Corporate venturing is the cool new shiny toy in the innovation playbook. So cool and shiny, that I’m losing track of the new CVC arms being launched- eager to join the VC bandwagon, and provide an added ooomph-factor to their innovation pursuits. Being a corporate investor has never been sexier than now.
But launching a corporate VC comes with it’s drawbacks, pitfalls and challenges. Traditional VC funds can take years of hustling, networking and building trust and a track-record to get off the ground and raise funds. With corporate’s, it can be off-the-balance-sheet in a matter of months. Speedy, certainly. Well thought-out, not always.
You see, in most instances corporate VC’s play a tricky juggling act between meeting short-to-mid-term company-wide strategic objectives- and proving they are not going to throw $50 million in the bin (a cursory number I’ve just selected) to their shareholders. Let’s keep in mind that the majority of these shareholders sitting in a boardroom, whilst very wise about P&L’s and dividends, have in most cases, had little to no contact with startups. Let alone invested in one. But they hear it’s cool, and that the company will appeal so much more to millennials- and hey, if Competitor X is doing it…et voila! CVC unit signed off. But can it be as successful as a traditional venture capital fund?
In this vein, I thought I would highlight how to not fall prey to some of the typical trappings that come hand-in-hand with launching a corporate venture capital fund (and how to navigate them-because they’re going to prop up, trust me). Corporate venturing can be successful- and yes (GASP!) it can generate multiples when the foundations, investment strategy and logic is right.
Here are the 7 deadly sins committed by most incipient corporate venture capitalist units:
(Note: this applies specifically to early-stage, minority corporate investors– and focuses on fund strategy and management for internally managed funds. Sins made when negotiating a deal with startups merits another post onto itself).
Sin #1: Corporate Venturing is not open-innovation
Corporate venturing is increasingly being regarded as another tool in the innovation and open-innovation box. To this effect, it is also often linked directly to the innovation arm of the guilty. Is it a vehicle to source innovations relevant to a company? Of course. Can it be managed like an open-innovation program? No. Open innovation is frequently at the top of the innovation funnel, dealing with (potential) innovations at the idea stage- whilst corporate venturing is much lower down- and exists to invest in startups with a PoC and product-market fit at the very least. An open-innovation program exists to create and accelerate nascent innovations- whilst a corporate venturing unit is there to invest in, and scale startups. Open-innovation can be very hands-on, and conducted in quick bursts- whilst venturing is operationally distant, and conducted over years. Open-innovation is experimental, corporate venturing ultimately- focuses on generating returns. Does that mean they do not go hand-in-hand? No. An open-innovation initiative can be a great search filter for future investment opportunities within a narrow search field. But before it comes into the headlights of your CVC unit, remember that it has to go through a couple of stages in the innovation funnel first- and should not be used as a vehicle to fund open-innovation.
Sin #2: Never mind governance
Whilst corporate governance is on top of the agenda for most corporates, this seems to fall in priority-level when it comes to corporate venturing. Legal and governance stuff can be boring and complex- we know- but getting this right (or wrong) will make all the difference- not disregarding the venturing unit/arm has a fiduciary duty to it’s LP’s- regardless of who they are. Fatal roadblocks can occur down the line if the right questions aren’t asked from the onset: Is the CVC unit tied to the company or independent? Is it funded off the balance-sheet on a case-by-case-basis or does it have fixed-term funding? Is it internally or externally managed? Who does the investment team report to? Can the investment team make investment decisions independently, or does it need approval from an investment committee? Is the investment committee internal, or is it composed of qualified industry experts?…And the list goes on. I get it- focusing on the governance structure is not the sexiest activity you can do as a budding corporate venture capitalist- but it may be the most important. It will impact your legal structure, decision-making process, transparency, timing, due diligence and everything in between.
Sin #3: Strategy vs. numbers
Regardless of what I hear, corporate venturing will always be linked to the strategic objectives of a company- however far off and distant they may seem. Strategic objectives provides guidance around future search fields, investment stage, priorities, risk-adhesion, support and anticipated ROI (and in most cases this isn’t always financial). Due to this, investment decisions can be cast aside for more…ahem, intangible strategic ROIs. This can lead to flailing investments down the line, ridiculous valuations (yes, CVC units are guilty of inflating valuations when investing due to their…you got it, perceived strategic value), shifting priorities, and an enhanced focus on corporate alignment rather than scale. To avoid this, from experience, keep your investment team away from the strategic integration and venture-client relationships you may develop with a portfolio firm. Let them do their job, and leave managing venture-client relationships-if any- to another unit (such as your innovation team, or which ever department is most relevant to the relationship). The last thing you want is a fire-sale because your strategy has changed and your investment portfolio is strongly tied to it (looking at you GE). From the investment team’s perspective- the first three years of the venturing arm’s lifecycle should focus on sourcing and investing within the given strategic search fields, and providing the guidance to scale the portfolio- and then should shift fully to financial performance. In any case, no investment EVER should be carried out without identifying exit scenarios, other than those which involve the company.
Sin #4: It’s all mine- my precious!
Gollum reference aside, this is the number one sin all corporate venture capitalists will make at some point in time. No exceptions. You find a startup. It’s developing a product/technology of significant strategic value. You want it for yourself. Alone. What if your competitors get their hands on it? We need to invest. Now. We need the IP. All to ourselves. However, if you’re a minority corporate investor in early-stage startup- this may be just a little problematic. At best, any IP jointly developed can be secured through shareholder’s agreements and contracts. At worst, you’re just crippling the startup from scaling outside your sphere- which means, it will probably fail. I’ve seen startups sign away on exclusivity, or come to the table with such terms that it makes it nye-on impossible to get other investors on board. So if you run into a startup that holds such immeasurable strategic value- acquire it- don’t come in as a minority shareholder. Save the founders, and yourself the time and trouble- and ensure you keep having great deals come to the table.
Sin #5: One-way deal flow
Some corporate venturing units strongly believe that most, if not all deal-flow should be in-bound. This also applies to sources of deal-flow. It’s perfectly normal to have preferred partners and trusted sources of deals (accelerators etc) in place- but these need to be as diversified as your portfolio. Doing this right means a break-down by region, vertical and stage- and not to forget that some of the best deals come from word of mouth. Accelerators typically have 1-2 batches a year, and even if they are Y-Combinator grade, this can, over time, lead to an undiversified- therefore more risky portfolio. I personally have a preference for the value-chain approach: identifying search fields and deal sources which fall across the corporate value chain, and where the involvement of other accelerators, corporates and investors can add significant value and expertise to the performance of the firm, rather than be seen as a competitive threat. Talking and making yourself known to future deal sources should also start early- as these relationships are based on trust, and takes time to develop and enable you to catch the best deals early.
Sin #6: FOMO
I’ve noticed a recurrent pattern- which seems to happen consistently in seasonal peaks among corporate investors: FOMO. A startup(s) from an accelerator batch graduates- and shows potential. It’s also been featured a few times in the news. The founders are talking the talk. There’s a fit with your search field. But you realize you’re not alone- your competitors are also talking to them- hell, there’s a buzz around them– better invest quickly! Is it truly a good fit or is it FOMO (fear of missing out)? I’ve been there- we’ve all been there. But whilst being able to act with speed is valuable both to founders and corporate investors, making a deal out of fear of losing out is not. The result: you skimp on due diligence and risk missing out on key details- as well as the tendency to over-value the potential (in both the strategic and monetary sense). Don’t act on FOMO. Maintain the appropriate due diligence and investment processes you have in place and get to know the founders. I cannot repeat this enough: when it’s an early-stage investment, the team is the most important thing you are evaluating- and potentially investing in. Don’t ignore red flags by fear of losing out.
Sin #7: It’s all about the perks
I’ve noticed that startups raising funding either actively look for corporate venture capitalists, or avoid them like the plague. No middle ground. There is a (perhaps slightly true) belief that they will get over-involved, eat-up the company, or lose interest quickly. For those founders actively seeking out corporate investors, they typically do so to accelerate industry know-how, feed into existing supply chains, and optimize their product/technology. When launching a corporate venturing unit, consider what added-value you are not only willing, but able to provide. Will you be an active or passive investor? Is the aim to develop venture-client relationships with your company? Will you be providing support in hiring and talent acquisition? Will you open-up supplier and client networks? Basically, you have to consider from the on-set what will be your service offering making you a more attractive partner (yes, I repeat- partner), attract top startups, enable horizontal portfolio integration, and enhance performance. Don’t skimp on this- as this will require buy-in company-wide and will impact the time, resources and ultimately economics of the fund. Remember that startups attracted to corporate investors look for smart money, especially when they are early stage- so have your infrastructure and innovation funnel in place to cater to this.