rant discussion yesterday on how big companies seek to become more open to technology, one question we received was how does Corporate Venture Capital fit into this mix? This is a question we get often, and the answer is it depends on a lot on how the Corporate VCs operate.
Corporate VCs are just like traditional venture capitalists, but instead of operating their own fund with money from other investors, they are embedded within large companies, who provide all of the capital.
Corporate VCs have a reputation for being a bit slower and sleepier than traditional VCs, less willing to take risks in an inherently risk-centric field. This reputation is largely unfair. There are hundreds of these firms now, and hence a very wide array of behaviors. The funds have very different incentive and risk profiles from each other, but also a considerable variance from traditional funds. A lot of their behavior is determined by how the parent company views the role.
To greatly oversimplify, there are two ways to structure corporate venture teams – they can either operate as independent, stand-alone funds or they can serve as a funnel for the company’s larger strategic objectives. Sometimes these two functions overlap, but in our experience the best funds have a very clear, well-defined mandate. They key differences between the two largely rest in the areas of incentive structure and decision making authority. Below we compare the two models, and we are going to make some generalizations, as always individual practices can vary considerably from these ‘norms’.
Corporate VCs that operate as stand-alone funds have the advantage that they can generally move much faster and take more risks. Usually, these teams can make investment decisions on their own, or with the approval of some form of corporate investment committee, usually run by the CFO or CEO of the parent. The other big advantage these teams have is that they can usually pay competitively for talent. Since they have an independent fund structure (or something close), the team can participate in the upside of deals. The primary drawback is that these teams tend to have far less integration with the broader company.
We once worked for a company which had one of the best-known, longest standing corporate venture firms. Someone from another corporate venture team asked how this company handled M&A integration with portfolio companies, and we had to pause. To the best of our knowledge, this company had never acquired any of the venture team’s portfolio companies, maybe a handful over 20 years. The venture team was just not connected to the broader team.
By contrast, corporate VCs that act as scouts or strategic pathfinders for their larger companies move at a different pace. We have seen a lot of these funds pop up over the past ten years, as non-tech companies look for some tech angle or high-growth area. By their very nature these companies are much better integrated into the parent company. Often, they serve as an incubator, grooming start-ups for eventual acquisition into the mothership.
These arrangements often sit much easier within the parent. Once they have brought in a few successful acquisition targets, sales channels or new products, there is little questioning of their value to the company. By contrast, the stand-alone funds are often the subject of corporate jealousy and often the target of some new executive re-organization scheme. That being said, their pay structure is often very different, as their is no easy way to tie performance pay to the outcomes without a standalone fund. No one really wants to see the corporate parent in a bidding war with their own venture team. This makes a bit harder to recruit, but also reduces a common source of friction with the broader company.
The big drawback of this approach is that decision making takes much longer. Investment decisions often need buy-in from the business unit most closely related to the start-up. This not only slows things down, but can also warp decisions. Often (really, really often) the relevant business unit is allergic to the outside approach, a condition known as Not Invented Here syndrome. Often, this happens with good reason. Usually, no one knows an industry as well as the people running a business in it. So this team is prone to automatically dismiss a glossy pitch from a start-up looking to ‘disrupt’ them. As a result, these corporate venture teams tend to do fewer deals, and in the worst cases leads to no deals getting done over years.
For start-ups seeking corporate venture dollars, it is important to understand this distinction. We always advise start-ups to evaluate their VCs for what they can provide other than cash. This usually includes wisdom hard-earned from past mistakes and introductions that VC principals can provide. In the case of corporate VCs however, there is often the expectation that the VC can bring access to the parent company as a customer or some kind of partner. Stand-alone corporate venture funds cannot reliably provide this beyond an initial introduction. The less independent corporate teams often have much more pull with the business units, ideally they have brought other successful start-ups to the company in the past and can leverage the relationships they built through this. So often this is the preferred path for start-ups, but as we noted, this path can take far longer and be much more complicated than a traditional VC investment.
Over the past 20 years or so, many venture investors have sought to build out their capabilities to offer their portfolio companies services beyond funding. This includes help with Finance, HR, PR, M&A and customer introductions. This practice has not been lost on Corporate VCs, and there are now many of these that are seeking to systematize their ability to introduce portfolio companies to their broader companies. This is not easy, and only a handful of venture teams have really mastered this, but when it works it can be very powerful.
For companies looking to set up corporate venture teams, we think the most important thing to do is to define very clearly, from the beginning, what the goal of the team is, recognizing team structure will have a big impact on the final outcome. There may be a tendency to prefer the less independent model – less friction, better integration – but corporates need to be honest with themselves about how open the broader company will be towards these types of introductions. If the executive team is going to have to force top-down acquisitions on the business unit anyway, a stand alone venture team may make more sense. And not for nothing, we know some corporate venture teams that boast the best ROI of any unit within their companies.
The worst thing that big companies can do is take a half-hearted approach. If you want your company to have access to the latest, hottest start-ups make sure there is someone inside the organization who understands how those deals are structured – and valued. We know many start-ups who have done full-on, in-depth pitches to corporate C-suites, with full business unit buy-in, only to be rebuffed by a CEO (or, more likely, CFO) who wants that five-year forecast model to plug into their DCF analysis and tries to value the start-up with the corporate PE multiple. These exercises waste everyone’s time.
We have seen both models succeed and both models fail. And that distinction often comes down to initial expectations and objectives. All in all, we recognize that corporate VCs often get second-class treatment at the bar at Rosewood Sand Hill Road happy hour, but done well, these teams can be a great fit for the right start-up.