The missing middle: Value capture in the market for startups

We argue that innovations that involve both upstream (technological) and downstream (commercialization) challenges are disadvantaged in a startup-based innovation system where startups develop inventions, while incumbents acquire startups. We propose an analytical model in which startups are more efficient at solving technological challenges and incumbents are more efficient at solving commercialization challenges, and where uncertainty about the best acquirer prevents complete contracts. We find that when both technological and commercialization challenges are present, as commonly observed in deep tech innovations, startups are able to capture a smaller fraction of the value created. This introduces a bias in the direction of innovation as projects that are primarily characterized by one type of challenge are more attractive investments compared to projects, equally or more valuable, which face both challenges. We discuss the implications of our model for startup strategies, empirical research and deep tech innovation policies.