Producing new insights and sharing third-party or academic research on the impact of venture capital is a key focus for Venture Forward in its mission to drive the narrative of VC and inform the public about the critical role the VC industry plays in the U.S. economy. Venture capital as an investment vehicle with active management is oftentimes misunderstood, and startups receiving VC funding can be mischaracterized with other segments of the economy. Research, like the one highlighted in this post, that quantifies and better explains the positive relationship between high-growth startups on economic growth is important to both VC investors and industry outsiders in understanding the broader impact of the venture industry beyond innovation and financial returns.
Innovation-driven entrepreneurship (IDE) is the principal driver of economic growth among all forms of entrepreneurship. Such is the finding of a growing body of academic literature which distinguishes between the contributions of self-employment, small and medium size enterprises, and technology- and innovation-driven startups to increases in gross domestic product (GDP). A new NBER working paper by Professors Botelho, Fehder, and Hochberg highlights this literature and the fact that a small subset of innovation-driven, high-growth startups are responsible for the bulk of the relationship between entrepreneurship and economic growth. That IDE startups have a principal role in this relationship has important implications for venture capital (VC) and the U.S. economy, since venture funding is the most prominent source of financing for IDE entrepreneurs.
Entrepreneurs are commonly thought of as the conduits by which new ideas are introduced into the economy through new products and services. This idea goes at least as far back as Schumpeter in the 1940s, who characterized entrepreneurs as engaged in a process of “creative destruction,” displacing existing modes of production with more productive ones. Many researchers seized and built upon Schumpeter’s observations, creating an expansive body of theoretical literature focused on entrepreneurial discovery and economic growth which, in recent decades, has emphasized the importance of new firm entry for economic growth.
The importance placed by researchers on new firm entry gave birth to a belief that business dynamics (the process of firm entry, expansion, contraction, and exit) play a fundamental role in economic growth, with some studies showing that new firms disproportionately drive job growth. However, the growth rate of these new firm entrants exhibits positive skewness (i.e., the probability distribution has a “long” right tail with large outliers driving up the mean), hinting that a smaller subset of high-growth, innovation-driven businesses (IDE startups) is responsible for most of the relationship between entrepreneurship and economic growth (instead of new firms in general). This trend holds not only in the U.S., but also across many other developed countries, underscoring the importance of IDE-run businesses in developed economies compared to “traditional” business entrepreneurs who create new businesses but have little desire to grow, innovate, or bring new products to market.