R&D Incentives, Reputation, and Syndication in Venture Capital Contracting, PhD Thesis Chapter

The possibility for idea theft is a well-known problem in the financing of innovative companies: the potential expropriation of an entrepreneur from the rewards of his research effort destroys incentives for R&D. Recent cases of litigation over intellectual property reflect how severe the problem has become in the venture capital industry where financiers may obtain perfect oversight of their entrepreneurs' ideas and research. ln this paper we argue that syn- dication, that is joint investment by at least two venture capitalists, alleviates the incentive problem arising from the possibility of idea theft. Since venture capitalists loose reputation when entrepreneurs litigate following expropriation, syndication implies an increase in the reputation at stake in start-up firms. Given the potential loss of reputation, syndication in- duces lead venture capitalists to refrain from expropriation and thereby enhances incentives for R&D. The model implies that i) syndication enhances innovation, ii) projects aiming at more fundamental research will be syndicated more frequently, iii) at early stages, only good reputation VCs will be involved as syndication partners.