Inside the Mind of a Corporate VC
With Corporate Venture Capital on the rise, here are three tips to help founders secure investment
I recently hosted a networking dinner for Israeli tech entrepreneurs, where I quickly found myself in the proverbial hot seat.
After a few drinks, the conversation found its way into the world of corporate venture capital (CVC), and how challenging it sometimes was for most of these entrepreneurs to deal with large corporations, especially when it came to due diligence process.
The main frustrations stemmed from how different the CVC experience was when compared to other investors (e.g., the length of the process, types of questions, people involved).
So naturally, being part of a pharma/digital health-focused CVC that reviews approximately 300 companies a year (with an investment portfolio of 8 companies), I decided to write this article.
After all, CVCs play a growing and important role in the innovation landscape — according to CBInsights, CVCs invested approximately $53Bn in 2018 (a whopping 47% increase from 2017) and participated in 23% of all venture rounds last year, where their investment sizes were about 20% larger than the more traditional VCs.
So whether you want to better understand a CVC’s due diligence process in more detail or wish to learn more about CVCs in general, I invite you to peak inside the inner-workings of corporate VCs — the following three tips are designed to help you best engage with them:
So you’ve received the phone call — a CVC would like to start diligence and move forward with assessing your company for a potential investment.
Mazel tov!
But, the CVC space is quite unique, and it’s especially important to have the right expectations going into the process. When it comes to due diligence in particular, here are a few ways that CVCs differ from other investors (e.g., traditional VCs, angels):
Financial Returns vs. Strategic Value
Unlike more traditional investors, CVCs balance strategic benefits with the future financial returns of an investment. In fact, I’ve noticed that CVCs investing solely for financial returns are on the decline.
A CVC investment will often focus on unique technologies, novel datasets, new and complementary products/services and exciting external talent, all in the hopes of providing themselves with longer-term corporate benefits.
These benefits could be fairly straight-forward, like enhancing an existing product or opening up a channel to new markets, or they can be more abstract, like creating a specific innovation ecosystem which will help attract the best talent.
For example, one of our strategic objectives as a Pharma player is to think ‘beyond the medication’ into all aspects affecting a patient — that’s why we invested in Pacifica, a company that builds digital tools for mental health (e.g., anxiety, depression) as we know that many patients with chronic skin conditions suffer from depression and stress. We also know that improving mental health could, in turn, assist with chronic skin conditions.
From my experience, a company’s financial performance and metrics, while important, are often weighted less by CVCs than an amazing strategic fit.
Analytics vs. Pilots
CVCs are, by definition, attached to a larger corporate entity, which gives them the opportunity to go beyond traditional diligence approaches and take your solution for a ‘test-drive’ before deciding on an investment.
These tests often take the shape of pilots that explore a technology’s performance in the CVC’s specific industry.
For example, even though we’re focused on healthcare, we’re currently running a pilot with a cybersecurity company that can detect various stress levels in one’s voice (stress is an important precursor for skin diseases). As the founder had never tested their solution in our space, we’re able to recruit patients with skin diseases into a small-scale pilot to see how relevant this tech is for our unique focus area.
This can be a multi-month process, designed to battle-test the validity of the tech before any investment is made.
The benefit here is that these pilots often generate new data beneficial for the entrepreneur, so even if the investment goes south, you’ll be left with (hopefully) some interesting data sets and a great story to tell future investors.
So while pilots are not always required, this approach is often unique to CVCs.
Full Transparency vs. Selective Probing
Traditional investors often want full transparency into the various aspects of a company, performing deep business, tech, people, market and legal analysis.
It might sound counter-intuitive, but given that CVCs are part of a larger organisation, which often operates in the same market as a potential investment, sometimes full diligence is difficult.
As most diligence is done under a Noncompete Agreement, there’s always a potential risk of uncovering something unique in the diligence which might prevent the organisation from later pursuing a similar future approach.
Imagine a microchip design company performing diligence on a new startup with a potentially more effective microchip. Should the company fully uncover the IP behind the startup’s design, this might legally prevent them from pursuing a similar design path in the future — a risk that needs to be carefully managed.
Closer to home, we’ve recently been exploring a few apps in the skin disease diagnostics space that utilise various machine learning algorithms to detect skin conditions. While it would have been tempting to do a deep dive on the algorithms used for the analysis, given that we’re in a similar space, we actively decided not to look too closely (so that we’re not prevented in future from creating similar disease-detecting algorithms).
Instead, we worked with the startups to think through the best approach forward, and decided to send multiple anonymised pictures of various skin conditions to test how accurate the algorithms were, without actually understanding their specific algorithm in detail and looking too closely under the hood.
This often means that the entrepreneur should be ready to work with the CVC to design a custom diligence process which keeps everyone’s existing and future IP safe.
Professionals vs. Practitioners
You’ll definitely meet some interesting people during the diligence process, so let’s examine these corporate folks a bit closer.
Often for CVCs, the people performing the diligence are subject-matter experts for which the diligence process is a small part of their day-to-day work.
For example, for regulatory diligence, you might often be speaking with a company’s Chief Compliance Officer — sure she’s doing the diligence now, but 99% of her time is spent focusing on real-world regulatory issues that could impact her company.
Also, as the various parts of diligence will often be assigned to various functions within an organisation (e.g., Scientific, Clinical, Regulatory, Sales, Marketing), you’ll most often be speaking with people that are not your traditional “professional investor”.
This means that they will have a varying level of risk tolerance and understanding of the overall investment process.
So in addition to thinking about how to tailor your information to these experts, think about what information they may find irrelevant, or beyond their expertise.
But there’s another important tip — leverage your communications with these experts to help gain useful insights from subject matter experts to strengthen your own offering, irrespective of the outcomes of the diligence process.
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Now that you’ve seen key features of the CVC thought-process, here’s an example of a diligence checklist we use to evaluate opportunities:
A few things you may have noticed about this checklist:
- Simplicity: we use a simple ‘red-yellow-green’ system to identify the key risks and assumptions of any investment, which we can often articulate after a few meetings with the founders and employees of the company.
- People-Driven: We try to involve at most five or six colleagues during the diligence (since most of them have a full-time day job running other corporate functions) which means our diligence is heavily dependent on the expertise of our team versus detailed quant models and analytics.
- Quick — we realise that we’re competing against more traditional investors, so rapid turnaround is important, and we try to have a go/no go to the founders after a few weeks.
- Customisable — while the above is an example of the most important areas we focus on during diligence, there’s often opportunity-specific customisation that happens during the process, but the above checklist does cover ~80% of what we look for.
Starting the diligence process with a CVC can be an exciting time in a company’s journey.
Remember that even if an investment does not end up happening, the process is often value-adding (e.g., via pilots, new data generation and access to industry experts).
Here’s how you can best prepare to ensure your journey is a smooth one and that you get through it with as little bumps in the road as possible (and hopefully some money in your company’s bank account):
As you’ve seen, often the CVC’s process is uniquely different from that of other investors, and hopefully, the insights I’ve shared will have opened up new ideas on how to best engage with CVCs.
After all, engaging with a potential investor can sometimes be a complicated process, so I’m hoping that this article helped shed some light on how we assess opportunities and work with our talented and dedicated entrepreneurs.
Best of luck with your (ad)venture, and see you at our next networking dinner!
