Is Corporate Venturing Good For Returns? In Aerospace?
Earlier in the year, Salesforce acquired Steelbrick for $300 million. One of the interesting things about the deal was that Salesforce Ventures was an investor in Steelbrick, as well as a competitor in the same space, Apptus.
This scenario is a great case of a corporate venture firm performing as a great market intelligence service, generating financial returns, AS WELL AS providing its parent company options. Options are worth something. We do not know how much Apptus is worth, but is rumored to be a unicorn, likely way more than any corporation would purchase the entity for — though they may pick it up when it does IPO, considering IPOs are considered the new down-round.
Corporate venture arms, when used effectively, can be great sources of competitive advantage as well as financial return (Salesforce Ventures is likely to make at least 5X with Apptus’ IPO). The number of corporate venture arms has increased over the last decade, not only because the markets are “up” in terms of deal flow and in value ( in “up” markets, more venture capital firms, to include corporate venture arms, enter the market), but also because the landscape of sourcing competitive advantage from innovation has fundamentally changed. With companies and people like Steve Blank talking about innovation outposts, with the innovation cycle speeding up, with the ability to capture innovation considered to be a competitive advantage, companies cannot afford not to be involved in venturing in some shape or form.
According to Josh Lerner, HBS Professor of Entrepreneurship, when the genomics revolution was transforming the pharmaceutical industry, Eli Lilly realized that its survival might hinge on its ability to catch up with this disruption. (HBR October 2013). The company launched a corporate venture-capital fund in 2001 in order to engage with the innovative, biotech start-ups tackling innovation (and opportunity) in and around genomics. By 2013, Lilly Ventures had been involved in more than 30 such collaborations, many of which gave its parent company valuable insights into the science of developing drugs by analyzing biological data, realized that its survival might hinge on its ability to catch up with this disruption.
Biotech is capital intensive, has long development life cycles, and is heavily regulated. The fast moving commercial world has pushed these large companies to change their historic business model to actively engage in innovation. Not doing so means getting left behind.
I see the aerospace sector as similarly structured, with similarly long investment cycles and similarly byzantine government oversight. Yet, even as competition has pulled forward (other countries’ technology foundation and capabilities have closed the gap significantly with the U.S.), the industry still relies on internal innovation efforts. Why not combine internal innovation with sourcing innovation from external sources, and start the learning process, given market environment conditions is starting to cause the sector to move in that direction? The Customer Set (OSD, US Navy, US Air Force, NASA) is doing so already.
A corporate VC fund like Lilly Ventures can move faster, more flexibly, and more cheaply than traditional internal R&D efforts to help a firm respond to changes in technologies and business models. In some cases, corporate venturing efforts can even help stimulate demand for a company’s own products. At the same time, of course, its investments should earn attractive returns — an added benefit for a tool that helps capture ideas that may ultimately shape an organization’s destiny.
For decades, large companies have been wary of corporate venturing. Some have seen their venture initiatives fail outright, and many more have given up too quickly. The median life span of corporate venturing programs has traditionally hovered around one year. Even firms with successful funds have sometimes struggled to make use of the knowledge gained from start-up investments. To be sure, running successful corporate VC programs isn’t easy: companies’ processes and rules can make them slow-footed and unfocused. But, as disappointment with R&D results grows, there are indications that corporate venturing may be gaining ground — and respect.
The data show that well-managed corporate venture funds can hold their own with independent VC firms, and even outperform them. For companies that have found traditional in-house research unequal to the task of generating valuable insights into next-generation technologies or the movements of the market, the creation of a venture fund might well prove to be what executives are always looking for — the breakthrough idea that changes everything.
Witness the recent performance of Corporate Venture. My analysis and insights are derived from recent posts and data provided by CB Insights (take a look at #corpvcdata), the National Venture Capital Association, and PwC’s Money Tree report which makes freely available their data collection (posted here: https://www.pwcmoneytree.com/HistoricTrends/CustomQueryHistoricTrend).
2015 is on track to have approximately $15B invested by Corporate Venture Capital entities, in around 400 deals. CB Insights and Pitchbook general agree on these numbers; the Money Tree report placed CVC investments at around $6B in around the same number of deals. Regardless of the discrepancy, the trend since 2009 has been on the upswing, with some CVCs investing in earlier stage companies as they gain experience and traction.
Trends alone do not spell success, I also estimated the # of exits, thus far, for CVCs. I went back and looked at the number of deals done in 2008, which is 532, and then looking at the number of exits for CVCs in 2015, which is 270, allowing the average of 7 year lifespan of a start-up to exit. Given that this figure is approximately 50% of total investments, this is not bad. Some companies likely will take longer to exit. Some may still fail. We also are assuming an exit means reaping of a modicum of financial success — at least 1X return if not more. But, qualitatively speaking, these figures are not bad.
I also postulate that exit rate and financial return improves with CVC participation in the marketplace. Of late, there is a fair amount of sharing of deal flow between independent VCs and CVCs; the partners of CVCs often come in and purchase independent VC portfolio companies — the venture investment giving them very early access to companies, an ability to potentially shape them, albeit indirectly. A case in point is the Salesforce purchase mentioned at the beginning of this post.
We can also look at the numbers presented below, from a study performed by Thomas Chemmanur and Elena Loutskina. Start-ups that went public after being funded by at least one corporate venture-capital investor outperformed those funded exclusively by independent VCs. These figures, drawn from 1980–2004 data, are averages for the three years following the IPO.
The study suggests that it is a corporate venture arm’s greater industry specific knowledge arising from strategic fit, and greater failure tolerance because of this inside knowledge and insight, that drives some of this performance. They also show that the public markets recognize this in IPO pricing. (Chemmanur, Loutskina, 2008/2012: http://ccg.tsinghua.edu.cn/uploads/image/CVC%20pape%20July%202012.pdf)
This study confirmed my gut that strategic investors have a deeper understanding of the domain a start-up is in, and that they could act as superior beta customers for a start-up. I make this statement drawn from my current experience with a 3D bio-printing start-up where Cedar Sinai wants to come in as early, and collaborate early, on the start-ups terms, but closely, so that they can learn from the start-up, but also so the start-up can learn from them, where they provide the ultimate user environment where the technology developed can be incepted from the get-go in the environment it needs to work in. Call this ultimate User Engineering. Just the collaboration alone, let alone speaking potential financial support, drastically increases the odds of this start-up’s success. It also vastly increases Cedar Sinai’s ability to remain on the cutting edge — remain competitive.
My next post on Corporate Venturing will highlight some of the key steps for establishing a successful corporate venture effort, based on my research and experience. Later, I will also juxtapose corporate venturing with the new innovation outposts that some large firms (and countries) are experimenting with, as extensions of their R&D centers.