For Innovation Success, Choose a Corporate VC

The Night I Invented Crony Capitalism

When it comes to venture funding, backing by corporate venture capitalists — whether solely or in a syndicate — is far better for biotech start-ups than merely receiving support from independent VCs, according to research from Wharton’s Mack Institute for Innovation Management. With their expansive access to experts, market resources, infrastructure and other assets, corporate VCs are twice as good as independent VCs in propelling a start-up toward innovation success.

Gary Dushnitsky, a senior fellow at the institute and a professor at London Business School, and Elisa Alvarez-Garrido of Georgia State University, tracked the performance of biotech start-ups funded by both types of VCs in terms of the number of patents granted and scientific articles published. Knowledge@Wharton recently spoke to Dushnitsky about the implications of their research findings.

Knowledge@Wharton: We’re speaking today with Gary Dushnitsky, a professor at the London Business School and a former professor at Wharton. He’s also a senior fellow at the Mack Institute at Wharton, and he’s going to speak to us about an interesting topic, having to do with venture capital and how it’s used in the biotech industry. He will talk about the two kinds of venture capital — independent venture capital that funds startups, and corporate venture capital, often coming from pharmaceutical companies.

Gary Dushnitsky: I have indeed been studying … the landscape for VC finance, and specifically, some of the interesting changes we’ve seen, with large corporations investing hand-in-hand or side-by-side with the more traditional and independent venture capitalist. In one of the projects that I would like to focus on today, we specifically looked at what is the effect that this shift in the funding landscape has on biotechnology startups.

We have observed, as did many practitioners, that there has been a change in who provides capital to many biotech startups, from mostly being a traditional, independent venture capitalist over the last couple of decades, to large corporations — pharmaceuticals playing an increasingly [bigger] role.

From a startup perspective, it’s great news that there are additional or alternative sources of funding. What was really curious for me and my co-author, … who graduated from the Wharton School, was to understand not just what are the financial implications to biotech startups, but maybe equally important, what are the innovation implications. What does that mean when you receive funding from a different capital provider?

What we find is that corporate-backed biotechnology startups tend to exhibit higher innovation rates. They tend to do better in terms of their patenting output, as well as in terms of their scientific publication output — both at the time when they receive the investment, and maybe more importantly, four years after receiving the investment.

So we report evidence to suggest that the identity of the investor has significant implications on the startups’ innovation trajectory.

“Corporate-backed biotechnology startups tend to exhibit higher innovation rates.”

Knowledge@Wharton: Which, if any, of your conclusions surprised you?

Dushnitsky: One of the things that was interesting was to uncover the magnitude of the effect of the different investors…. We basically look at a couple of categories of startups and we divide them into innovation leaders — those biotechnology startups that tend to perform or tend to have patenting output and publication output above the median for their age group — and innovation laggards, which were basically the reverse of those startups, with below the median level of patenting and publication output.

What was surprising to see was that corporate investors tend to convert innovation laggards into innovation leaders within a four-year, post-investment [period] at a rate of 28%. That is about double the rate we have seen for independent VCs Twitter , who tend to convert innovation laggards into leaders at the rate of only 14%. This sheer magnitude of being affiliated with the corporate investor seems to be quite important.

And when we dig slightly further into that, we look at a couple of mechanisms that seem to be associated with this evidence. The first one of them is proximity, specifically, the ability to leverage knowledge, infrastructure, laboratories and so forth of the large corporation. The second one has to do with the ability to navigate clinical trials, compliance and other requirements that are important in taking the science and developing it into a drug that you and I can find in a marketplace.

Knowledge@Wharton: Could you tell us a little bit about the study’s design?

Dushnitsky: The findings of the report basically tracks back to two companion papers, one of them published in Nature Biotechnology a few years ago and another one that is forthcoming in Strategic Management Journal.

We basically looked at the population of U.S.-based biotechnology startups that have been active between 1990 and 2003 and we further tracked the patenting and publication performance seven years out. We specifically categorize those startups into four categories, looking at the performance of patenting and scientific publication. You would be anointed as an innovation leader if your patenting and publication track record is above [the median value] for your age cohort. And you would be denoted as an innovation laggard if you are below the median value both in terms of patenting and publication.

We then ask the following question, “Of those that are innovation leaders, what fraction of them have been funded by independent VCs and what fraction of them have been funded by corporate investors?” We looked at two points in time. What was their innovation profile at the time they received the investment, as well as and maybe more importantly, four years down the line once the investor effect have had a chance to play out.

What we find out is that there’s evidence of selection — corporates tend to invest in more innovative startups. But importantly, there’s also evidence of nurturing, affecting the innovation trajectory. Corporates are associated with a greater increase in innovation performance, in comparison to independent VCs.

Maybe one last important point to note is that oftentimes, those corporate investments are a part of a syndicate that involves independent VCs along with a large corporate investor.

“Corporate investors tend to convert innovation laggards into innovation leaders within a four-year, post-investment [period] at a rate of 28%. That is about double the rate we have seen for independent [VCs].”

Knowledge@Wharton: Specifically, what are some of the practical implications of your findings for businesses or consumers or regulators or other researchers?

Dushnitsky: We believe that there’s an important implication for at least three major groups. For entrepreneurial ventures, and especially founders of these biotechnology startups who are interested in offering a new therapeutic solution to the world, what we do is we help them navigate or make sense of this new funding landscape…. There are increasingly many corporate investors and … our study, to the best of my knowledge, is the first one to actually tell entrepreneurs and biotech founders what would be the innovation implication, what would the patenting and publication record look like if they were to be affiliated with one type of investor versus another, at least by looking at evidence from past biotechnology startups.

For investors, the implications are also quite important. A lot of the findings that we report here are based on syndicates that involve corporate and venture capitalists. And so, we call attention to the fact that there are real opportunities for different types of investors to walk hand-in-hand in syndicating and supporting research that is both financially lucrative and have a high innovation potential.

And then, finally, for policy makers, we think that there’s important evidence in terms of the role that relatively new capital providers play. It could be the case that startups affiliated with a large corporation might be seen as simply a corporate affiliate or a corporate division and might not be able to enjoy the same federal resources or other grants and so on. By showing that corporate venture capital-backed startups actually have significant innovation performance, we call policymakers to embrace those kinds of startups and investors as important parts of the biotech ecosystem.

Knowledge@Wharton: What misperceptions might your study dispel?

Dushnitsky: We have seen the presence of corporate venture capital progressing in multiple waves over the last century and this century. The first observation … [dates] back to the ’60s. We are now arguably in the fifth wave of corporate venture capital. And there’s a strong sense of what these kinds of investors can and cannot provide.

What our findings suggest is that at least in the world of life sciences, where you have long-standing corporate investors — GSK, Johnson & Johnson — as well as others that have been around for many years, such as Pfizer, Eli Lilly, Takeda and others, they seem to be an important part of funding biotechnology startups. And maybe increasingly so, many venture capitalists are rethinking the allocation of funds they have been putting into this sector.

“The identity of the investor has significant implications on the startups’ innovation trajectory.”

Knowledge@Wharton: What sets your research apart from other analysis conducted on this topic?

Dushnitsky: A lot of the work that we have seen in this space takes a look at the financial performance — how do different investors perform in terms of a financial metric such as return on investment, likelihood of an IPO and so forth. We believe these are extremely important parameters and we endorse much of the research, either by practitioners or academics.

However, we believe that in certain sectors, in life sciences in particular, it’s important to look not just at the financial performance of the startups, but whether or not they live up to the motto of actually being vehicles of new [ideas and approaches] to the world of innovation. At the end of the day, … all of us are looking for a new drug, new therapeutic solutions and so on.

We specifically focus not on the financial dimension, but the innovation dimension — patenting and publication of cutting-edge therapies and drugs and so on — in order to understand whether the changes in the funding landscape have an impact on innovation and not just the financial outcome.

Knowledge@Wharton: What will you look at next? How will you follow up your research?

Dushnitsky: We have at least a couple of ways in which we would like to push this forward. The first one is we will try to better understand the mechanism by which large pharmaceutical companies support the research and development or innovation outcome of biotechnology startups. We already have some evidence in terms of the structure of the corporate venturing unit, the relationship with the startups and how that affects innovation performance.

What I would also like to look at is basically, what other sectors — in which corporates are becoming increasingly important players — might pan out? Now when we look at the world around us, we see an explosion of corporate investors. [From retail to defense to fashion and high technology industries], we see corporates becoming more active in investing in startups.

I think that there are certain sectors that experience growth in corporate investment that might exhibit similar patterns [as biotech]. Specifically, in the automobile industry where the digital revolution — the connected car, autonomous driving and so forth — have led GM, BMW and many others to set up their own venture arm. Similar to life sciences, these industries exhibit long development time horizons, substantial capex investment and could have or is likely to exhibit similar patterns in terms of … contributions of these corporates in their support of startups within that sector.

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