High-tech entrepreneurial firms’ innovation in different institutional settings. Do venture capital and private equity have complementary or substitute effects?

ABSTRACT

The paper explores whether venture capital (VC) and private equity (PE) investments have complementary or substitute effects on innovation in high-tech entrepreneurial firms in different institutional settings, focusing on different levels of capital market development, entrepreneurial culture, and intellectual property rights protection. Using a panel sample of 326 firms from 12 EU countries observed from 2009–2013, the empirical results show that the VC/PE effect on high-tech entrepreneurial firms’ innovation is stronger in countries with a less-developed capital market. This suggests that VC/PE investments play a substitute role. A partial substitute role of VC/PE is also detected in firms located in countries with a low entrepreneurial culture. However, no significant evidence emerged regarding the level of protection of intellectual property rights. The results are generally robust to various econometric specifications. The implications of the resulting framework, the study’s limitations, and opportunities for further research are also discussed.

KEYWORDS:

• High-tech entrepreneurial firm
• firm innovation
• venture capital (VC)
• private equity (PE)
• Europe

JEL:

• O30
• G24

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Indeed, by lowering transaction costs, a well-developed capital market allows capital to be allocated to the entrepreneurial ventures with high economic return prospects, thereby improving technological innovation and growth (Alfaro et al. 2004; Rajan and Zingales 1996; Carpenter and Petersen 2002). Furthermore, contextual social settings play a fundamental role in generating and absorbing innovation. In this regard, a widespread entrepreneurial culture is considered fundamental to enabling the success of innovative regional and national clusters (Stuetzer et al. 2017; Beugelsdijk 2010; Rutten and Boekema 2007). Further, the regulatory framework conditions have been recognised as another key determinant of firms’ innovation efforts, with a favourable IPR protection regime encouraging innovation (Blind 2012).

² The VC/PE effect on firms’ innovation, in countries with different levels of capital market development, entrepreneurial culture, and IPR protection, is not obvious. On the one hand, if VC/PE are substitutes, we may assume that VC/PE have more prominent effects in countries with weaker contextual drivers of innovation (by using their networks and resources to afford other kinds of spurs to entrepreneurial innovation). On the other hand, if VC/PE are complements, we may suppose that VC/PE have a more prominent effect on innovation in countries with stronger contextual drivers of innovation.

³ Young entrepreneurial firms need to look beyond local markets for funding and to innovate to compete in the global market (Cerrato and Piva 2012; Baumol 2010). Hence, they may seek out international institutional investors who operate in global markets and wish to invest in innovative firms. These arguments were confirmed by Corsi and Prencipe (2017) in their study of the effect of foreign VC/PE on innovation performance in 3,962 European independent SMEs. Chiefly for young, entrepreneurial European firms, the likelihood of attracting equity funding, either through foreign VC/PE or from public markets, increased in the late 1990s with the integration of European financial markets (Muzyka, Leleux, and Guegan 1998). Since then, seeking a global market of investors, young entrepreneurial firms may increase the likelihood of receiving positive evaluation and investment for their intangible assets, such as those related to R&D and innovation (Hursti and Maula 2007).

⁴ Norway is not an EU member but takes access to most of the union’s internal market through affiliation of the EEA.

⁵ The final dataset is available from the authors on request for research in the same or a related field.

⁶ For more information see: http://www.doingbusiness.org.

⁷ The marginal effects are estimated using standard Poisson regressions because the generalized linear models using IRLS and IV correction with Stata’s ‘qvf’ command do not allow the computation of marginal effect.