Large, established corporations increasingly rely on external sources of innovation. One way these corporations seek to support innovation activity is through corporate venture capital programs.
According to the National Venture Capital Association (NVCA), established corporations invested greater than $4 billion in venture capital in 2014, representing greater than 10% of all U.S. venture capital investments for the yr.
There are many different structures and practices associated with corporate venture capital, which, in part, reflect the diverse goals of corporate investors, which regularly go beyond financial returns. For example, corporations akin to IBM and Cisco have used their venture capital programs to explore possible merger and acquisition opportunities.
Established corporations also use them to complement internal research and development departments, providing them with latest technologies and ideas that complement future product development efforts. For others, venture capital programs could also be a option to engage with latest, disruptive products or technologies and monitor latest, disruptive products or technologies that might potentially pose a threat to their existing business.
The dual goals of corporate venture capital programs – strategic and financial – offer more structuring opportunities than are needed for independent venture capital firms. If you are considering launching a venture capital program for your organization, it is necessary to decide on a structure that aligns with your organization’s priorities.
We recently accomplished a Research work examining the trade-offs between building a corporate venture capital program internally and building it externally as an independent entity outside the company. We also looked at how different organizational and legal structures impact human resources policies and investment practices, which can ultimately help achieve corporate goals.
Based on what we learned from our in-depth interviews with investors and investees in the U.S., Europe and Asia, here are some key issues corporations should consider when establishing a venture capital program.
Internal and external
Generally speaking, internal entities in which corporations invest from their very own balance sheets are more conducive to strategic investments that support the corporate sponsor’s existing core business. However, they often make slower decisions and are subject to greater fluctuations in strategic direction and resources, depending on the financial health of the corporate sponsor.
External entities can have greater flexibility in decision-making and be more agile and autonomous in exploring investments in latest business areas or innovations that have the potential to disrupt core operations. One consequence of this difference is that external entities could also be higher suited to early-stage investments where the link to the core business is sometimes unclear and there is uncertainty about the startup’s strategy and direction. They also are likely to attract experienced investment managers and provide the corporate sponsor with each strong financial returns and strategic advantages.
Consider strategic goals
Internal units are higher when short-term strategic goals are clear and require strategic investments to pursue those interests, or when the external environment is unfavorable and the need for tight control of investing activities is paramount. In such cases, strategic considerations may outweigh financial considerations.
On the other hand, when there is less strategic overlap between the investor and the investee, it could also be more appropriate to measure the performance of a corporate venture capital program based on financial returns. This is easier to do with an outdoor unit.
Taking advantage of synergies
Focusing solely on financial goals makes it very difficult for corporate venture capital units to compete with more experienced in-house VC firms that provide greater incentives to their managers. The most successful corporate venture capital programs are people who can leverage the existing resources of the corporate sponsor as a key differentiator. A careful look at technology transfer opportunities between corporate sponsors and investees could potentially create value for each parties.
Ecosystem development
When combined with other tools (akin to internal R&D, mergers and acquisitions, strategic alliances), corporate venture capital programs can be excellent for growing the ecosystem. This allows you to create your personal partner networks or value chains, without the burden of integrating partners into the existing business of a corporate sponsor. The sponsor can then retain influence due to a minority share in the share capital. For example, Google, Motorola, and Apple have used venture capital programs to assist create an ecosystem around their wireless and Web businesses.
The corporate venture capital model is still developing and is less mature than the internal venture capital model. It has taken a long time for in-house VC firms to determine their popularity and know-how in supporting startups.
At the same time, an increasing variety of corporate venture capital programs have moved from internal to external units in recent years, making it premature to attract definitive conclusions about whether external units are outperforming internal units. Because latest entrants typically adopt established industry norms, it will likely take many years to find out the best organizational structure for newly established venture capital programs.