Corporate venture capital (CVC) has become increasingly popular in recent years as corporations seek new ways to fuel growth and innovation. CVC is a type of venture capital investment where a corporation invests in early-stage or startup companies in order to gain strategic benefits and access to new technologies, products, or markets. In this article, we will explore the benefits and drawbacks of CVC, as well as best practices for corporations looking to start a CVC program.
Benefits of Corporate Venture Capital
One of the main benefits of CVC is that it provides corporations with access to new technologies, products, and markets. By investing in early-stage or startup companies, corporations can gain early insights into emerging technologies and markets. This can help them stay ahead of the curve and position themselves as leaders in their respective industries.
Another benefit of CVC is that it allows corporations to diversify their investment portfolios. By investing in a variety of early-stage companies, corporations can spread their risk across different industries and technologies. This can help them avoid the risk of investing too heavily in one particular area and suffering significant losses if that area doesn’t perform as expected.
Finally, CVC can also provide corporations with a valuable source of innovation. By working closely with startups and early-stage companies, corporations can learn about new approaches to problem-solving and gain insights into emerging trends and technologies. This can help them develop new products and services that better meet the needs of their customers.
Venture financial liquidity: total capital invested and deal count (1999-2017).
Drawbacks of Corporate Venture Capital
While there are many benefits to CVC, there are also some potential drawbacks that corporations should be aware of. One of the main drawbacks is that CVC can be a time-consuming and resource-intensive process. Corporations need to dedicate significant time and resources to identifying potential investment opportunities, conducting due diligence, and managing their portfolio of investments.
Another drawback of CVC is that it can be difficult to measure the return on investment (ROI). Unlike traditional venture capital investments, where the goal is to achieve a high return on investment within a relatively short period of time, CVC investments are often made with a longer-term strategic goal in mind. As a result, it can be difficult to determine whether a CVC investment has been successful or not.
Finally, CVC can also create conflicts of interest between the corporation and the startup or early-stage company. For example, the corporation may have a vested interest in acquiring the startup or early-stage company, while the startup or early-stage company may be more interested in building a successful standalone business. This can create tension and lead to disagreements over strategy and direction.
Corporate VC investments as a share of total investors’ capital in 2018.
Why Does Corporate Venture Capital Make Any Sense?
A corporate venture capital is an independent arm of a company that allows them to make a small bet (own a percentage of the project rather than the entire project) on a big idea and gain access to innovative and entrepreneurial talent. Corporate venture capitalists, like traditional venture capitalists, invest in high-growth, moonshot-type projects. CVCs, on the other hand, are thought to be more long-term oriented than traditional VC.
Still, whether CVCs prioritise strategic wins and innovation over financial returns is debatable, as we’ll discuss further below in How to Get Corporate VC Right.
But why do corporations invest in venture capital instead of just R&D or go all-in with a full-fledged acquisition?
Corporate Venture Capital Can Uncover Growth Avenues with Minimal Commitment
Because companies can invest their CVCs off the balance sheet (usually), they can invest in R&D on a larger scale than the P&L allows. At the same time, businesses can gain access to creative and ambitious talent that they would not normally find in the corporate world. Furthermore, companies can make small bets on a variety of moonshot projects rather than owning the entire project, as they would have to do if they were solely responsible for the project with their own R&D dollars.
While the graph below may be oversimplified, and the exact “level of commitment” between R&D and CVC is debatable, it does provide a relative idea of how much bang for your buck each innovation channel provides.
Acquisition vs. R&D vs. Corporate Venture Capital
The chart below oversimplifies acquisition vs. R&D vs. CVC. There are nuances that can make an acquisition strategy quite innovative but not very committed (e.g., a serial outright acquirer of small, cutting-edge companies). We created this chart, however, to help categorize the most common ways these strategies work.
We’ve also caveated the chart to only show the “first interaction,” which means it doesn’t depict what would happen if a CVC turned its partial investment into a full-fledged acquisition. In that case, where the strategy falls on our spectrum is somewhat subjective and idiosyncratic.
Level of commitment vs. level of innovation: Acquisition, R&D, and Corporate VC (first interaction).
An Acquisition is the most serious commitment a company can make to a project. If you buy a company, you usually don’t get “backsies” if you don’t like what you get. However, unless it’s an acqui-hire where you’re really just hiring talent, the level of future innovation for the core company is relatively low once that company is acquired. An acquisition is typically made to broaden breadth or to delve deeper into a currently served market; however, it is a one-time event.
You have some commitment flexibility with Research & Development. You have a group of R&D experts working on whatever projects the company deems important. You can take people off one project and put them on another. But what if you want to investigate something in which your current R&D experts are not experts? A strong reason why big, out-of-the-box innovation is unlikely to happen with a company’s existing R&D team, according to Toptal Venture Capital expert Alex Graham, is that “you don’t want to innovate yourself out of a job.” However, within a certain range of innovation, internal R&D can be successful because they understand the corporate culture and their customers. Apple and Netflix are excellent examples of successful, innovative internal research and development.
Corporate Venture Capital may provide the lowest level of commitment while also providing the highest level of innovation. The level of commitment is low because you do not need to buy an entire company or staff your entire R&D team on one project, but it is not zero because you must invest in the actual setup of the CVC. It’s worth noting that a CVC investment could eventually lead to a full-fledged acquisition. The initial corporate venture capital investment provides some level of access to financials, a better understanding of the business’s pros and cons (versus coming in cold without a prior relationship), and access to a younger company that is likely innovating to solve a newer problem.
CVC has a high level of innovation because it provides access to a plethora of new ideas formed by young, nimble companies solving previously unsolved problems.
Comparison of the pros and cons of acquisition, R&D, and CVC.
While working as an analyst at Vodafone Ventures, Systematek Venture Capital expert Khaled Amer witnessed this in action: “A CVC brings a fresh perspective into the areas of innovation. As a telecom company, we asked ourselves, ‘How can we expand into IoT?’ and ‘How can we increase data consumption by providing digital media content through various websites and apps?’ We had to innovate outside of our core business.”
Amer went on to explain why Vodafone is interested in CVC as an innovative growth channel: “Vodafone is a large telecom company. We were turning in big numbers with high profits, but our growth has slowed significantly in recent years. We went to CVC to innovate outside of our core business and to try to improve topline growth.”
Corporate venture capitalists are solely concerned with strengthening the parent company’s strategic position (as opposed to traditional VCs, which tend to focus on financial payoffs). The parent recognises that they cannot match a young, agile startup’s ability to innovate and break through, so they use their own in-house VC to get ahead of the competition and a piece of that “nimbleness.” “Pearson Ventures gives Pearson the ability to have the first look at new ideas coming through the door and the ability to acquire or invest in the ones that look most promising,” said Steven Southwick, a Systimatek finance expert and CEO of Pointful Education.
Pearson, the British education conglomerate, recently committed $50 million to Pearson Ventures, stating, “Because education will look very different in 2030, Pearson, like learners around the world, will need to continue to learn, adapt, and reinvent itself: finding new business models, incorporating emerging technologies into its products and services, and finding new ways to collaborate with education institutions, government, and businesses.”
CVC: On-balance Sheet vs. Off-balance Sheet – Another Nuance
It’s also worth noting that CVC can be divided into two types: on-balance-sheet and off-balance-sheet. An off-balance-sheet CVC would be to the right in the graph above, while an on-balance-sheet CVC would be to the left (but still to the right of R&D). According to Natasha Ketabchi, a Systimatek Venture Capital expert, “items on a company’s balance sheet must be very closely related to a company’s core business directive; if a CVC is held off the balance sheet, it grants the company more freedom in its venture portfolio.”
Best practices For Corporate Venture Capital
Despite the potential drawbacks, CVC can be a valuable tool for corporations looking to fuel growth and innovation. To ensure success, corporations should follow these best practices:
Set clear goals and objectives: Before starting a CVC program, corporations should clearly define their goals and objectives. This will help them identify the types of investments that are most likely to support their strategic priorities.
Establish a dedicated team: Corporations should establish a dedicated team to manage their CVC program. This team should have the necessary expertise and resources to identify potential investment opportunities, conduct due diligence, and manage the portfolio of investments.
Develop a clear investment strategy: Corporations should develop a clear investment strategy that aligns with their goals and objectives. This should include criteria for evaluating potential investment opportunities, as well as guidelines for managing the portfolio of investments.
Build strong relationships with startups and early-stage companies: Corporations should focus on building strong relationships with startups and early-stage companies. This includes providing mentorship and support, as well as access to the corporation’s resources and networks.
Measure and evaluate performance: Corporations should establish clear metrics for measuring the performance of their CVC program. This should include both financial and non-financial metrics, such as the impact of the investments on the corporation’s strategic priorities and the success of the startups and early-stage companies in which the corporation has invested.
Manage conflicts of interest: Corporations should proactively manage potential conflicts of interest between themselves and the startups and early-stage companies in which they have invested. This includes being transparent about the corporation’s intentions and goals, and working collaboratively with the startups and early-stage companies to develop a mutually beneficial strategy.
Stay agile and adaptable: CVC is a dynamic and rapidly changing field. Corporations should stay agile and adaptable, regularly reviewing and updating their investment strategy and portfolio in response to changes in the market and emerging trends.
Innovation vs. Chest-beating
When done correctly, corporate venture capital can be an exciting way for businesses to stay ahead of the competition. Wilson may be correct when done incorrectly: CVCs may have “devil”ish tendencies. Perhaps it was overzealous founders intent on world dominance, one wave pool at a time.
Building An Accurate Financial Model is a Compass, Not a Crystal Ball
Most companies will either (a) raise capital to fund the massive growth opportunity they’ve demonstrated, or (b) reduce marketing spend and harvest the free cash flow that results in 12-18 months.
Similarly, the COVID-19 models used by governments around the world produced forecasts that were significantly off from the actual results. Given the inherent uncertainty in a novel virus, this should come as no surprise. This is meant to be a realistic, rather than cynical, assessment. All models are incorrect by definition, but there is a six-stage process for improving their accuracy over time.
Stage 1: The Hatchet
The first step in financial modelling is to challenge every assumption:
- Why are your customer acquisition costs comparable to those of your billion-dollar competitor?
- Do you truly believe you can go from cold call to sale in four months? What is your background in selling seven-figure contracts to Fortune 500 companies?
- How will all of your new sales hires be productive from the start?
- You have no budget for customer success but still expect extremely low churn – why?
- Is your product sufficiently distinct from your main competitors to justify charging 50% more?
I work with a lot of SaaS (Software as a Service) companies, and three of the most important Key Performance Indicators (KPIs) are Customer Acquisition Cost (CAC), Customer Churn, and Customer Lifetime Value (LTV). Each of these assumptions is driven by another: CAC is a function of how much you spend on marketing and promotion, how many people click on your ads, how many people take action on those ads, and how many of them convert to free and, eventually, paid customers, and when.
All assumptions are assigned to KPI families before making any business decisions. The CAC KPI incorporates both marketing funnel and sales assumptions. How many prospects can your salespeople handle simultaneously? What is the closing percentage? How long does an average sale take? We will only begin implementing the business plan after we have found sufficient support for all of those assumptions.
This step is analogous to the COVID-19 pandemic that we are currently experiencing. These models, too, are based on assumptions. R0 is the assumed rate at which the SARS2 CoV-19 virus spreads naturally through a susceptible population. Other assumptions revolve around COVID-19’s impact after infection.
None of those assumptions were well understood from the start, and Western health officials should have challenged them all before making final decisions to mandate various forms of social distancing.
Stage 2: The Known Unknowns
The Known Unknowns are the variables in a financial model that are less certain. When I work with clients to determine which assumptions to focus on, we sit down with a whiteboard (or a Zoom room with a blank Google document) and sort them all by degree of certainty as well as importance within the model.
Conversion rate to sale (Conversion Rate) is a critical assumption for a consumer SaaS company. My client is a healthcare app with a free product, a paid subscription product, and commissions for referring customers to service providers. They assumed that 50 people out of every 1,000 who downloaded the free app would eventually upgrade to paid subscribers. This was based on recent data, but it could also have been based on competitors’ experiences or their previous experience with another company. Every assumption in a model is the result of a team’s belief that those specific assumptions make the most sense given the information at the time.
We knew the Conversion Rate rate had a large impact on sales growth and profit margins, and we were less certain of our assumptions around that rate, so this variable was our main focus. You can see these results fairly quickly if you run a consumer SaaS business with a relatively high volume of sales and a short sales cycle. When we have enough data, we can either be satisfied that our assumptions were correct or see that there is a problem that needs to be addressed because we overestimated the Conversion Rate.
The real question we’re trying to answer, based on anecdotal reports, is whether you can transmit it efficiently when you’re asymptomatic.
Similarly, public health officials were aware that several of their assumptions at the time were uncertain: R0, symptomatic rate, hospitalisation rate, hospital capacity, fatality rate, and so on. R0, for example, is more complicated than it appears. A good R0 assumption had to account for all behavioural changes, which varied in application and effectiveness depending on the characteristics of a region (e.g., urban: congested New York City vs. a rural town in South Dakota). The Effective Reproduction Number, Re, is used to describe the rate of virus reproduction under different conditions and at different times.
Both my SaaS clients and public health officials must fully focus on gaining a better understanding of the model’s key variables. They proceed to the next step, measurement, once they have determined which hard data to focus on.
Stage 3: Measurement
We’ll dig deep into the Conversion Rate assumption during Measurement: Are people clicking on the ads and downloading the app at the expected rate? How quickly are they converting to paying customers? How long do they take to convert to paid customers, and how long do they stay once they do?
The problem now is that there are a lot of unknowns… We weren’t sure at first if there were asymptomatic infections, which would have resulted in a much larger outbreak than what we’re seeing. We now know for certain that there are.
This process can also be seen in the COVID saga. Early in the pandemic, experts like the WHO predicted that the virus would kill 3.4% of people worldwide, a terrifying figure given that the flu kills 0.12% of people (but with a range of estimates around that figure). That was the figure reported in the press; behind the scenes, the models most likely included a wide range of options. However, the estimates were clearly based on a higher figure than appears to be probable based on current data.
Based on current data, it appears that the percentage of people infected with the virus that causes the symptoms we know as COVID is much higher. Given the larger denominator, the fatality rate must be lower, likely closer to 0.12% than the original 3.4% figure. It turns out that the models we used were pessimistic rather than optimistic, so we had to revise our hospitalisation and mortality estimates:
Source: Governor Cuomo’s office
This is unquestionably a much better problem to have than the opposite, thanks in part to a prudent bias towards caution. What happens next?
Stage 4: Tinkering
Right now, world leaders are collaborating with scientists to re-calibrate their models. They are experimenting with which policy levers to use and which to relax. Some assumptions will be universal, but many will be specific to a particular region or environment.
I go over each assumption within each KPI with my clients to determine how well-calibrated the model is. When an assumption does not match reality, we collaborate to figure out why. Is the value proposition less than we anticipated, and are we communicating it to the prospective customer? Is the product priced appropriately? Is there a call to action that will compel them to buy? Have we made the registration process as simple as possible?
We may try a few different approaches to see which one improves the underperforming metrics the best. Sometimes there is an easy fix, but most of the time we have to tinker a little to gain confidence in a particular path. A/B testing is a method used by software companies: You divide your targets into closely comparable groups and test one approach on the A group and another on the B group to see which consistently outperforms the other.
All patients (including trauma call types) must now be considered infected, and all people (including coworkers and family members) have been exposed due to community spread.
While few A/B tests on policies are likely to be conducted to determine which policies work best, there are a variety of approaches being taken by different countries and different jurisdictions within countries that can be nearly as illuminating. Municipalities and medical professionals all over the world are constantly adjusting their approach to this disease, based on both feedback from their own patients and published research on how other patients reacted to various treatments.
Stage 5: Recalibration
This is the point at which the rubber hits the road. You’ve identified your key performance indicators (KPIs), measured them against your predictions, identified those that are off, pinpointed the assumptions that are causing them, and tested various hypotheses about how to improve them.
Governments all over the world are recalibrating their policies. Most are putting plans in place for a gradual return to normalcy, guided by progress on the rate of spread, hospital and testing capacity, and overall community preparedness. You can bet that the outcomes will be closely scrutinised.
This is decision time in both business and public health – choose a path and move forward. Consider not only the payoff of success, but also the likelihood and cost of failure in terms of time and resources. Identify success metrics and manifest when you expect to see the results. Assign ownership if your chosen path necessitates significant changes to your processes. This will get you ready for the last and most important stage.
Stage 6: Go Back to Step 2
There is no Stage 6 – fail. Return to Stage 2 immediately. Every successful company in the world is constantly identifying, measuring, tinkering with, and recalibrating their assumptions. CEOs should meet with their finance teams at least once a quarter to review all of the company’s key performance indicators and prioritise what needs to be improved. Teamwork should be used to develop innovative solutions, but ultimate responsibility should be assigned to the relevant business leaders. Those leaders must foster a culture of constant identification, measurement, tinkering, recalibrating, and ultimately forging ahead.
Conclusion: Corporate venture capital
Corporate venture capital can be a valuable tool for corporations looking to fuel growth and innovation. By investing in early-stage or startup companies, corporations can gain access to new technologies, products, and markets, diversify their investment portfolios, and source innovation. However, CVC also has potential drawbacks, such as time and resource intensiveness, difficulty measuring ROI, and conflicts of interest. To ensure success, corporations should follow best practices such as setting clear goals and objectives, establishing a dedicated team, developing a clear investment strategy, building strong relationships with startups and early-stage companies, measuring and evaluating performance, managing conflicts of interest, and staying agile and adaptable.