Making Corporate Venture Capital Work

Corporate venture capital (CVC) — equity investments in startups made by corporate entities — is steadily rising in the market. In 2018, the number of active CVC business units rose to 773, a 35% increase over the previous year. These CVC units participated in 32% more deals and invested 47% more funding over the same period. While technology giants like Google, Intel, and Salesforce were the most active investors, CVC units have been established by corporations across the globe in many industries beyond tech. Johnson & Johnson, Mitsubishi, Robert Bosch, Unilever, Novartis, and Airbus are just a sample of corporations that recently established CVC activities.

As CVC researchers and practitioners, we’ve studied hundreds of CVC operations and deals across the world to identify a portfolio of better and worse practices. In theory, CVC provides a win-win for both established corporations and startups. In addition to capital, startups gain access to valuable corporate resources, industry know-how, advice, and, perhaps most important, contacts and sales leads. For corporations, the benefits include the possibility of above-average financial returns connected with any venture capital investment, and strategic benefits such as access to new technologies or insights that may otherwise be unavailable.

Studying many CVC cycles, however, has taught us that the worlds of venture capitalism and corporate investing are not always easy to combine. After a period of initial enthusiasm, many CVC units falter or close, failing to achieve either financial or strategic returns.

Our research illuminates the main reason for such failures: Many corporations struggle to find the balance between traditional venture capital and internal corporate investment. These two investing approaches differ in important ways, from how portfolios are evaluated and managed to how executives are compensated. The combination of these risks leads to what we call the “stuck in the middle” syndrome, which tends to weaken benefits of both approaches rather than reinforce their strengths.

To overcome this syndrome, we’ve identified three simple rules that may increase the rate of CVC success.

Rule No. 1: Start With a Traditional VC Approach, Then Adapt

Most corporations already have departments that evaluate new investment opportunities, such as merger and acquisition (M&A) teams, innovation units, and business plan competitions. It’s tempting to integrate CVC activity into these entities. But, investing in startups is substantially different from other corporate investment activities.

We recommend establishing a CVC unit built on venture capital industry best practices. These include hiring VC professionals who understand how to successfully navigate the VC ecosystem, have experience structuring venture deals, and bring in an established network to source promising deals.

Unfortunately, attracting VC insiders can be challenging, especially for first-time CVC investors. One significant barrier is that among VC insiders, CVC units have a dubious reputation for failing to identify, incubate, and successfully monetize startups. As Fred Wilson, a managing partner at Union Square Ventures, put it at the 2017 CB Insights Future of Fintech conference, “Investing in companies makes no sense. Don’t waste your money being a minority investor in something you don’t control.” To help overcome this challenge, CVC units can use best practices from the venture capital world, including keeping relative independence from the corporate host. However, even this may not quell the feeling that corporate bosses can pull the plug on the CVC activity at any time.

VC insiders also have different expectations than typical corporate executives when it comes to compensation. They are used to receiving a carried interest — a performance bonus paid out if the fund returns profits above a certain level. These profits are normally shared on an 80/20 basis between the investors and the investment team. This particular type of compensation can be substantial relative to other corporate bonus schemes and thus may cause friction within the corporate environment.

We also recommend not requesting strategic rights as part of the funding of new ventures, because these may keep startups from reaching fair market value when they are sold. For example, call options, or the right to match an acquisition offer, can scare off potential acquirers, who risk losing the acquisition to the CVC sponsoring organization. Asking for strategic rights may also steer the most promising startups away from CVC deals, as the founders and existing investors may fear the exit price will be compromised.

Rule No. 2: Create Processes and Incentives for Employees

CVC investments typically come with an implied promise to give the startup nonfinancial benefits, such as access to corporate knowledge and resources and exposure to potential customers. In reality, these benefits tend to be overstated, since there is little to no incentive for corporate employees to help or collaborate with startups.

This problem’s solution involves both implicit and explicit elements. Top management should make cooperation a fundamental part of corporate culture by actively encouraging employees to collaborate with startups — and by doing so themselves. This helps to demonstrate commitment and relevance. For employee motivation, companies should adopt corporate incentive systems that help match employees with relevant skills and knowledge to work with startups. These incentive systems may extend to including participation in compensation schemes paid to the investment team. We also recommend establishing internal bridge roles or linked teams, made up of employees acting as intermediaries between the startups and relevant corporate entities.

GV (formerly Google Ventures) and Germany’s Metro Group are good examples of CVC units committed to creating value for their portfolio companies. GV has dedicated teams that make sure its portfolio companies interface with Google technology and talent. Metro Group grants portfolio companies preferential access to its international store network and customer base of independent hospitality businesses.

Rule No. 3: Build Communication and Structures to Gain Insights From Startups

A key distinction between VC and CVC is the investment objective. While traditional VC firms strive only for above-average financial returns, CVC units also pursue strategic objectives, such as getting ahead of new trends and technologies. CVC units should therefore be clear about not only their financial objectives but also strategic goals — and set up processes and incentives to achieve them.

This often means clear and effective communication protocols need to be put in place, so that the right people in the corporation gain the insights they need about new industry trends, opportunities, and threats. For example, involving the CVC unit in corporate strategy discussions, innovation activities, and digitization committees can foster the transfer of insights from startups to relevant corporate stakeholders. It can also be helpful for startups to provide regular information updates, new technology seminars, and meet-and-greets to expose their ideas and insights to as many corporate employees as possible. Through regular and continuous involvement between corporate employees, the CVC unit, and startups on various levels, a culture of sharing and learning, beneficial to both sides, can be established.

We suggest that corporations define clear processes and structures that allow CVC units to capture and share insights gathered from their work with startups. Such processes can happen through close links between the customer-facing part of the sponsoring corporation, the startup, and the CVC unit. One such link from the Metro Group is a process that catalogues both internal and customer pain points and links them to startups in its CVC ecosystem offering relevant solutions. They also hold regular meetings to explore how theses startups can work with the company and its customers to resolve problems.

Combining Traditional VC Strength With Corporate Resources

CVC units aim to combine the best of two worlds — the strengths of traditional VC firms and the support of corporate knowledge and resources. The potential synergy from pairing corporations with new ventures is promising, but many CVC units fail to deliver value.

CVC activities based on a traditional VC model, supplemented with specific processes and incentives, will ensure that startups get the benefits they need to grow and that corporations gain sorely needed insights.