Venture capital and corporate venturing not only provide capital, but also specialised advice, human resources, technological capital and monitoring. Thus, one could imagine that a match between technology startups and these investors can create value for both sides, besides social welfare gain through technology development and diffusion.
Moreover, the extent of value creation could be higher when the quality of match is better – when the quality of startups and the volume of funding is higher. Despite this, and like any interorganisational relationship, the startup-investor matching process is not free of tension, which reduces the likelihood and quality of the match. It is a well-established issue in organisation and strategy research that startups are deterred from such relations due to concerns about potential misappropriation of their resources by their investors.
Therefore, startups may hide their key technological information when collaborating with investors, resulting in information asymmetry – hidden information – between the investor and technology startup, known to be an obstacle in venture financing and referred to in the literature as “swimming with sharks”.
Strategic information withhold is significantly relevant for the case of CVC-startup matching. Unlike independent VCs that have the mission to finance and support a startup purely to maximise returns, CVCs have dual objectives. Besides sharing the mission of maximising a startup’s return, they invest to gain a window on new technology. This strategic objective is often claimed to be more important than a startup’s financial return.
The strategic objective to gain information from startups about new technological bets have made startups reluctant to collaborate with CVCs, especially those active in similar technological fields, and quick to hide key technological information. However, this behaviour may cause value creation and welfare losses.
Research shows that CVC investments create high values and are important sources of finance for the development of innovative technology startups. Moreover, due to their industry experience, ownership of advanced complementary resources and expert human capital, CVCs are likely to create higher value for startups compared with independent VCs. Matching with a CVC may increase the likelihood of success and eventual financial return for both startup and CVC.
Understanding how information asymmetry impacts corporate venture financing activity is pivotal in discussing remedies to these issues. But measuring such an effect is an empirical challenge.
Our study is an effort to measure the causal impact of information asymmetries on the likelihood and quality of CVC and startup matching, thanks to a change in US patent law in 1999. The American Inventor’s Protection Act (AIPA) as an exogenous shock, provides an exceptional and unique opportunity to answer the questions above, without endogenous concerns. As a result of AIPA, high-tech startups experienced a change in the dissemination of their technological information, which reduced information asymmetry significantly.
The shock was that the link between intellectual property and value appropriation was transparent. As a result, in these industries, startups lost their information advantage over CVCs. Our theoretical arguments discuss how the shock would impact the likelihood and the quality of the match in such industries. We theorise that as a result of this shock, CVCs face less-risky investments. And from the startup’s side, the tradeoff between receiving finance versus risk of misappropriation becomes much less relevant, since the information is already revealed. Thus we expect that the likelihood of CVC-startup matching will increase compared with VC-startup matches, and, conditional to that, the quality of matches should improve after the shock. More-over, with lower informational constraints for the CVC and misappropriation concern for the startup, we expect the match process to become smoother, resulting in a faster match formation.
To test our theory, we took a sample of 38,286 rounds of investment in 14,418 high-tech entrepreneurial ventures. We appreciated that endogeneity may be an issue. Hence by exploiting the exogenous shock we employed difference-in-difference methodology, using the industries hit by the shock as our treatment group. The results confirm our theoretical argument that informational disclosure increases the likelihood and quality of CVC-startup matching compared with independent VC-startup matches. Moreover, CVC-startup matching happens significantly faster compared with VC matches after the shock. In order to allay concerns about the robustness of our results, we used an extensive list of controls, alternative measures of dependent variables, subsampling and a placebo test.
These results still cannot conclude that a startup would be better off by revealing information to and collaborating with a CVC compared with an independent VC. However, as a first step, it provides unbiased evidence of the positive outcomes associated with such an action.
Extract from a paper published on Social Science Research Network