Investment Cycles and Startup Innovation

We find that VC-backed firms receiving their initial investment in hot markets are more likely to go bankrupt, but conditional on going public are valued higher on the day of their IPO, have more patents and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is particularly true for the most experienced VCs. Furthermore, our results suggest that the flood of capital in hot markets also plays a causal role in shifting investments to more novel startups – by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments