Jerry Cao (Assistant Professor, of Finance Singapore Management University) and Po-Hsuan Hsu (Assistant Professor of Finance, University of Connecticut) recently looked at patent data for VC-backed firms in the U.S. from 1976 through 2005 to empirically examine the signaling effect of start-up firms’ patents on entrepreneurial performance and financing patterns of venture capitalists (VCs).
From their findings:
Not only does patenting play an important signaling role between VCs and entrepreneurs, but our results show that start-up companies’ patenting prior to any VC investment is credible by leading to higher IPO success rates. Accordingly, entrepreneurs tend to wait for patent filing before asking for VC money and tend to file more patents when the degree of information asymmetry is higher. Consequently, patenting start-up firms not only attract larger and more experienced VCs in first VC financing round, but also receive significantly larger amounts in first rounds or all rounds of investment, and experience longer investment incubation periods. All these findings are consistent with the signaling role of patents in equilibrium. Patent filing also helps to enhance entrepreneurs’ control in start-ups: new ventures with prior patents are significantly less likely to be acquired in trade sale than those without patents.