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. It is assumed that a CVC can move faster, more flexibly, and more cheaply than traditional R&D to help a corporation respond to changes in technologies and business models. 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) can impact corporate VCs. In this blog I start taking 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. Today 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.
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 innovation culture and Jeff Dyer et al. call innovation DNA. Culture defines every company regardless of whether it is an early stage startup or a global enterprise. Culture influences behavior and for this reason is a very important issue for corporate innovation. This can be demonstrated repeatedly as corporations work with startups. Based on the experience I have gathered from the startups I have built as an entrepreneur, and the ones I have funded over the past 15 years as a VC, I always claim that the first 10 employees, starting with the startup’s founders, define a company’s culture. Corporate culture is driven by leadership, is based on performance management, and can only be achieved if there exists a common vocabulary among the individuals that live it. Innovation culture implies:
- Hire the best. Today, more than any other time in the past, there is a war for talent going on in every industry and among companies of every size. Companies with strong innovation culture are great at identifying the best talent, offering the right incentives to attract these individuals, and providing the right environment to keep their employees motivated, productive and well-compensated.
- Trusting. Corporate employees, from the CEO down, need to accept that they need help in achieving their innovation goals (be it sustaining, disruptive or continuous), and all goals for that matter. Employees need to trust their colleagues regardless of rank and feel certain that they will do what is appropriate for the company to achieve its goals rather than what is good for the individual.
- Embracing 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 further 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. Ultimately they must understand which type of risk they are willing to take. Embracing risk also implies looking at different areas and favoring outlier ideas in order to identify the disruptive opportunities.
- Accepting failures. Failures are a normal consequence of embracing risk and seeking innovation. As such, corporations must come to terms with the fact that in the same way that most startups fail, so can their own innovation efforts. Innovation-related failures should be seen as opportunities to learn rather than as excuses for not trying something new out, or 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. Corporations must seek to establish the failure rate they are comfortable with.
- Moving fast, experimenting with new ideas, iterating. Corporations must understand the importance of experimenting with new ideas and pushing their boundaries. They must also appreciate of doing so with a sense of urgency. Startups thrive on experimentation, pushing the envelope and moving fast. These characteristics impact their ability to disrupt. How to set up an experiment is as important as the experiment itself. Sometimes, the experiment is too ambitious and its results not adequately beneficial. Corporations must also 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, in other words operate under uncertainty like all startups do. Finally they must realize that innovations often come from the rapid iterative refinement of some breakthrough ideas. This approach, by the way, doesn’t mean lack of evaluation and measurement, which corporations like to do. It necessitates, however, the use of innovation-KPIs rather than execution-KPIs.
- Assimilating fast. As part of the innovation culture the corporation will also need to empower its employees to quickly assimilate the most promising of the ideas and innovations, even when they are not fully ready or run counter to existing practices. For this reason employees must feel empowered and trusted. They must also learn to collaborate in an effort to make up an innovation’s potential initial incompleteness.
- Celebrating success. In the same way that the corporation must learn to accept failures as a normal step to seeking innovation, it must learn to celebrate success. On this front must can be learned from the way startups celebrate even small successes and from the way their investors encourage them to do so.
CEOs such as Larry Page (and Eric Schmidt before him), Jeff Bezos, Marc Benioff, Mark Zuckerberg, and Paul Jacobs (now executive chairman at Qualcomm) all exhibited these traits and built innovation-driven cultures in their companies. Recognizing the importance of the right innovation culture, corporations such as IBM and BMW are fencing off their new business units (IBM’s Watson unit and BMW’s iBrand unit) from the rest of their established business units. Other companies like Verizon and Samsung are establishing major operations in Silicon Valley and in the process trying to adopt the innovation culture pioneered by the likes of Google, Yahoo, Facebook and the myriad of startups.
One way to influence the corporate culture is to hire entrepreneurs that have founded and ran startups, or entrepreneurs that have the characteristics of startup founders. Companies like Walmart and Home Depot have done exactly that by acquiring companies with strong founders and then establishing new units these founders can operate. Walmart’s ecommerce unit has thrived as a result. In addition to bringing the right culture, these entrepreneurs also know how to work with VCs and should be able to collaborate effectively with the corporation’s venture unit.
As Google and its venture group (Google Ventures) clearly demonstrate, the CVC group’s culture must be a reflection of the corporate parent’s innovation culture. In addition to the corporate innovation culture, the CVC’s culture must be consistent with the group’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.
- CVCs didn’t establish realistic timelines for achieving the innovation-KPIs associated with their venture investing objectives. Figure 1 below depicts the typical timelines associated with: acquisitions, venture investing and startup incubation. PwC provides an additional perspective on innovation timelines. The timelines associated with investments and incubation are consistent with what I and other VCs use for our early-, expansion-, and growth-stage investments. We assume that early stage investments, not unlike incubation, typically have a 7+ year horizon to maturity and exit. Expansion stage investments, where there is a product that is robust enough to be sold in a repeatable manner and a business model around which the company can scale, typically have a 4-6 year horizon to exit. Finally, growth stage companies being more mature have a 2-4 year horizon to exit.
To understand the timelines associated with each activity it is important to also understand the objectives of each activity. For example, since 2000 IBM has completed 138 acquisitions of which at least 13 were done in support of its big data management and analytics business unit (see Figure 2). The timeline for achieving a positive ROI from the acquisition of a mature company, such as Cognos, is typically 2-3 years. By comparison the timeline for achieving a positive ROI from the acquisition of an earlier stage company, such as Vivisimo is typically 4-5 years. More recently IBM started investing in early stage startups in order to develop a partner ecosystem for its Watson platform (see Figure 2). These investments need a longer period, typically 7+ years, before ROI commensurate with their risk at the time of the investment can be realized.
Reviewing Salesforce.com’s acquisition and investment record, parts of which are shown in Figure 3, one can see that more of the company’s transactions were driven by innovations goals, e.g., data as a service, mobile, social, than in support of existing business units.
Figure 3: Acquisition and venture investment by Salesforce.com since 2000
During the dot-com period, CVCs, most of whom at that time were financially motivated investors, were investing in private companies which they perceived as leaders in major emerging, internet-related markets. For this reason they were making these investments under terms that would provide risk-adjusted ROI multiples typically associated with late stage investments within a period of 3-4 years, as most late stage investments are expected to do. They were not realizing that they were investing in companies with early stage characteristics, including risk. 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 with whom I have spoken told me that they 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, these time horizons are 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, Qualcomm Ventures and AMEX Ventures, have financial returns as a secondary goal. Recently we’ve started to see three different types of financially driven CVCs, depending on the source of their capital. The first type includes the CVCs that have a single LP, their corporate parent. The majority of financially driven CVCs, including the firms mentioned above are of this type. The second type includes firms that aggregate the resources of several corporations and provide a bridge between these corporations and startups that want to work with them and a particular market or geography. A good example is WiL whose corporate investors include Japanese companies such as ANA, Sony, NTT, Nissan and others. WiL helps startups work with its LPs and helps them enter the Japanese market. Another example is Iris Capital whose corporate investors include Orange and Publicis Groupe. Touchdown Ventures and CapBridge Ventures are also embarking on a similar approach. The third type includes firms that receive funding only from corporate LPs but does not have the strategic goals of the firms that belong to the second type. The best example is Allegis Capital.
The money invested by strategic CVCs and the first type of financially driven CVCs always comes from one source. 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.
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 4, their contribution to the overall VC investments is increasing.
Figure 4: 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.