Venture Capitalists and the Patenting of Innovations

Abstract

We model patent-signaling by informed venture capitalists to incumbent acquirers of developed innovations. We show that, to signal, venture capitalists develop more patents with higher impact than incumbents would. A tightening of patenting requirements by the patent offices, such as an increase in the required inventive step, increases the pool of unprotected early-stage ideas, which venture capitalists are better at judging than incumbents, and decreases the number and breadth of patented claims needed to separate highly valuable from less valuable innovations. Consequently, such a tightening would make venture capitalists more likely to back entrepreneurs and increase entrepreneurial incentives to innovate.

How Many Patents Does it Take to Signal Innovation Quality?

“…The firm can be a true innovator that has spent I 2 and that 15 We believe it is reasonable to assume that the true innovator who has completed the project resulting in an innovation obtains a higher profit than the false type. Moreover, our assumption resembles the positive correlation between innovativeness and profitability commonly postulated in the innovation literature (see O 'Donoghue, 1998 andFabrizi et al, 2013). Some authors make an even stronger assumption by representing innovativeness and profitability with the same variable (see O'Donoghue, Scotchmer and Thisse, 1998).…”

“…A series of recent theoretical papers focuses on the informational content revealed by the decision of whether to patent or keep the innovation secret and/or by the decision of how much innovation-related information to disclose (Anton and Yao, 2003and 2004, Jansen, 2011and Fabrizi et al, 2013. This literature does not focus on the bad patents issue which, instead, is our main concern.…”

“…InYao (2003) and(2004) and inJansen (2011) only true innovators were considered Fabrizi et al (2013). analysed the case of a firm possessing either a "good idea" or a "bad idea", with the latter requiring greater costs in order to be patented.…”

How many patents does it take to signal innovation quality?

“…8 Fabrizi et al (2013) present a model where venture capitalists patent to signal the quality of the innovation to incumbents. They show that a tightening of the patentability standards would make venture capitalists more prone to back entrepreneurs and increase entrepreneurial incentives to invest in R&D. 9 The number of applications as a signal of quality is considered also by Conti et al (2013a).…”

Learning and collusion in new markets with uncertain entry costs

“…By reducing α, and giving a larger share of the surplus to the follower, the mechanism designer reduces incentives to preempt and delays inefficient entry of firms on the market. 4 The optimal compensating payment mechanism is then given by the lowest value of α for which condition (13) holds.…”