This paper considers the impact of the intellectual property (IP) system on the market for entrepreneurial finance. If the market for entrepreneurial finance were efficient, investors' valuations of start-up firms should be independent of whether their patents' were pending or granted. However, during the pre-grant period, the need to disclose unprotected knowledge, asymmetric information and adverse selection could result in lower valuations. This study therefore estimates whether patent grant, which reduces uncertainty about the scope of the IP rights conferred, enhances start-ups' valuations by venture capitalists. Original panel data pertaining to 317 Israeli technological start-ups, who received more than 980 financing rounds, enter a fixed-effects analysis that controls for firms' unobserved heterogeneity. The results show a positive association between patent applications and firm valuations for firms whose technology is not software based. No association is found between patents and the valuations of software firms. The additional impact of granted patents is positive and significant for non-software firms who are younger, in their pre-revenue stages and during early financing rounds but small and insignificant for more mature start-ups. These findings suggest that, in the case of younger start-ups, uncertainty about patent scope, coupled with imperfections in the entrepreneurial finance market, adversely affect the relationship between entrepreneurs and investors. A more speedy examination process of younger firms' patent applications therefore could enhance their ability to attract financing.
