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I have always been intrigued by how young companies develop and mature. Where do they get their financing and how do they survive in the market? What factors might be associated with identifiable growth patterns, especially in the biotechnology and medical device industries, over time?
I believe in the maxim that one should pay attention to one’s best teachers. Recently, one of my teachers at The Wharton School of the University of Pennsylvania, Lawton R. Burns, PhD, and his colleagues evaluated market entry and exit issues for biotech and medical device companies funded by venture capital firms. I am summarizing their findings here.
Economic research has documented that innovation is neither fostered by large firms nor prevalent in concentrated industries. Instead, we now recognize that small firms play a critical role in technologic innovation, especially in the biotech and medical device sectors. What are the market entry and exit patterns of these firms, and what factors are associated with those patterns over time? It is this important public policy question that my former professor tackled in his study.
Burns defined “entry” as the date of a firm’s founding and “exit” as either the unsuccessful dissolution of that company via bankruptcy, successful dissolution of that company via acquisition by another firm, or the successful transition of that company into the public markets via an initial public offering (IPO). Organization research labels entry and exit rates as “demographic processes because of their resemblance to birth and death rates in a population of firms. These rates tend to be positively correlated across industries; the likelihood of one rate increases the likelihood of the other.” Venture capital-backed firms constitute 40 percent of employment in biotechnology and 83 percent of employment in the medical device industries. “In addition to this direct effect, venture capital funded startups have a job multiplier effect on other economic sectors and contribute to the health of several state economies by virtue of their impact on jobs, sales revenues, and economic growth.”1 Simply put, venture capital is the lifeblood of the biotechnology and medical device sectors. Burns examined patterns and correlates of market entry and exit using the VentureXpert database on all start-up companies that solicit venture capital financing and the Venture Economics Industry Code, which classifies firms within a sector according to similar technologies. He sampled all firms in the two sectors for which founding, financing, acquisition, or IPO dates were available. Using sophisticated modeling techniques and regression analysis, Burns came up with some fascinating results. His analysis suggests that venture capital firms play a role in fostering firm entry, but they play a much more pronounced role in fostering successful firm exit. I found this profoundly counterintuitive. It turns out that on the entry side, venture capital financing does not appear to spur new entry directly but indirectly through its financing of firms in other sectors and its financing of prior entries both within and across sectors. On the exit side, moderate levels of venture capital financing promote successful exits, which also are fostered by a greater level of venture capital experience with other companies and investments. It appears that venture capital-backed firms in the biotechnology/medical device arena use their funds for a successful exit, meaning they are either purchased by a larger company or they go public independently.
Why are these findings important? Because financing appears to be somewhat stable, which suggests that venture capital firms are concentrating their investments in a relatively fixed number of startup companies. The multi variate regression model used by Burns suggests that this behavior is associated with a so-called “good exit” and, thus, with technologies that get successfully commercialized. Of course, there are other predictors of firm entry and exit that are beyond the scope of this market model, but the findings are clear: Successful exit, either going public or being purchased, is a venture-backed gain. Policymakers, then, should recognize that the biotechnology and medical device sectors are interdependent and that venture capital firms play an important role in both. As always, I am interested in your views. You can reach me at email@example.com. Please also visit my blog:«http://nashhealthpolicy.blogspot.com».
1Burns LR, Housman MG, Robinson CA. Market entry and exit by biotech and device companies funded by venture capital. Health Affairs. 2009;28:w76–w86.