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    • COVID-19 Business Impact Center
      COVID-19 Business Impact Center
      Financial Distancing: How Venture Capital Follows the Economy Down and Curtails Innovation
      07 Jun 2020Working Paper Summaries

      Financial Distancing: How Venture Capital Follows the Economy Down and Curtails Innovation

      by Sabrina T. Howell, Josh Lerner, Ramana Nanda, and Richard Townsend
      Common wisdom holds that VC investment and VC-backed startups are relatively insulated from downturns. This study shows that the relative quantity and quality of innovation declines more for VC-backed firms than for other types of firms during downturns.
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      Author Abstract

      Although late-stage venture capital (VC) activity did not change dramatically in the first two months after the COVID-19 pandemic reached the U.S., early-stage VC activity declined by 38%. The particular sensitivity of early-stage VC investment to market conditions—which we show to be common across recessions spanning four decades from 1976 to 2017—raises questions about the pro-cyclicality of VC and its implications for innovation, especially in light of the common narrative that VC is relatively insulated from public markets. We find that the implications for innovation are not benign: innovation conducted by VC-backed firms in recessions is less highly cited, less original, less general, and less closely related to fundamental science. These effects are more pronounced for startups financed by early-stage venture funds. Given the important role that VC plays in financing breakthrough innovations in the economy, our findings have implications for the broader discussion on the nature of innovation across business cycles.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date:
      • HBS Working Paper Number: HBS Working Paper #20-115
      • Faculty Unit(s): Finance; Entrepreneurial Management
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      Josh Lerner
      Josh Lerner
      Jacob H. Schiff Professor of Investment Banking
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      Ramana Nanda
      Ramana Nanda
      Sarofim-Rock Professor of Business Administration (Leave of Absence)
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