I started writing these posts with the hypothesis that in their effort to innovate, corporations must re-invent the traditional R&D model with one that augments the R&D efforts with venture investments, acquisitions, strategic partnerships and startup incubation. Corporate VCs (CVCs) are expected to play a big role in this innovation quest. With that in mind corporations are establishing such groups in record numbers, including corporations from industries that have not traditionally worked with venture capital. Corporations have been providing their venture organizations with significant size funds to manage, and expect them to invest in companies of various stages and geographies. Today’s CVC prominence can result in many advantages for entrepreneurs and co-investment partners but also carries risks, many of which are due to the way CVCs are set up and operate within the broader corporate structure. In the last blog I examined how the disruption of institutional VCs (IVCs). In this blog I will take an in-depth look of corporate VCs. I will examine the different types of corporate VCs, compare the characteristics of today’s corporate venture groups to the characteristics such groups had in the late ‘90s, and describe the areas where CVCs must focus on in order to succeed. In the next blog I will provide some ideas on how to best set up a CVC organization based on my work with such organizations to date.
A short historical perspective
This is not the first time CVCs have entered the startup ecosystem. According to BCG, the first time was in the mid-60s. The main driver at that time was financial returns rather than innovation even though that period was also characterized by technological advancement and strong corporate performance. The next entry of CVCs into the very small startup ecosystem occurred in the early ‘80s and was again financially motivated. The first institutional VC firms (IVCs), as we know them today, were also being formed at that time. That foray came to an abrupt end with the stock market crash of 1987. Ten years later, during the dot-com era, the technological innovation that was being created and the stock market performance brought CVCs back to the startup ecosystem. For the first time investing in innovation became a motivating factor in addition to the drive for financial returns. The 2001 recession ended the third wave. The most recent wave of corporate VCs begun around 2006 but CVC group formation has picked up steam around 2009-2010. As I mentioned in my previous post, according to Global Corporate Venturing, today 1100 corporations have active venture funds. The average CVC program is only four years old with most investing members being part of the program for less than 3 years. Based on my conversations with several corporate executives the CVC group formation is now driven by the existential threat most corporations across industries are feeling due to technology- and business model-driven disruptions.
The money CVCs invest always comes from one source whereas institutional VCs have many LPs in each fund. However, even then the structures of a corporate investment vehicle vary widely. They range from a traditional single LP fund structure with a sunset period that just like in institutional venture funds, is 10 years, to a very loose, off the balance sheet evergreen allocation or committed capital allocation.
CVCs in the Dot-Com era
During the dot-com era CVCs shared a few characteristics. They were:
- Mostly part of US companies. Corporate venture capital was dominated by three industries: high technology, pharmaceuticals and telecommunications.
- Staffed with corporate executives rather than investment professionals.
- Investing large sums of money (maybe as high as $15B/year) primarily in late stage rounds they wanted to lead alone.
- Interested primarily in Internet technologies for connectivity and communication.
In addition to the 2001 recession the third CVC wave came to an end because:
- Their corporate parents lacked what Gary Hamel calls an innovation culture and DNA. Culture is a very important issue for corporate innovation and can be demonstrated repeatedly as corporations work with startups. Innovation culture implies that the corporation must:
- Embrace risk. Several types of risk are inherent in venture-backed companies (technology risk, management risk, etc.). These companies raise capital in order to address these risks. Their investors understand this reality and help them in the process. IVCs realize that despite their best efforts a startup may not be able to overcome its risks and ultimately fail. Corporations may consider these risks unreasonable or imbalanced but they must be prepared and willing to deal with them. Embracing risk also implies looking at different areas and favoring outlier ideas in order to identify the disruptive opportunities.
- Accept failures. Failures are a normal consequence of embracing risk and seeking innovation. As such, corporations must come to terms with the fact that most startups fail. Innovation-related failures should be seen as opportunities to learn rather than as opportunities to criticize and assign blame. Consider concepts such as Minimum Viable Product that is embraced by startups and Zero Defects used by large corporations in order to understand how much the typical corporate must change in order to adopt innovation.
- Move fast, try out new ideas, iterate. Corporations must understand the importance of speed and of the sense of urgency startups thrive on and how these impact their ability to disrupt. They must then try to understand how the strict adherence to corporate processes can negatively impact their ability to become disruptive innovators. Their innovation culture must empower them to make decisions and operate on partial information. Finally they must realize that innovations can come from the rapid iterative refinement of some breakthrough ideas.
- Assimilate fast. As part of the innovation culture the corporation will also need to make an effort to quickly assimilate the most promising of the innovations being funded by its CVC organization even if they run counter to existing practices.
As Google and its venture group (Google Ventures) clearly demonstrate, the CVC group’s culture is invariably a reflection of the corporate parent’s innovation culture. In addition to the corporate innovation culture, the CVC group’s culture must be consistent with the organization’s goals. If the corporate venture group’s goal is to achieve top financial returns, then the CVC must adopt a culture that is similar to that of institutional VCs, particularly the new-style VCs.
- They didn’t establish realistic timelines for achieving their goals. They were promising to their corporate management quick ROI even though they were investing in companies with early stage characteristics. Figure 1 below depicts the typical timelines for three types of activities for obtaining disruptive innovation: acquisitions, venture investing and startup incubation. For example, the timeline for achieving a positive ROI from the acquisition of a mature company, such as Cognos that was acquired by IBM, is typically 2-3 years. By comparison the timeline for achieving a positive ROI from the acquisition of an early stage company, such as Nicira that was acquired by VMWare is typically 5-7 years. With such acquisitions, by the way, the probability of achieving positive ROI is lower because the acquired early stage company carries significantly higher risk. Similarly, as is shown in Figure 1, the typical ROI timeline for a venture investment in an early stage company is 4-6 years whereas the corresponding timeline for an investment in a seed stage company such as the ones found in incubators or accelerators could be 7-10 years.
While most technology-driven disruptive innovations require a 5-7 year time horizon to reach the industry impact stage, most of the corporate venture investors I have spoken tended to invest with a 3-5 year ROI horizon, something that many continue to this day. There are two reasons for this. First, such time horizons fit with the general corporate ROI timelines that favor shorter-term results. Second, it is consistent with the average tenure of public company CEOs that stand at 3.5 years and for other corporate executives that stand at 5 years.
- The CVC teams were staffed with corporate executives rather than experienced venture investment professionals. This was done because many corporations at the time felt that in their CVC groups they needed individuals with strong corporate background and understanding of business processes. They also didn’t put in place compensation packages that would have been attractive to venture investment professionals, e.g., carried interest-based compensation. As a result, they couldn’t attract talent with institutional VC experience.
- They co-invested with institutional venture investors who had different economic and risk objectives than the CVCs. Many of the relations with these investors were incidental, with IVCs often viewing CVCs as “easy money.” In addition, many IVCs operated (and to this day continue to operate) under the assumption that if an early stage company accepted a corporate venture investment, then future partnerships with other corporations, or potential acquisition options, may be constrained. For this reason institutional VCs tended not to engage corporate VCs with their early stage portfolios and when they did, hesitated to show them the best companies in their portfolios.
- They could not convince the business units that the CVC group was strategic to the corporation in providing over the horizon visibility to innovation. One reason for this perception was because little or no knowledge was transferred through the CVC groups and their portfolio of investments to corporate business units. In very few instances at that time the portfolio companies of a CVC formed strong partnerships with the parent corporation’s business units.
Corporate Venture Capital today
I organize CVCs into two broad types. The first, and largest, category includes the business development-driven CVCs, or strategic CVCs as they are also called. The goal of these organizations is to use investments as a means to develop closer relations with startups in order to a) identify among them partners for the company’s business units thus helping their strategy, or even future acquisition targets, b) monitor the development and evolution of new technologies and business models, and c) better understand new markets. Four examples of such CVCs include: Citi Ventures, Verizon Ventures, Dell Ventures, and Unilever Ventures.
The second type includes the financially driven CVCs. The goal of these organizations is to use investments in order to achieve financial returns for their corporate parent. Four examples of such CVCs include: Google Capital, Intel Capital, GE Capital, and Sapphire Ventures (SAP). Some strategic CVCs, such as Nokia Ventures, have financial returns as a secondary goal.
Today’s CVCs have the following characteristics:
- Corporations from around the world and from a wider variety of industries, e.g., automotive, logistics, manufacturing, CPG, and energy, are establishing corporate venture groups. Moreover CVCs today are pursuing investments globally.
- Invest in several different technologies, e.g., big data, cloud computing, cleantech, food. These technologies may be relevant to the corporation’s core business products and services, e.g., Citi Ventures investing in Square, areas that are adjacent to its core, e.g., Tesla Motors investing in solar energy, its enterprise capabilities, e.g., storage, big data, or completely outside the scope of its current business, e.g., Verizon Ventures investing in adtech company BlueKai.
- The CVC groups are staffed differently depending on their type. Strategic CVCs that have been formed in the last four years, such as Dell Ventures, are more likely to employ partners with institutional VC experience. As a result, these CVCs have become better at evaluating startup risk and feel more confident investing in early stage startups with validated aspirations for successful returns. By comparison, older strategic CVC groups, such as Verizon Ventures, are more likely to till employ only corporate executives and in fact several are staffed by a rotating group of executives with no investment experience. These groups remain unable to develop institutional knowledge about investments, which is necessary for their long-term success. But even in those cases, the executives have a business development and business development background. Today, most financially driven CVCs are staffed with individuals who have significant institutional VC experience and they actively recruit additional partners from IVCs.
- Participate in early and later stage investments. Early stage investments enable them to fulfill their innovation mission by giving their corporate parents over the horizon visibility to new technologies and business models. CVCs have learned that in order to remain effective and influential with their early stage portfolio companies, they must be willing to participate in follow on financing rounds. There is an extra opportunity for CVCs because of this flexibility. As a certain segment of the IVCs is being disrupted, CVCs have the unique opportunity to fit between early stage VCs, e.g., micro-VCs, and private equity firms and thus improve their position as long term partners of startups. Late stage investments enable CVCs to identify strategic partners to their corporate business units, e.g., Intel’s investment in Cloudera, or opportunities to set up new business units, e.g., GE’s investment in Pivotal along with the creation of the big data business unit. CVCs also syndicate rounds with other CVCs or institutional VCs. Finally, even though CVCs invest significantly less money annually (MoneyTree estimates about $3B/year but increasing to $7B+/year based on 2014 trends) than in the past, as shown in Figure 2, their contribution to the overall VC investments is increasing.
Figure 2: Percentage of Total VC investment coming from CVCs
Driven by the accelerating rate of innovation, its scope across several technologies and business models, along with the increasing opportunities for incumbent disruption these are causing, corporations from many different industries and countries are establishing venture groups at a high rate and allocating funds of significant size. Similar past efforts have not been particularly successful for a variety of reasons including lack of corporate innovation culture and appropriate timelines to ROI. Corporations are applying lessons from those past efforts as they set up these groups and try to improve their innovation efforts.
(Cross-posted @ Re-Imagining Corporate Innovation with a Silicon Valley Perspective)