Inside Out
The spectrum of corporate innovation from R&D to venture capital
Innovation is a hot topic, and it can be confusing for large corporations. With terms like incubator, accelerator, and corporate venturing frequently mentioned but rarely defined, the menu of innovation options can be overwhelming.
A useful framework for understanding corporate innovation distinguishes what “innovation assets” are controlled by the corporation from what belongs to others. These innovation assets include everything from patents, technology, inventions, business models, customer contracts, and even legal entities. For the purposes of this framework, let’s explore these assets and define whether they are inside or outside of corporate control, to understand the different types of corporate innovation. For the record, corporate venturing is an umbrella term that can include all of the approaches described below.
R&D: Inside-Inside
Research and development has been an innovation lifeblood of our economy for nearly 50 years and continues to be important for corporations. According to the National Science Foundation, in 2015 corporate R&D accounted for $355 billion out of a total U.S. investment of $499 billion in research and development.
Per our framework, these corporate innovation efforts start inside (as research) and stay inside (as development). The innovation assets begin as fundamental science and engineering, patents, and business plans, potentially turning into new products or even entire lines of business for “intrapreneurs” attempting to complement or extend the company’s core business. These internal innovation efforts represent an opportunity for corporations to disrupt themselves, as they chart the path of their evolving businesses.
The corporation maintains full control of its R&D innovation assets at all times.
Incubators: Inside-Outside
Like R&D, incubation is a form of internal innovation. In the most common incubator model, ideas are generated inside the corporation, developed, and then spun out. Because the entity that owns the incubator plays such a prominent role in creating the new business, incubators often receive equity ownership stakes similar to those of startup founders. Incubators typically recruit entrepreneurs to take ownership of the startup, although sometimes internal employees spin out along with the new company. Not all internally incubated business concepts are spun out, in which case they are functionally similar to R&D.
Corporate incubators nearly always focus on sectors relevant to the parent company, and there are many examples of successful corporate incubation programs and startup spin-outs, including:
—McDonalds’s spin out of Red Box (acquired by Coinstar for $150M+)
— Google’s spin out of Niantic Labs & Pokemon Go (reportedly worth $3.5B)
— Oracle Labs’s development of the Java programming language
— Amazon’s Lab 126 creation of the Kindle, Echo, and Fire products
According to New Markets Advisors, a significant portion of Fortune 500 companies — including Procter & Gamble, IBM, Walgreens and The Hershey Company — have some sort of incubator efforts in at least one business unit. On the other hand, incubation can be difficult. A 2012 study of 300 corporate incubators stated that only half deliver on their strategic goals, and only a quarter deliver on their financial goals.
It’s also important to note that not all incubators are housed inside corporations. Idealab! is a successful 20-year old startup studio in Pasadena, California that has launched more than 150 startups, but is independent from any specific corporate parent. In addition to its accelerator and venture fund, Betaworks also operates a “startup studio” that founds new companies, develops the concepts into fundable businesses, and spins them out.
In the corporate incubator model, the corporation maintains full control of its innovation assets until such time as the new company is spun out. The corporation may maintain partial control after the spin out.
Accelerators: Outside-Inside-Outside
Accelerators are examples of external innovation, in which startups are born “in the wild” and apply to participate in a limited-time program with a mix of academic curriculum and unstructured elements. The programs deliver benefits that leave the startups in an advanced condition compared to when they started. These benefits include mentorship, technical product assistance, business development introductions, recruiting support, legal services, fund raising advice, and sometimes capital investment, as well. As a result, innovation assets start outside the corporation, go inside the accelerator, and then return to the outside economy, after completing the program.
If you are trying to distinguish between incubators and accelerators, remember this rule of thumb: if a startup can apply to participate in the program, it is an accelerator, not an incubator.
Accelerator programs are often affiliated with corporations but managed by third parties. Techstars is the most visible example of this approach, operating programs for Amazon Alexa, Barclays, and Cedars-Sinai. These programs typically offer investment in exchange for ownership, usually between 5–10% of the startup’s equity, and not approaching the “co-founder” stakes in the incubator model. These programs provide corporations with the opportunity to explore commercial deals with startup participants. As with incubators, there are many successful accelerators that are not affiliated with corporations.
In the corporate accelerator model, the corporation maintains limited control of a startup’s innovation assets during the time the startup is participating in the accelerator program. If the terms of the accelerator program also include an investment, or board representation, the corporation may also maintain limited ongoing control.
Venture Capital: Outside-Outside
Corporate venture capital (“CVC”) activity is increasingly mainstream, having accounted for 44% of all capital deployed in U.S. venture capital deals in 2016, according to Pitchbook. In this external innovation model, a startup is funded by a corporation seeking to accomplish a mix of strategic and financial objectives. The innovation assets (i.e., the startups), begin outside the corporation and remain outside the corporation.
Like an accelerator, corporate venture capital arms take a minority equity position in the startups they fund, but the size of the ownership stake depends on the amount of the investment, the stage of the startup, and other market conditions. Other key differences include the rate at which startups are added to the portfolio (a corporate venture program typically adds fewer investments per year than an accelerator), and the depth of involvement (a corporate venture investment often leads to a substantial ongoing relationship).
While CB Insights reported that 107 new corporate investors made their first investment in 2016, other programs were quietly cancelled. As with incubator and accelerator programs, it can be difficult to maintain these innovation efforts. Corporate venture capital efforts can fail if they are not run according to industry best practices, if they do not receive sufficient executive support, or if they do not deliver measurable results in a reasonable period of time.
In the venture capital model, the corporation maintains limited control of a startup’s innovation assets from the time of investment until an exit occurs. The extent of the corporation’s influence on the startup will vary according to the terms of the investment, including whether the investor receives board representation.
M&A: Outside-Inside
Mergers & acquisitions is a well-understood technique for bringing external innovation in-house, with $1.7 trillion spent by U.S. and European corporate buyer according to Pitchbook. In this model, innovation assets (i.e., startups and established companies) begin outside the corporation and are brought inside the corporation via acquisition.
In the M&A model, the corporation maintains full control of a startup’s innovation assets beginning at the time of acquisition.
R&D has long been a trusted methodology for internal corporate innovation, while M&A is an established way to bring external innovation under corporate control. Over the coming decade, ongoing corporate exploration of the incubator, accelerator, and venture capital models will expand the use of these additional forms of external innovation, too.
This story originally appeared on TechCrunch.
Liked what you read? Click 👏 to help others find this article.
Scott Lenet is President of Touchdown Ventures, a Registered Investment Adviser that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs.
Unless otherwise indicated, commentary on this site reflects the personal opinions, viewpoints and analyses of the author and should not be regarded as a description of services provided by Touchdown or its affiliates. The opinions expressed here are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual on any security or advisory service. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. While all information presented, including from independent sources, is believed to be accurate, we make no representation or warranty as to accuracy or completeness. We reserve the right to change any part of these materials without notice and assume no obligation to provide updates. Nothing on this site constitutes investment advice, performance data or a recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Investing involves the risk of loss of some or all of an investment. Past performance is no guarantee of future results.
