Moonshots are a myth part 2: How a portfolio-first approach to external corporate investment keeps companies grounded in new customer problems, too.

Bionic
Bionic
Jul 2, 2019 · 7 min read

Article originally published on LinkedIn.

Photo by Austin Distel on Unsplash

External corporate investments typically follow two paths: corporate mergers and acquisitions (M&A) and Corporate Venture Capital (CVC). The former addresses gaps in product, technology, data, or channels. These mergers and acquisitions are typically one-offs, and done right they can be incredibly strategic. They add new revenue streams, diversify companies, and open up opportunities to play in new spaces. They address outside forces and bring solutions to new problems.

They’re also risky as hell. To be transformational, they have to be big. When they don’t pay off, they can be career-ending catastrophes. Just ask what used to be Yahoo. Or ask Microsoft, which needed new leadership and a new transformation to recover from big misses like its $8B Nokia acquisition and subsequent failure to catch up in the mobile marketplace.

Unsurprisingly, most companies apply a moonshot mindset to their external investments as well, making one or two expensive, reactionary acquisitions a year that rarely solve a customer problem. They’re usually staged to solve the company’s problem.

If nearly all large companies participate in M&A of some kind, far fewer take advantage of the full opportunities and impact of CVC. Let’s be honest, many companies making CVC investments struggle for the permission to do it well, investing in products and services that enable or enhance their core offerings, not the discovery of new customer problems that drive and create the core of the future. (They also often lack the talent and the committed capital to keep the fund at arm’s length from the core Business As Usual.)

In a growth mindset, CVC and M&A go hand in hand. The former is a hedge against the latter, encouraging a wide variety of small, early, inexpensive bets on startups and emerging technologies.

Here are four reasons to adopt this portfolio-first investment strategy:

  • Validate the Future

When you invest in a variety of startups, you invest in experiments designed to validate the future ahead of the enterprise. Startups are solutions to new problems and serve as sensors to indicate when you are “right and on time” for transactions. This validation can also come by understanding where the money from conventional VCs is flowing by partnering with them instead of competing. CVCs act as a lead investors in less than 25% of the deals they do to ensure there is another pair of eyes.

  • Access the Commercial Truth

Big bets have a way of justifying themselves despite red flags (confirmation bias). They can quickly turn into success theater and intellectually dishonesty among otherwise honest leaders because they’re too expensive to fail. With a lot of eggs in a lot of small, focused baskets, you get real, gritty intelligence with minimal pain, because the relative cost of failure is low and the cycle time for learning is faster.

  • Gain Pipeline Intelligence

When the time comes to acquire one of your portfolio companies, you’ll benefit from an established relationship with their teams and more intimate knowledge of their processes and growth trajectory. Acquiring these companies will become safer bets for you because they are known quantities. You’ll also save time convincing the larger organization of the startup’s benefits because you’ll be aligned with the leadership, and your enterprise will be a more competitive acquirer with a clear thesis and transaction speed. Furthermore, getting in early helps gain access to high competition follow-on rounds of startups with strong traction.

  • Build an Ecosystem Based on Creating Value

A portfolio of startups providing utility for customers outside of your core product offerings creates an interconnected ecosystem for customers, with your relationship at the center. Think of Amazon’s Alexa: It still needs third-party entities to develop new skills and build integration with a wider range of hardware to fuel mass adoption by consumers. And that is exactly why Amazon has set up a $100M fund to invest in companies that build on the Alexa platform by integrating it with additional hardware.

The numbers emphatically support this investment strategy. Consider that 6% of all deals closed — roughly one in 20 bets — are responsible for 60% of all wins. That means that to find one big winner, you should expect to invest in around 20 bets in a given space. To do that, you’ll need a sound methodology to build your portfolio.

Here are three pillars for success in CVC.

1. A Defined Investment Thesis

Your investment thesis is a guiding principle for making investment decisions. It’s not rigid, nor does it need to be. It just has to help you identify the opportunity areas to explore while minimizing the distraction of “bright shiny objects”: strategies, technologies, and channels that are sexy and seem promising but won’t actually help your business. That’s trend chasing, which is fundamentally different from funding solutions to new needs that matter to your customers.

Developing your investment thesis starts with mapping the ecosystem, or defining the influences shaping the market. In the apparel industry, for example, the ecosystem is rapidly evolving to include influences that didn’t exist 20 years ago. E-commerce, direct-to-consumer, digital showrooming, responsible sourcing, AI, fulfillment technology — they’re all developments that need to be accounted for.

You need to understand how customers feel, how they make decisions, the problems they encounter, and how the ecosystem is affecting customer behavior. You need a data analytics engine that accounts for all these signals across all the touchpoints customers have with businesses. These days, that’s an exploding number of signals that need to be distilled into clear insight. This is what AI and machine learning will bring to bear over the next decade. If you don’t control your customer data, someone else will.

Lastly, you need to align your findings to your enterprise growth goals. Your focus needs to be on the outside forces — the emerging technologies and models that will help you provide solutions to your customers’ problems. Everything else can go.

2. Committed Capital

You don’t need an avalanche of capital to deploy CVC effectively. More than 40% of all CVC funds have invested under $50M. Remember, this is about more bets, not bigger bets. If you need to make a minimum of 20 investments to get to that big, transformational idea, that’s a lot of checks, but they’re relatively small early on. Consider an example where you start a $20 million seed-stage fund. With 20 bets to place, that’s around $600K for each initial investment, reserving 40% of your fund for follow-on investments. That’s a portfolio of 20 bets at a fraction of the cost of a larger M&A deal where you only get one chance to get it right.

After three years, you will validate some business models and technologies, and others will fall by the wayside. Your early investments can now inform early, high-conviction acquisitions that have been de-risked to a degree, given all that you’ve learned from your portfolio companies, and given that you’re making multiple, less-expensive acquisitions, rather than one giant, risky transaction. You get what Nassim Taleb calls “unbounded outcomes.” That is, you can only lose the money you put in, but you could have a billion-dollar company in your portfolio if just one of these companies works out. From a growth perspective, you have nothing to lose.

3. An Investment Team

To make all this work, you need the right people in the right roles. The investment team needs to be close to the overall corporate strategy, develop the investment thesis, intelligently identify opportunity areas, shepherd deals through, and actively manage the health and growth of the portfolio. The team should comprise the following functions:

  • The Principal/ Portfolio Manager: This individual signs off on the investment thesis and ensures the CVC goals are aligned to the overall corporate strategy. Ideally, this individual has investment experience already.
  • Deal Flow Managers: These roles are responsible for sourcing and tracking potential startups to fund and exploring the opportunity areas that need to be validated. This group is also responsible for assessing the insights that come back from the next team.
  • Diligence and Execution Roles: This team of analysts works on market validation and accounts for startups’ exit plans.
  • Portfolio Management Team: This function has governance to monitor the investments, ensure they’re tracking against strategic goals, and nurture the relationships between CVC and the startups. Former entrepreneurs and business development experts can be valuable in this role when it comes to partnering with the startups.
  • Commercial Lead: This individual is familiar with all the different products and services within the various business units and has relationships with the relevant internal players in order to help commercialize the portfolio’s products and services within the enterprise.

In the end, the purpose of CVC should be to accelerate learning. This means taking the company into new territory, exploring opportunity areas it may have little direct knowledge of to start. Given this strategic importance, it is imperative that the CVC reports to the top management of the company. More than three-fourths of CVC funds report to either a CxO or the head of strategy.

Companies that view M&A and CVC as serving two fundamentally different purposes — with M&A being viewed as somehow more strategic to the company’s growth, and CVC being viewed as a “nice to have” — miss a glaring opportunity. CVC staged through small, diverse bets, equates to inexpensive learning critical to new growth. It offers intelligence on new customer problems that the company wouldn’t have explored otherwise but can’t really afford to miss or drag its feet on. These inexpensive bets can and should shape the larger, more expensive bets.

Ultimately, these are all avenues to fill your portfolio of bets — organic and inorganic — that become your always-on engine for growth. Forget that moonshot. This is about building a ladder to the moon.

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