We need to be concerned about how the financial crisis will affect innovative activity in the United States and beyond; and in some critical technology sectors, larger enterprises could take a note from entrepreneurs. Scott Stern of Northwestern University's Kellogg School of Management, David Hsu of the University of Pennsylvania's Wharton School and Joshua Gans of the University of Melbourne's Melbourne Business School investigated how entrepreneurial startups chose to commercialize new technology. Commercializing can be competitive, with entrepreneurs placing products in markets themselves, and therefore developing or purchasing access to the infrastructure they need to bring products to market. This also means competing directly with established companies. Or commercializing can be cooperative, with entrepreneurs pursuing mergers or licensing agreements with established companies.
The researchers found that entrepreneurial companies were more likely to strike deals with established companies in industries in which it's expensive to get a product to market and difficult to challenge incumbents. For example, there are comparatively more licensing and acquisition deals among biotechnology and medical device companies because these startups have to invest in considerable regulatory competencies, along with specialized marketing skills.
Cooperative commercialization also allows larger corporations to draw from outside ideas, picking the most promising work at later stages, which means they can cut their most speculative research and developmental activities and rely on the smaller startup's research.
Companies take fewer risks during financial crises, which means that cooperative commercialization in certain industries will be less prevalent. Larger companies won't want to take a chance on the entrepreneurs. So even though the financial crisis only truly accelerated in the later half of 2008, the number of U.S. companies with venture capital backing that were acquired decreased almost 28% from the previous year. The collapse was starker on a quarterly basis. More than 70 acquisitions took place in each of 2008's first three quarters. Only 37 took place in the fourth. It seems that established companies -- and venture capitalists -- have been finding technology startups less attractive.
There are some industries in which established companies rely on entrepreneurial startups for the next generation of ideas. So even as the recession abates, there may not be a key stock of intellectual capital available. The government has mainly focused on making sure larger enterprises survive -- banks and auto companies, for instance. But it's worrisome that smaller companies are being overlooked in technologically dynamic industries. We'll need the creativity of technology startups to preserve economic growth beyond the next few years.
It's too simple to suggest bailouts for entrepreneurs. But it may be a time to renew efforts in programs that assist entrepreneurial technology companies. For instance, the Small Business Innovation Research grant program in the United States increases such companies' access to early-stage capital. Because, in the long run, the liquidity of our knowledge capital is just as important as the liquidity of our financial markets.
This article is adapted from “A Dearth of Exit Strategies,” by Joshua Gans, which appeared in the Spring 2009 issue of MIT Sloan Management Review. The complete article is available at http://sloanreview.mit.edu/smr"