Riding the next wave of corporate venture capital

Today, corporate venture capital (CVC) is increasingly regarded by organisations as a vital weapon in their entrepreneurial and innovation armoury. According to one 2009 study, around 20 per cent of the Fortune 500 have created a CVC unit. CVC occurs when a large corporation becomes, in essence, a kind of venture capital firm. This happens when a mega-corporation, such as BASF, Cargill, Deutsche Telekom, GlaxoSmithKline, Intel, Johnson & Johnson, Siemens, or UPS, create an entity that can fund much smaller companies — with the aim of benefiting both the entrepreneurial venture and the larger firm. Such CVC activity goes back at least 50 years, and corporate interest in such ventures has ebbed and flowed. 

Now the tidal direction is clear: CVC is on the rise. And among those riding the next wave of CVC are some of the corporate world’s sexiest and most successful names. Look at some of the CVC activity of recent years. 

In 2008, the $150 million BlackBerry Partners Fund started investing in software application ventures. The fund owes its name, as well as part of the capital under management, to Research In Motion, the Canadian company that develops and sells BlackBerry handheld devices. 

Interestingly, Apple, the US-based firm that manufactures the competing device, iPhone, chose not to follow a similar strategy. Apple decided to forego investment in iFund, a $100 million fund launched at the beginning of 2008 by the prominent venture capital firm Kleiner Perkins Caufield & Byers. Apple’s decision cannot be attributed to a lack of familiarity with venture capital investments. Its Strategic Investment Group was a leading corporate investor in the late 1980s and early 1990s, with several successful ventures in its portfolio including PowerPoint (sold to Microsoft) and Sybase. 

Elsewhere, in October 2009, Google Ventures (part of the search engine giant, Google) led a $15 million investment round in Adimab, a biotech venture. Adimab is developing a computerised platform that scans millions of molecules in search of candidates for further, more expansive, laboratory tests. Executing complex searches over large amounts of data is a Google competency. It is hoped that the Adimab investment may unlock a new industry domain. 

Riding the new wave 

CVCs, predominantly a large company phenomenon, are a recognition by big corporations that they do not have a monopoly on the next big thing. These firms create CVCs in the hope that they may help them identify novel products, services or technologies that have the potential to be substitutes for those they currently provide. In industries in the midst of rapid change, CVCs allow insights into new developments taking place that companies have been unaware of. They also can be used to fund ventures that may assist in building an ecosystem, namely increase the value of existing corporate businesses. Basically, corporate venturing activity is an acknowledgement of the importance of having a way to scan, identify and leverage innovative ideas developed by others.

Of course, CVC has been popular before (see sidebar). But the new CVC wave is different from previous waves in a number of respects: 

Should we fold or stay in the game?

In the past, the average lifespan of CVC programmes was 2.5 years — a third of the average lifespan of investments by independent venture capital (VC) funds. Today, the average CVC programme has been in operation for 3.8 years, and many notable programmes are entering their second decade of activity. More than 40 per cent of the 350 or so corporate investors between 2000–2009 had been in operation for four years or longer, nearly double the length of those in the previous waves — a change driven by significant persistence in venturing activity and one that may be a reflection of a broader pattern of transition towards embracing external sources of innovations. 

Location, location, location

A growing fraction of CVC portfolios includes ventures based outside the US, including many in developing countries. The fraction of CVC investments in US-based ventures declined from 88 per cent between 1991–2000 to 75 per cent between 2001–2009. UK-based ventures continue to account for two per cent of total CVC investment. And developing countries are increasingly involved in such activities: Chinabased ventures account for four per cent of the total investment amount during the fourth wave, up from one per cent during the previous wave; and India entered the ranks as one of the top five recipients of corporate venture capital, accounting for one per cent of global CVC investments. At the same time, the geographical location of corporate venture capital programmes remains largely unchanged. Data provider VentureXpert records a slight decrease in the fraction of investment disbursed by US-based corporate investors: down from 83 per cent (1991–2000) to 78 per cent (2001–2009). Finally, the fact that corporate venture capital, overall, tends to originate and reach the same countries does not necessarily mean that funds are invested domestically: CVCs are used at times to learn about geographically distant markets or to access distant technologies. 

Choosing partners

The software and telecommunication sectors, which dominated CVC portfolios in the 1990s, continue to attract a significant, but somewhat smaller, fraction of corporate investment. Biotechnology ventures account for almost 20 per cent of aggregate CVC investment, up from about five per cent in the previous decade. The semiconductor sector exhibits a similar pattern. As a fraction of total CVC investments the medical devices and health care services sector has expanded dramatically, while that of the media and entertainment has diminished in relative terms. Today, the industry and energy sector attracts significant attention from independent VC funds, which in turn stimulates CVC investment. Along these lines, it is important to note that some corporations invest in ventures that operate in their own sector while others invest in neighbouring sectors. For example, nearly 50 per cent of all CVC investment by chemical and pharmaceutical companies went into ventures within those sectors, while only 18 per cent of all CVC investment by semiconductor firms went into semiconductor ventures. 

Rules of the game

The governance of CVC activities involves the structure of a CVC programme, the degree of autonomy it has and the compensation of the personnel charged with making investment decisions. Basically, there are programmes in which current operating business units are responsible for CVC activities, while others involve separate organisational structures devoted to CVC activities. There also is substantial variation in programme autonomy in terms of capital allocation and decision-making. Some programmes are allocated a large amount of capital up front, while others receive the necessary funds on an ad hoc basis. The discretion to make investments (that is, fund a particular venture) and exit (that is, sell a venture or take it public) is fully delegated to the CVC programme in some corporations, yet remains subject to scrutiny and corporate approval in others. Finally, there is a lively debate regarding CVC compensation schemes. Flat-rate corporate salary was the prevailing compensation scheme among CVC personnel in the past and is still a common practice in a large minority of programmes. 

What next? 

My close examination of the differences that mark the waves of CVC investment reveals that corporations that have stayed the course with venture investing have tended to make equity investments in innovative start-up companies with strategic, rather than simply financial, motives. Over time, companies that have stayed the course for strategic reasons have reaped not only strategic benefits, but also financial benefits, primarily because such strategically driven programmes exploit synergies between the companies, creating actual value that in turn is translated into superior financial performance. 

Moreover, analysing the databases of hundreds of companies to compare firms that invested corporate venture capital and those that did not makes it clear that the greater the amount of corporate venture capital invested, the greater the innovation rate of the investing company. In fact, corporations that make venture investments to gain access to outside innovations also tend to have strong internal research and development capabilities. The two paths complement one another rather than competing for the same research dollars. In addition, firms that invest for strategic reasons are more likely to continue to invest — and invest in larger amounts, perhaps because strategically oriented firms are more likely to learn how to make good investments over time. 

For many, the limited lifespans of CVCs in the past has been seen as a major hurdle. This fourth wave, however, brings reassurance on that score. Today, an increasing number of corporations have come to view corporate venture capital as a key component of their innovation strategy and have put in place policies that may allow them to overcome some past problems. 

One such problem during earlier waves was the fact that the compensation of CVC personnel was not tied to their successes and did not match the financial incentives offered by independent venture capital initiatives. As a result, quality personnel left corporations for VC funds, and CVC programmes suffered from low managerial and investment competencies due to poor staffing. In this wave that has changed: today, more and more CVC programmes have been structured to minimise these compensation and staffing problems. For example, in May 2009, Lilly Ventures, the CVC arm of Eli Lilly, announced that it was to ‘go it alone’, a decision made by Eli Lilly to make it easier for the CVC to offer its employees more competitive compensation packages in line with traditional VC firms. 

Finally, one of the key questions in the past was whether or not to engage in CVC activity. In contrast, nowadays we observe corporations with multiple CVC funds and the question shifts towards how to best manage and coordinate among the programmes. The focus shifts from initiation to management of CVC programmes. 

Indeed, it seems as though this new wave of corporate venture capital is creating a lasting foundation for how companies can innovate, expand and grow. In the end, we are left with the question of whether, in the long run, this wave marks the beginning of a permanent build-up of corporate venture activity, one that will withstand the erosion that followed in the wake of earlier waves  

This article was taken from Business Strategy Review, for the latest business thinking from all London Business School faculty