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How Patents Affect VCs’ Funding Decisions? — Case of Early Stage Ventures

Güncelleme tarihi: 4 Kas 2019

*This article is the first part of a series on how patents affect VCs’ funding decisions. In the following series, we will look at impact of patents on receiving VC funding for startups located in US, Europe and Turkey respectively with case analysis.

Startups are always on the lookout for market opportunities to expand their scope of impact in the market and build a successful company. There are a number of ways of developing such a strategy: technological innovation, building a blue ocean, focusing on customer experience, differentiation and low-cost approach, internationalization etc.

Patents are strong indicators that show the product has a unique value and a solid R&D background.

In order to carry out these scaling-up strategies, startups need resources, i.e., funding. Funding options basically consist of VCs, CVCs, angel investors, government support and incentives. For startups to be qualified to obtain such funding depends on commercialization potential, business model, financial turnover rate, technology, management skills, technical capability, innovation potential, feasibility, go-to-market strategy and IP value. Patents are strong indicators that show the product has a unique value and a solid R&D background. They are a direct outcome of the inventive process, and more specifically of those inventions which are expected to have a commercial impact. They are considered as an appropriate indicator for capturing the proprietary and competitive dimension of technological change. [1]

Even though, as mentioned before, there are various reasons why funding authorities choose to invest in a startup, this article will focus on the effect of patents on funding decisions, particularly of VCs. Thus, patent information will be taken as statistical indicators to show to what extent they affect the investment decisions of VCs.

Patents and VC Investments:

Patents are considered as one of the quality signals for VC funding.

Entrepreneurs have to convince potential investors on the growth potential of their company. Since the quality of the venture is not directly observable, external parties base their decisions on tangible assets. Thus, VCs rely on quality characteristics to approximate a start-up’s quality before making investment decisions. In our case, the role of patents will be taken as quality signals for VC funding. Another study shows that VCs value patents more than angel investors, which suggests that startups interested in raising venture capital might anticipate VCs’ preferences and be more likely to patent than those targeting angel investors. [2]

"Start-ups that filed at least one patent prior to applying for VC funding obtained a 51.7% higher amount of VC funding than did start-ups that did not file."

Kauffman Firm Survey (2013) reports that only 8.8% of high-tech startups, which are those that most likely to try to raise VC funding, have patents. (Among non-high-tech startups, the fraction is reported lower at 2.2%.) VCs tend to provide financing over several financing rounds. In this way, VCs try to eliminate information asymmetries regarding the startup’s performance and potential. Patents have both a signaling and a protection function: VCs view patents as a quality signal in terms of firm’s technological advancement and innovation capabilities. In a study carried out by Z