Financial Returns Matter in Corporate Venture
Investment performance does not require a trade-off against strategic benefits
When contemplating a new corporate venture (CVC) program, executives often ask how to “balance” the financial returns from startup investments against the strategic value that the program can create. I believe this question illustrates a common misconception that achieving one goal requires compromising the other. In my experience, the best corporate venture programs focus on maximizing financial and strategic performance.
While strategic goals may be the initial impetus for many CVCs, the financial goals are just as important. I’ve heard multiple CEOs or senior corporate executives say, “David, it’s ok for us to lose money or tolerate lower returns if we can achieve our strategic goals, right?”
My answer has always been, “No, it is not ok for corporate venture capitalists to lose money.”
In my opinion, there are four primary reasons why financial returns matter:
1. Alignment of interests
2. Financial returns can generate strategic returns
3. Improved deal flow
4. Innovation can be a profit center
1. Alignment of interests
When a CVC invests in a startup, the corporation engages with two new constituents: the founders and executives who lead the startup portfolio company, and the other venture capitalists who co-invest in that particular startup. In the vast majority of situations I’ve seen, both these stakeholders have one principal goal only: to make money by generating a return on their equity position.
It’s critical to remember that neither the startup management team nor the other venture capitalists in the deal will share in the strategic benefits generated by the CVC. What startup founder or venture capital co-investor would want a corporate investor on the cap table whose interests were misaligned with theirs?
To create alignment, the corporate investor must care about the financial returns on its equity investment, just as much as the other stakeholders do.
2. Financial returns can generate strategic returns
It should be fairly obvious that strategic engagement can generate financial returns. When a corporation works with a startup on a mutually beneficial commercial transaction, both sides receive value. Not only does the corporation receive strategic benefits, but the startup also becomes more successful and (all other things being equal) the CVC’s equity is worth more.
But the inverse is also true. Financial returns can generate strategic value.
This is because startups that are on a path to financial success have a much better opportunity to produce strategic engagement. The implication is that corporations should want to work with the best startups, which usually means those with an improving financial return profile. These innovators have found product-market fit, are demonstrating that they can execute their business plans, and have figured out their go-to-market strategies. Without this type of startup progress, it’s difficult to imagine how a corporation can engage in a way that creates strategic value for the CVC’s parent company.
Corporations often say learning and insights are among the most important goals of their venture programs. While failures can certainly generate learning, insights about new markets and solutions are more likely to be generated from successful investments, more so than the losses.
3. Improved deal flow
Because entrepreneurs and venture capital co-investors seek corporate investors who are aligned, they are generally more comfortable with CVC investors who have previously been successful. That is especially true if the corporation also has a demonstrated track record of facilitating commercial relationships with startups or providing other positive impact that helps deliver a positive exit. This can become a virtuous circle:
- The corporation provides support and adds value to a startup, including by executing a commercial transaction
- The startup becomes a successful financial investment, exiting via M&A or an initial public offering
- The positive investment track record leads entrepreneurs and VCs to seek out the corporation as an investor
- Higher quality and quantity deal flow will likely lead to additional successful investment opportunities, and therefore more chances for the corporation to provide support and add value to successful startups
4. Innovation can be a profit center
A corporate VC effort that focuses on financial returns and successfully returns capital will likely generate investment profits for the parent company and cover the cost of the program. This is the holy grail of corporate venture capital — the corporation receives all the strategic benefits of the startup investment program, but without costing the corporation a dime. Financial returns in the form of profits will also likely lead to the long term survival of the investment program. What CEO would eliminate a corporate venture program that is making money for the corporation and providing access to external innovation at the same time?
At Touchdown, we like to joke that “it is never strategic to lose money.” While in my opinion, no large corporation should be in venture capital solely for investment profits, the best programs I’ve seen have a dual screen for financial and strategic returns. The best financial investments should lead to strategic benefits, not to mention long term survival.
David Horowitz is a Co-Founder and the CEO of Touchdown Ventures, a firm that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs.
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