The Organization of the Innovation Industry: Entrepreneurs, Venture Capitalists, and Oligopolists

Exit of venture-backed firms often takes place through sales to incumbents. We show that in such an environment, venture-backed firms have stronger incentive to develop basic innovations into commercialized innovations than incumbents, due to strategic product market effects on the sales price of the venture-backed firm. This will increase the price for basic innovations, thereby triggering more innovations by entrepreneurs. Consequently, a venture capital market implies that more innovations are created, and that these become better developed. Moreover, we show that to exist in equilibrium, venture capitalists must be more efficient, otherwise incumbents will preempt venture capitalists entering the market by acquiring basic innovations.