How does the IP system affect innovative entrepreneurship?

The acquisition and management of IPR are critical in helping firms transform their innovation potential and creativity into market value and competitiveness. This is particularly the case for new enterprises, as these rely heavily on exploiting intellectual capital in their business models.

Protecting an invention is only one of the many roles that IPR may play in innovative firms. Other functions that companies fulfill with IPR (OECD, 2011; Cohen, Nelson and Walsh, 2000) are:

The role of IPR in accessing external finance is particularly important, especially in the risk capital market (see IP and markets for finance). For knowledge-intensive start-ups, patents are often the only asset entitlement they can use to raise funding. The emergent secondary market for patents should facilitate entry by these firms by providing a salvage value for those that fail (Hall and Harhoff, 2012).

Shane (2001) also stresses that an effective IPR system allows entrepreneurs to have more time to grow their businesses before their ideas are imitated. For a new firm, time is crucial in order to collect funding, develop the supply chain and reach the market – all aspects in which incumbents have a competitive advantage. Furthermore, effective patent protection may allow a new firm to compete on the basis of differentiation rather than on the basis of costs. This is another a crucial asset for new ventures, since incumbent firms generally have a strong comparative advantage in producing at a lower cost.

On the other hand, Shane (2002) suggests that the efficiency of the patent system also positively affects the probability that an invention is licensed rather than directly commercialized by the inventor, as inventors often do not have a comparative advantage in technology commercialization. Since many licensees are incumbent businesses, patent licensing may ultimately reduce the entrepreneurship rate. However, an efficient patent system should also reduce the information asymmetry between the inventor and the licensee by expanding available information on the quality of the invention. This ultimately improves the efficiency of the licence market and increases royalties earned by the inventors. The author shows that these hypotheses hold true for a sample of academic inventors at the Massachusetts Institute of Technology during 1980-1996.

Recently, some scholars have stressed how the IPR system in the United States has become “sand rather than lubricant in the wheels of American progress” and needs a deep reform (Jaffe and Learner, 2004), while others go even further by arguing its gradual abolition (Boldrin and Levine, 2012). One of the main reasons for these criticisms is the growing trend of opportunistic patent litigations by non-practicing entities (NPEs) or large incumbent firms that have lost their innovative momentum. This activity imposes a de facto barrier to entry for new businesses that lack a large defensive patent portfolio, which in turn adds costs and uncertainty to their innovation. To the extent that there are economies of scale in the patent litigation process, opportunistic patent litigation may disproportionately affect small entrepreneurial businesses (see IP enforcement and litigation).

Helmers and Rogers (2011) analyse a sample of high- and medium-tech start-ups in the UK in order to assess the effect of the decision to patent. They attempt to carefully isolate the patent effect from other factors, to conclude that patentees have higher asset growth than non-patentees at an annual rate between 8% and 27%. Balasubramanian and Sidavasan (2011) explore a dataset from the US census, matched with information on US patents for the manufacturing sector during the period 1975-1997. They find that firms that patent for the first time experience a significant increase in employment, capital, added value and output, as opposed to similar non-patentees. Measured by any metric, patent acquisition (or application) at the time of initial investment is largely irrelevant to the firm’s subsequent progress through the venture capital cycle. Wagner and Cockburn (2010) examine the effect of patenting on the survival prospects of 356 Internet-related firms that made an initial public offering on NASDAQ in the late 1990s (at the height of the tech bubble), to find that, conditional on other factors that determine a company’s survival, patenting is positively associated with survival.

Mann and Sager (2007) study the linkages between patenting and the venture capital financing cycle of software start-ups. While patents at the time of initial investment are largely irrelevant to subsequent progress through the venture capital cycle, they find that later acquisitions are significantly correlated with indicators of access to venture capital. Haeussler et al. (2009) find that patent applications play an important role in signaling the value of the company to VC investors in German and British biotechnology firms. Sichelman and Graham (2010) analyse a large survey of start-ups and early stage companies in the fields of biotechnology, medical instruments and IT; these companies cited financing and improving exit opportunities as important motives for obtaining patents. Criscuolo and Menon (2012) explore a large cross-country database of funding deals in the clean-tech sector between 2005 and 2010, in order to understand what determines the probability of being funded; they find that companies owning one or more patents are significantly more likely to be funded. The same study also finds that the characteristics of the patents matter, with more radical patents being positively correlated with funding probability. This finding is consistent with a number of studies arguing that new firms are more likely to commercialize radical innovations than incumbents (Henderson, 1993; Tushman and Anderson, 1986).

Cockburn and MacGarvie (2011) find that entry rates in the US software industry are smaller in markets where there are more patents, although firms that hold a patent are more likely to enter the market relative to firms that do not have a patent. This is consistent with previous evidence supplied by Bunch and Smiley (1992), who analyse survey data to find that patenting is one of the most common adopted strategies to deter the entry of rival firms.