How Venture Capital Thwarts Innovation

22-Mar-2005 5:00 PM EST

IEEE Spectrum Magazine

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Newswise — Venture capital lights fires under scrappy and ambitious start-ups. It can help bring great new ideas to market, some of which go on to disrupt entrenched industries, spawn entirely new ones, and perhaps even change the world. In theory, venture-capital-backed start-ups are the best engines of innovation.

But are they in fact? With venture capital funding an order of magnitude greater today than it was in the early 1990s, now is an excellent time to ask: has all that funding during the past decade brought more innovation or less?

In an article in the April issue of IEEE Spectrum, Bart Stuck and Michael Weingarten explain how venture capital funding works, and proffer four reasons why it produces so little genuine innovation. They are managing directors of Signal Lake Management LLC, an early-stage telecom venture-capital fund based in Westport, Conn., and Boston.

As venture capitalists themselves, the authors reserved judgment until they could accumulate and analyze the data from what has been the most frenzied decade in technology history. They examined 1303 electronic high-tech initial public offerings for a 10-year period ending in 2002, and sorted out those that were VC-funded and compared them to those that were not, rating them on a scale of 1 to 5.

What they found shocked them. Overall, the level of innovation during that decade was surprisingly low. Even more dismaying, it did not correlate well with VC funding: the level of innovation actually dropped sharply after 1996, even as venture funding was going through the roof.

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