Why is the Corporate Venture growing so fast? What are the keys?
More than a thousand major companies worldwide have launched a Corporate Venture Capital (CVC) fund , and, in the United States, they are taking part in one in five start-up financing rounds, supplying 20% of the amounts invested. There has been continued strong growth in the recent years. Around the world, they are taking part in rounds for a total of $ 83.5 billion in 2016 according to GCV, up 100% compared to 2014. CB insights assess that their share of financing representing $25.8 billion : why this massive increase? French version here
Corporate Venture Capital is a risky investment in innovative companies, like any venture investment, the difference is funds come from a large company. Unlike the investments of conventional venture capital funds that only respond to a financial logic, the return on investment of these funds is also strategic. And their strong growth in the US as in Europe shows that it works.
A very wide variety of profiles
There are several segments of Venture Capital funds: from seed investment (companies not yet making significant income), to regional, sectoral funds … up to “Capital Development” aiming at profitable companies, to enable them to expand, geographically or through M&A.
Corporate Venture funds have an even greater diversity of profiles because in addition to this size segmentation, each industry has its specificities, and each company defines its investment policy. Nevertheless, we note that Corporate Venture investments have many similarities with Venture Capital:
- it’s a bet on the team, its talent, its complementarity, its ability to adapt and grow
- it is a bet on a market segment and the ability of the team to seize it within a reasonable timeframe
- it’s a portfolio logic: you have to diversify your bets to optimize your efforts.
- it’s an investment that has an exit horizon, which is profitable, after a few years
- We must be able to “follow” the successive rounds of financing in companies with an interesting development
Corporate Ventures also have their own objectives
Most of the CVC investments are done for strategic reasons. The non-financial objectives generally observed are:
1- Identify innovative start-ups, which will be able to bring innovations into the company’s field of activity, to better seize opportunities, to gain competitive advantages or better anticipate disruption. This objective of economic intelligence concerns almost all corporate venture funds.
2 — Take positions to better steer their approach of subsequent acquisitions, this is the case of the main corporate venture funds . It is a relatively economical way to “derisk the future”, taking positions on technologies whose future is uncertain but promising. One in five Cisco acquisitions is a company Cisco Venture invested in. Google bought several companies in which Google Venture had invested, the largest being probably Nest.
3 — Allow the large company that makes the investment to innovate faster because the investment will allow start-ups to make the necessary investments to accelerate joint projects. This is particularly the case for technology companies in areas that are “Cash Intensive” (Medical, Aerospace …), especially in sub-areas in which the investment of traditional funds is rare.
4- Support the ecosystem of the company, and allow its business partners to go faster. The case of Salesforce is particularly striking: Salesforce Venture makes dozens of investments a year in companies that distribute complementary bricks of their product, with great success. Qualcomm, Intel, Microsoft Venture or Amazon Alexa venture are also great illustrations.
5- Finally, a Corporate Venture is often a strong accelerating factor in the shift of the company, both in its innovation, its cultural transformation and its digital transition, as mentioned in a recent article . The meetings between the collaborators and the entrepreneurs of the portfolio or the dealflow are as many acculturation opportunities.
These strategic objectives are not antithetical to financial objectives. Google Venture declares that its goals are only financial and some spectacular releases suggest they are very good.
In fact, Corporate Venture funds have strong competitive advantages: they know their business very well, they have in-house expertise, and access to market information that is not public. In addition, they have the opportunity to bring markets to the start-ups in which they have invested and bring them business in new territories
When it works well, a CVC is a profitable department that brings precious market intelligence. They are the first to see new trends through the start-ups they meet. The largest and most durable ones (Cisco, Intel, Qualcomm…) have shown that they are Core Business since they feed their business lines with novelty, prevent them from disruption, with a high return on investment.
On the other side, they can also implicitly dissuade their competitors from working with the start-up (especially when their proportion of capital is high), or focus too much on their own issues while other opportunities could be more carriers.
Corporate Venture investment also carries risks
- As in all Venture Capital portfolios, some Corporate Venture portfolio companies will go bankrupt. These companies, or their creditors, will be tempted to attack the corporate to recover what can. It is rare that the financial damage is large (in proportion to the investment) but it can end in the legal department.
- The team may lose sight of the strategic objectives of the company that created the fund, either by pursuing exclusively financial objectives, or by relying too much on business issues which the corporate slowly moves away from. In these cases, companies are tempted to outsource the fund after a few years as was the case with Nokia Ventures or Visa Ventures.
- Since the investment can have major strategic aspects, the corporate venture can create an inflation in the “premoney” investment values, especially as Corporate venture teams are rarely incentivized by exit gains, thus are potentially less attentive on valuations.
- There may be conflicts of interest between the company as an investor and the company as a customer. The representative of the fund is interested in the financial sustainability of the start-ups in which he has invested, while the business representative who is in partnership with the start-up has an interest in paying the joint projects as cheaply as possible.
- The Corporate teams can be very surprised that one of the ventures with which they are in active collaboration receives an acquisition proposal. Corporation Venture money has the ability to be much more patient than traditional funds, and will rarely be the first to push for an exit, except in the event of portfolio liquidation or strategic divergence. If the company has the opportunity to outbid on an exit opportunity, it may deter potential buyers, and again create a conflict of interest.
- The founders of start-ups can be very good entrepreneurs but with a culture that is very far from the culture of the company, which can create great difficulties for collaboration. By nature, the start-up is impatient and worried about its intellectual property. In my experience, it can create complicated situations even if all the parties have perfectly clear and aligned interests.
- A start-up, in which the corporation has invested, can have a very interesting solution at a given moment, but the company that has invested may be tempted to collaborate a few years later with a competing company whose solution has become more competitive. The time of the investment is a relatively long time (more than 5 years) but the time of the projects and the technology is generally faster.
How to optimize the opportunity and limit the risks of the Corporate Venture?
- A corporate venture fund must have a competent investment committee, like all funds. This could include external (non-conflicted) profiles that provide skills and a neutral outlook. It has to invite representatives of the business who are affected by the innovations of the start-up candidates for the investment. The files must be well prepared in all their facets, strategic and financial, short term and medium term.
- It must write — and keep — the investment thesis, especially in their strategic dimensions. Business executives have careers that evolve at a faster pace than the portfolio and conveying the initial intentions of each investment is valuable.
- If the investment is not only financial, each investment must have an identified business “sponsor”, a senior manager who is supportive of the investment thesis even before any decision on formal commitment to start a partnership. A start-up can be extremely interesting, but if it does not find an internal sponsor, the future of the collaboration will be limited. The intensity and diversity of this type of sponsorship will be important indicators of the success of the CVC within a company.
- The shareholders agreement of each start-up must be consistent with its investment thesis.
- If the objective is to create synergies, it is necessary to locate the investment teams as close as possible to the business teams to facilitate the immersion of the CVC team in the company’s strategy, particularly to create informal exchanges. On the other side, it must be easy for business teams to meet dealflow start-ups to get inspiration and share their expertise.
- It is necessary to set the pace of the investment deal and set time-limit targets between the first meeting and the investment (typically less than 6 months), and the negative response time for most start-ups who will say no.
- The CVC representative on the board of the start-up must be a senior, qualified and very involved person, but he cannot be the “client” of the start-up in the company to limit conflicts of interest. The board is regular and his presence is obligatory. The exchanges are confidential especially with regard to operational collaborations. During the board of the start-up, the corporate representative must act only for the sake of the start-up. He needs to “bridge” this interest with the one of his group, which may be complex.
- Stay at an acceptable threshold of participation, below the drag-along threshold, that is to say, not allowing blocking opportunities for the sale of start-ups. If the sale of the start-up can be blocked, it will be much less attractive and this can cause many problems.
- It is good to integrate into the CVC team both people who know the company well and people who know the world of start-ups and investment to make the cultural bridge between these two worlds. The mission of the CVC team is to “sell” the right start-ups in-house, to the right person and at the right time. On the other hand, it is necessary to “sell” the group to start-ups, as a good long-term investor, reliable, trusted partner, with readable decision-making mechanisms.
- A good connection with the corporate’s ecosystem is important: accelerators, incubators, technology transfer departments of major research centers but especially with the investment areas (to be able to offer them to participate in subsequent rounds and receive their propositions of investment).
- It is necessary to match the investment pocket of the fund with the strategic objectives of the fund. If the goal is only sourcing, a fund of a few tens of millions of euros is enough, especially in areas with low capital intensity. If the goal is to invest in large start-ups (say, from the third round to limit the risk), or on areas that involve heavy investments, several hundred million euros are needed.
- It is better for the CVC to clarify with its ecosystem its target investment phases. From my experience, it is better to avoid seed stage. Indeed this phase “pre-revenue” generates an exciting dealflow but with a higher rate of defection. This requires specific know-how, which only some funds master. The company can achieve the same result with less effort by being an investor in one (or several) of these specialist VC seed funds, or even negotiating an opportunity to participate in subsequent rounds.
What is the evolution of Corporate Ventures?
The proof that the benefits are much greater than the risks is that the Corporate Venture is growing fast: ‘Follow the Money’. While the market unanimously observes that their maturity is progressing rapidly, that it is professionalizing quickly, it is also clear that some groups benefit much better from their CVC than others. Proof that there remains “best practices” to share in this area.
When a CVC was opened ten years ago, the market asked the company “why are you doing this?”. Today the question is asked to the actors who do not have this instrument “why don’t you have a CVC?”: minds have changed.
CVC is a powerful tool, serving the innovation strategy of each group, and its digital transformation. As the pace of innovation and disruption accelerates in all industries, it creates a Darwinism that makes these issues more and more essential. These factors are largely responsible for the strong growth of the Corporate Venture, and there are many good years ahead.
For those interested to dig further, there is a lot to read in the hyperlinks included in this post and I recommend a good book I recently received “Masters of Corporate Venture Capital”