Innovation Funding and the Valley of Death

Abstract

Innovation is a public good. As with other public goods, it is expected to be underproduced if only private incentives are present. Therefore, the law strives to encourage innovation via an array of stimulus mechanisms. The law offers three main mechanisms: intellectual property (IP), cash transfers—mainly prizes and grants—and tax incentives. Vast literature analyzes and compares these innovation stimuli in search of the optimal mix to boost innovation. Yet a key problem is largely overlooked: together, the existing stimuli do not cover the lion’s share of the innovation lifecycle. At the beginning of the innovation process, companies can win grants or prizes to cover research & development (R&D) expenses. When the company is already selling, it can enjoy IP payoffs and tax credits. In between, no targeted stimuli exist. This is an incongruity because most innovative endeavors struggle neither in the R&D phase nor at the sales stage. In particular, for startups in the high-tech sector, it is precisely the phases between R&D and sales that prove fatal. This phenomenon is so well-known that the market has created a nickname for it: “the valley of death.” The gap in funding yields high costs. First, underfunding yields an exorbitant startup failure rate, which represents innovation loss and harms the incentive to engage in innovation. Second, the dearth of funding produces inferior innovation and imposes competitive harm against well-funded incumbents. Third, distributive concerns arise because the current regime disproportionately affects entrepreneurs with less access to capital on the free market. This Article considers three main ways to alleviate these concerns. The first way is to “stretch” the existing stimuli to cover the post-R&D-pre-market stage of companies. The second possibility is to improve the private market for startup funding. Finally, a third solution consists of discrete policies to address the costs that the stimulus gap imposes without directly addressing this gap. For example, it is possible to conceive of ways to tackle distributive concerns of startup funding. This Article makes at least three novel contributions to the literature: first, it analyzes the gap in inducement tools in the innovation lifecycle, which is largely overlooked. Second, it explores the inefficiencies of stimuli shortages in terms of innovation policy. Finally, this Article takes the first step in exploring potential solutions.