 1990 and 2015 and research publication citations in patent data, the researchers find that highly science-oriented startups experience statistically significant delays in VC funding. Not only do these companies take longer to raise capital than their less technologically innovative counterparts, but they also raise lower amounts at lower valuations and are less likely to see successful exits.
The data supports the core premise that there are highly innovative companies that, for a variety of complex factors, face market headwinds inhibiting their ability to address pressing and costly challenges. It also points to the importance of closing gaps and supporting these companies with the resources needed to capture investor interest.
The paper states that more patents are correlated to earlier VC funding, but that a significant number of highly scientific patents are linked to decreased funding. The takeaway for economic development practitioners is that protectable innovation is important, but that too much emphasis on technology, or perhaps more complex technologies, are challenged to draw investor interest. Is it the innovation, the form or the investor that is the problem?
The authors propose that some funding delays are driven by technical founders who emphasize scientific discovery over the market validation signals important to investors. They also state that the higher a firm’s scientific orientation is, the larger the gap is between technical and market data. From a TBED perspective, it could also be that additional technical validation is a prerequisite to generating robust and actionable market signals.
The article points out that timing of funding is a critical factor for business success and that delayed VC rounds can lead science-based startups to fail before they can complete market validation. The authors also highlight the importance of early VC support in building the business expertise and practices often missing from science-based teams.
The authors emphasize the importance of science-based startups developing credible market indicators. One strategy they suggest is expanding the team to include members with relevant business experience and utilizing contractual language that aligns incentives between technical founders and investors. A key takeaway from the paper is that proactively addressing market questions and providing evidence of business success is highly important for funding and business success.
The authors identify several policy implications relevant to TBED efforts. They state that it is important to address both the lower levels and delayed funding for science-based startups. One possible solution they suggest is blended grant and equity instruments like those provided by the European Innovation Council.
The research presented validates the anecdotal experience of many founders, investors, and economic development professionals working with highly technical startups. The authors’ policy recommendations are also generally in line with many economic development strategies. Do these findings align with your experiences, or do you have a different perspective? The SSTI Innovation Finance community is a venue to discuss many of the issues faced by TBED professionals across the county. If you are interested in joining the conversation, please register for our Community of Practice.
This page was prepared by SSTI using Federal funds under award ED22HDQ3070129 from the Economic Development Administration, U.S. Department of Commerce. The statements, findings, conclusions, and recommendations are those of the author(s) and do not necessarily reflect the views of the Economic Development Administration or the U.S. Department of Commerce.