Innovation , Entrepreneurship and Financial Market Cycles

While hard data is difficult to find, the financial crisis appears to have had a substantial negative effect on investors’ willingness to finance innovative entrepreneurship. This dearth of capital is particularly worrisome in light of the widely recognised need for innovative ventures—the so-called “green shoots”— to reignite economic growth after the world-wide recession. A growing body of evidence suggests a strong relationship between entrepreneurship, innovation, and economic growth. This document first reviews the evidence concerning the relationship between innovation and entrepreneurship. It then turns to understanding the consequences of market cycles for these activities. We look at the way that financial considerations impact the innovation investment decision, and innovation in entrepreneurial ventures specifically. I then turn to the implications of the current economic crisis. and highlight four crucial observations: • The current global crisis is having a dramatic effect on the financing of innovation, whether through venture capital, initial public offerings, or corporate venturing. • This is not the first such crisis in entrepreneurial finance. • These patterns reflect the fact that financial constraints appear to limit high potential entrepreneurs. • These funding cycles are serious because of the importance of high potential ventures for innovation. I end by discussing the implications for the growing number of government programmes that seek to encourage financing for entrepreneurs and venture capital. Far too often, these efforts have ignored the relationships discussed above. 1 Katherine Han and Alexandra Lowery provided excellent research support. I thank Bill Kerr and Ramana Nanda for helpful conversations about financing constraints and entrepreneurship, as well as Chiara Criscuolo, Dominique Guellec, and Karen Wilson for useful comments on this document. Portions of this essay are based on Azoulay and Lerner (2010), Gompers and Lerner (2001), and Hall and Lerner (2010); I thank my co-authors for permission to use excerpts from these jointly authored pieces. I thank the OECD and Harvard Business School’s Division of Research for financial support. All errors and omissions are my own.