Courting Controversy: What Determines the Funding of Contentious Innovation?

We examine the pattern of Venture Capital (VC) investments into controversial innovations: start-ups that violate unwritten rules, traditions and existing norms. We ground our theoretical approach in the idea that ceteris paribus, start-ups that pursue controversial, contentious or objectionable business models can create legitimacy costs for their VC investors. From this, we formulate a set of predictions regarding how the legitimacy costs associated with such business models affect the matching process between VCs and start-ups. VCs who are closer to the core of the VC co-investment network derive significant benefits from their position and have more to lose from threats to their legitimacy; therefore, we predict that they are less likely to invest in potentially controversial start-ups. But because these VCs must balance any legitimacy issues against the financial risks and rewards of investing in a successful idea, we expect that their avoidance of controversial start-ups is attenuated when making decisions about large investments, when the potential financial rewards loom especially large. To test those predictions, we utilize existing data on VC investments combined with data obtained using a novel method of crowdsourcing the data collection. We find that investments in start-ups that have been rated as being potentially objectionable by independent raters recruited through Amazon Mechanical Turk (AMT) are in fact more likely to come from VCs who are more peripheral in the investment network, and that the effect is moderated by investment size. These results shed light on how social structure and market dynamics affect the direction of innovation within an important empirical context, as well as on the social evaluation of innovation in general.