Signaling by early stage startups: US government research grants and venture capital funding

Abstract

Early stage startups seeking to acquire resources struggle to demonstrate the legitimacy they need to transition from conceptualization to commercialization. They must efficiently cross thresholds over the organizational life cycle to assure their survival and growth. Earlier work in entrepreneurship has demonstrated that the strategies startups use to cross these thresholds involve costly efforts to signal the quality of their ventures. In this paper, we study the value that signals have for startups in an emerging technology industry by examining the impact of government research grants on the recipients' ability to attract subsequent venture capital (VC) funding. Governments around the world are establishing larger pools of funds to catalyze innovative efforts and support early stage startups. This is especially the case in the area of clean technology where the proceeds of carbon taxes or cap-and-trade schemes are being directed towards promising technologies that lower greenhouse gas emissions. We show that the VC community picks up on the signals that underlie these types of government grants and startups can use these as proof points to demonstrate their potential to transition across life cycle stages. In comparison to a sample of U.S. based clean energy startups that have not won prestigious research grants, those startups that have been awarded these grants from federal agencies were 12% more likely to acquire subsequent venture capital (VC) funding. Interestingly, the effect is only present for the six months following receipt of a government grant and not for later windows. This suggests startups are likely to use these grants expeditiously in their advancing their relationships with VCs and that the cachet that comes from these awards may decay over time.