Why Corporations Are Turning to Venture Capital to Drive Innovation
Corporate Venture Capital is growing rapidly. It is one of the fastest growing segments in venture capital. According to Pitchbook, corporate venture capital grew from $12 billion in 2011 to $194 billion in 2021. Corporate venture investments represent almost 30% of the $675+ billion in venture capital dollars deployed in 2021. Not surprisingly, the number of corporations investing in venture capital has naturally increased as well. 970 corporations made an investment in 2021 compared to only 273 investors in 2011.
Marc Vartabedian, Sara Castellanos, and Steven Rosenbush of The Wall Street Journal wrote an article entitled Corporations Outside of Tech Ramp Up Venture Investing citing the growth of non-technology corporations doubling down on venture investing.
But why are more companies, especially those in non-technology industries launching venture capital arms?
The rationale is that the venture capital process creates a disciplined approach to bringing external innovation into the corporation.
Venture capital has four main activities: sourcing, diligence, transacting, and portfolio management. These are the same activities that corporations need to excel at to bring external innovation into their respective organizations. Let’s explore each of the four activities in more detail:
1. Sourcing
The typical venture capital investor will source several hundred new deals a year. In corporate venture capital, sourcing is often targeted to specific industries. The best corporate venture capital firms have experience and relationships to generate not only the quantity but quality of the opportunities. As my Touchdown Ventures co-founder Scott Lenet wrote in Structure Beats Chaos in Corporate Venture Capital, “…the principle of selectivity: better decisions are driven by having a lot of choices…generating high volumes of potential deals requires an established reputation, sourcing relationships, and a team that can process the deal flow”
2. Diligence (Evaluating)
Once you generate and review the deal flow, the real value of the venture capital process is the filtering of that deal flow. Whether your corporation is evaluating a potential start-up company as an investment, business partner, or even an acquisition target, all of these activities require a process to diligence whether that start-up company is a viable candidate. My colleague Greg Bergamesco posted Dig for Diligence: A primer on the venture capital due diligence process. Greg provides a framework of preliminary and full due diligence along with highlighting the 4 major risks to a start-up company: market risk, people risk, technology risk, and financing risk.
3. Transacting
After successful completion of due diligence, it is now time to transact. In corporate innovation, transactions can take many forms: a straight investment, an investment coupled with a commercial relationship, a commercial relationship only, perhaps the opportunity is so strategic that the corporation decides to acquire the company outright. My colleague Eric Budin authored It’s Never Too Early where he argues a good first step can be for the corporation to enter into a pilot or that can help both the start-up assess product/market fit and for the corporation to continue their diligence on whether the target company is the right partner.
4. Portfolio Management
Whether the transaction is an investment, a commercial relationship, an acquisition, or any combination thereof, the most important activity is portfolio management. Due diligence does not end at the transaction; a best practice of portfolio management is that the start-up diligence process continues. Scott Lenet writes about the importance of portfolio management in The Most Overlooked Skill in Venture Capital: “Managing acquired companies, investments, and commercial partnerships can require more time than all other activities combined,” as illustrated in the graphic below:
Management does not end until there is a successful exit (you could argue this is really the 5th activity of venture capital) and in the case of corporate innovation that could be the start-up investment or partner has sold itself to the corporation or has been acquired by another strategic buyer or has gone public.
In summary, venture capital creates a process to source hundreds of opportunities, filter and diligence them and transact and manage. It is no surprise why that framework is the same one that corporations are turning to to drive innovation.
More corporations will continue to launch corporate venture arms for this reason. And yes, even in a downturn, corporate VC is Here to Stay. Innovation never ends, in a good economy and in a bad economy. We will continue to see the growth of large corporates turning to corporate venture capital to access external innovation. Scott predicts in his article A Dozen Innovation Predictions In the Coming Decade: “…by the end of the coming decade, CVCs [corporate venture capital] will compose approximately half of the venture capital market by global deal volume.” That actually already happened in 2018 based on venture funding dollars, so I will bet the over on that prediction.
David Horowitz is the CEO and co-Founder of Touchdown Ventures, a Registered Investment Adviser, that manages venture capital funds for corporations.
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