Why Your Corporate Venture Fund Should Have an External Investment Committee Member
Corporate venture capital (“CVC”) firms typically form an investment committee (“the IC”) to guide the corporate venture capital strategy, measure performance of the CVC, and ultimately empower all new and follow-on investment decisions.
Stanford Graduate School of Business Professor Ilya Strebulaev compiled primary data on over 160 CVC programs. Professor Strebulaev’s research on corporate venture capital investment committee composition showed that most CVC programs have between three to seven representatives, with a median of four representatives on the investment committee:
1. 54% of investment committees included the corporation’s CFO
2. 39% of investment committees included the CEO
3. Only 4% of investment committees included an external member
Only 4% of 160 CVCs included an external representative, an outsider not affiliated with the corporation, serving as a member of the corporate venture capital investment committee.
Professor Strebulaev begins to make the case for why an external member should be on the IC:
“Do IC members, executives of a company with a revenue often a hundred times the CVC budget, have the time and incentives to dive into details of what may seem to be trivial financial decisions…Do they possess sufficient knowledge to evaluate and select cutting-edge startups, especially outside the company’s core?”
Research from INSEAD further supports the idea of including external team members in a corporate VC:
“It turns out that having at least one team member with venture capital experience on-board brings deep practice knowledge, such as a better handle on how to look for new ideas, how to evaluate early stage start-ups and create contracts, etc. Without the full know-how and mind-set, teams lacking experience with venture capital tended to adapt the VC practices in unhelpful ways.”
Based on my experience managing multiple corporate VC programs, every CVC should have at least one external IC member. I believe there are four primary benefits:
1. Experience
2. Independence
3. Education
4. Fiduciary Duty
1. Experience
Professor Strebulaev’s research indicates CVC investment committees often include senior corporate executives such as the CEO, CFO, or a business unit leader. These executives tend to have significant experience operating large enterprises and also possess industry expertise. However, these executives typically have less experience or familiarity with venture-backed startups.
An experienced VC or CVC investor can complement corporate expertise by providing judgment as to whether the investment team completed adequate diligence, helping identify risks by applying pattern recognition from previous VC deals, reviewing venture deal terms to ensure compliance with industry norms, and evaluating whether the proposed investment could generate a sufficient venture capital return for the stage of investment. An external representative can likely help with the assessment of the startup’s management team and the quality of the other co-investors, since an experienced external IC member should have a large network of venture capital relationships to facilitate checking references.
An external representative can also be valuable when making follow-on investment decisions, since the corporation may be evaluating and negotiating terms that are specific to venture capital, such as bridge rounds and pay-to-play provisions.
2. Independence
Corporate investment committees may spend a lot of their time thinking about how a startup company addresses strategic needs for the corporation, including whether the corporate parent can become a customer or leverage the product or service of the proposed startup investment. While that mindset is important when evaluating a CVC investment, the corporation should also think about the opportunities the start-up has outside of the corporation’s four walls. When corporations make venture capital investments, they should want to ensure the market opportunity is larger than just the potential business that can be conduct with the corporation. If the corporation is the only customer, a minority investment is unlikely to produce venture returns.
An experienced and effective external IC member should help the corporate IC evaluate the startup’s prospects with other potential customers outside the corporate parent, and even beyond the corporation’s industry. The external IC member should ensure the investment team performed adequate customer references with other potential customers and partners.
Professor Strebulaev’s research noted that 29% of CVCs reported that a single vote is the pivotal decision maker. It’s logical to conclude that the most senior internal executive on the IC, such as the CEO or CFO, is that pivotal decision maker. An outsider may be the right person to point out risks or potential benefits to those senior executives, to offset a potential single point of failure. Would an IC consisting of executives who report to the CEO go against a strong-willed CEO? I have seen first hand how subordinates to a senior executive can be afraid to do so. Being willing to speak up when the facts are not being considered objectively is an important role that can be performed more easily by an independent IC representative.
Professor Strebulaev notes:
“Consider adding external IC members (an institutional venture investor or a representative of another CVC) who will provide, like independent board members, independent insight without the baggage of internal politics or conflicts.”
Nearly every large corporation has one or more independent members on its board of directors to provide objective governance and oversight, so why shouldn’t the corporate venture investment committee do the same?
3. Education
An effective external IC representative should also educate less experienced corporate executives on everything from how to conduct diligence, analyzing financial models including evaluating market size, understanding investment returns analyses, becoming fluent with venture capital terms, and more. A typical corporate IC member is likely unfamiliar with VC terminology like liquidation preference calculations, anti-dilution protection equations, various redemption rights, ROFR and co-sale rights, and protective provision thresholds, and many others. A diligent external IC member will take the time to not only explain the term clearly to the rest of the investment committee, but will explain why a particular term might be more or less important for a specific proposed investment.
CVC leadership should select an external IC representative who has not just experience, but also demonstrates a love of teaching, since those roles can contribute to the capability and performance of the entire investment committee.
4. Fiduciary Duty
Whoever serves on the corporate venture IC should act as a fiduciary in the best interests of the corporation. There are several requirements of being a fiduciary, including like disclosing and managing conflicts, as well as putting the corporate parent’s interests ahead of the IC representative’s own self interest.
Registered Investment Advisers (“RIAs”) are, by law, fiduciaries to the clients they serve. As such they not only undergo training to be competent fiduciaries, they also practice it day in and day out while interacting with their clients.
Moreover, under the U.S. Investment Advisers Act of 1940 (Section 202(a)(11), any person or firm that, (1) for compensation, (2) is engaged in the business, and (3) provides advice about securities, will need to register as an investment adviser (an RIA) with either the state where they operate or with the Securities and Exchange Commission, unless there is an appropriate exemption. Therefore, by including a compensated, external representative on a corporate IC who is a practicing VC investor, that individual should be, or be associated with, an RIA.
The Touchdown Ventures team has significant venture capital and corporate venture capital experience, having managed over 100 corporate venture capital investments as an external partner to more than 20 corporations. We also teach venture capital and corporate innovation at leading universities including the University of Michigan Ross School of Business and the UCLA Anderson School of Business. Our team has previously taught or guest lectured at the Wharton School of Business, Harvard University, Stanford University, University of California Berkeley, University of California Santa Barbara, California Polytechnic University, Carnegie Mellon, University of California Davis, the University of Southern California, University of Texas Austin, Stockholm’s Royal Institute of Technology, and many others. Touchdown Ventures is also a Registered Investment Adviser with the Securities and Exchange Commission.
Our team has served on over 20 corporate venture capital ICs, and we are available to serve on the VC investment committees of corporations seeking to maximize financial and strategic returns. As my co-founder Scott Lenet writes in his article on driving high performance investment committees, there are numerous best practices for serving in this role that can smooth the process for everyone involved.
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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