Pros and Cons of CVC — and what it has to do with firefighting [1/2]

If you’re a VC, this might sound familiar: Sitting with company representatives in meetings and being asked: “How can we overcome the challenges of the future?”

It’s the ghosts of Kodak or Nokia that are floating around the corporates’ heads. Keeping eyes closed with regards to progress and innovation (even or especially to the kind that could potentially cannibalize their current business model) might be a death sentence.

Photo by Toa Heftiba on Unsplash

That’s why more and more corporates seek alternatives to traditional R&D activities and consider investing in vehicles that allow them to participate in more disruptive developments. But it’s far from easy to facilitate this change. We want to give you some insights into how we believe corporates could leverage their innovation activities best. How to identify the best leads? How to collaborate? How to ensure knowledge transfer?

Benefits of venture activities for corporates

The good news first: It is not too late! Besides classical R&D and M&A the venture ecosystem provides great opportunities to ignite innovation:

First of all, an investment in venture offers new core strategic innovations and general access to new developments which aren’t available internally. It opens doors to external disruptive concepts and enables exposure to markets outside one’s core focus, while — in contrast to own R&D activities — sharing the risk with other investors. You may find the true disruption your company is capable of by exploring groundbreaking concepts outside of the main focus of business.

Furthermore, corporates are facing an apparent rivalry with start-ups for top grads (and also more senior professionals) with increasingly top grads choosing start-ups over corporates, according to recent studies. An investment in venture is thus also an investment in HR and gives you access to a very interesting talent pool.

Finally, if all goes the right way, an investment in venture can pave the way to attractive financial returns.

Despite only briefly naming a few, every corporate representative would probably directly shake hands and pick these advantages — “All roads lead to venture” — but hold on. The question is, is this road really the best of all?

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Development of corporate venture activity

The most common way to conduct venture activity is building a corporate venture capital (CVC) arm. Prominent examples in the industry are Google Ventures, Cisco Ventures or Johnson & Johnson Innovation.

Source: Pitchbook

In contrast to institutional venture capital funds (VC), which mainly invest for financial returns, a CVC invests to benefit from the aforementioned strategic benefits. As you can see in the graphs, the CVC market has increased significantly in terms of capital invested and deals conducted, recording similar relative growth as the total VC market. With approximatively $54.1bn funding in 2016, CVCs have established themselves as big players in the market. The >4x growth of funding since 2009 shows: Corporates are serious about this!

Not only this, it is also undeniable that corporates benefit from their venture activities. As they provide in-depth industry knowledge and customer contacts for start-ups in return, this looks like a real win-win situation, right?

All that glitters is not gold: CVCs face significant challenges

Well, it is not that simple! Corporates can provide strong value, but on the path to success we have observed four main challenges that they face regarding the collaboration between CVC and the aspiring entrepreneurs as well as the general strategy set-up.

(1) Conflict of interests — CVC can lead to significant conflicts of interest with competitors, strategic partners, founders, and even with the corporate mothership. Just imagine you are a start-up that would like to enter a strategic or operational partnership with a direct competitor of the corporate behind your CVC.

(2) Speed-limits and value added — CVCs usually have to follow sluggish corporate processes which limit their start-ups’ actual strengths. They lack certain speed of decision-making, innovation, flexibility, risk-taking and in particular the pragmatism that start-ups regularly need from their investors.

(3) Sustainability — CVC is a corporate vehicle and therefore exposed to corporate risks. “Boom-and-bust” developments like exchanges of executives can highly influence the CVC’s ability to act. This can, for example, lead to a situation in which the decision on follow-on investments becomes unattached from a start-up’s performance. A terrible imagination for a VC (and even more so for a start-up). What is interesting in this context as well: The average life span of corporate venture initiatives is only 5 years…

(4) Internal filling: We have observed that many corporates staff their CVC internally. The problem is this: The professionals in charge may have the required qualification, but are biased by years over years in the system. The bird’s eye view is simply missing. So, to put it rather provocatively: Would you let someone fight a fire who is (in part) responsible for it?

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Read in part 2 of this post which prerequisites corporates must fulfil to make their CVC a success and which even more promising alternative they might want to consider before rushing into CVC (spoiler alert: it has to do with institutional VC).

A big thank you to Fabian Degenhardt for co-writing this piece!