Corporate Venture Capital: How companies should be responding
Although Corporate Venture Capital (CVC) is not a new phenomenon, an increasing number of large incumbents are scrambling to buy innovation as they’re challenged by more nimble upstarts and out-of-industry competitors (see Amazon). In recent years, the number of these corporate venture firms and the volume and value of CVC deals has seen sustained growth, with the number of deals completed and the average deal size increasing over 18% in 2017 from the previous year. Interestingly, the average size of CVC deals repeatedly exceeds the overall venture capital average. From Intel to Pfizer to Hearst Publishing to Campbell’s to BP to Verizon to Mitsubishi, large legacy companies in every industry are getting into the game.
CVC is likely to not only continue but spread to an increasing number of industries. The proliferation of corporate venture investment is beginning to materially impact both big companies without venture initiatives and middle market businesses that will have to compete with ever-bigger giants — not to mention startups courting CVC or competing against CVC-backed companies. All three of these groups needs to think strategically about how they capitalize on or respond to the growth in corporate venture capital. Here’s our advice for execs of each type of company.
1) Big companies without CVC initiatives
Every large company with robust top and bottom lines ought to be considering how they can buy exposure to upside through innovation. Internal innovation efforts, while valuable, can become path dependent and unimaginative, conditioned by the industry status quo to think in a specific way about specific problems. But successful innovation — and therefore effective disruption — hinges on the introduction of fresh ideas that tackle problems in previously unforeseen ways. Just as an objective outside perspective allows consultants to add value that internal personnel cannot, so too does an unconstrained perspective allow startups to create new value that internal teams cannot.
Additionally, investing in innovative startups can actually be cheaper than insourcing the development of a new product, service or offering. A startup is incentivized to deploy capital in an efficient manner (although admittedly that doesn’t always happen), whereas internal resources have no incentive to use your capital wisely and may seek to develop a perfect solution rather than one that will sell and boost the bottom line now and in the future.
“Investing in innovative startups can actually be cheaper than insourcing the development of a new product, service or offering.”
While venture capital as a strategic investment does carry risk, the most successful companies have realized that such risk pales in comparison to the risk of not investing in the future. As other companies begin to buy their competitive edge, companies without CVC programs will begin to fall behind, offering legacy solutions to a market that’s moved on.
Finally, there are many well-documented ways to structure CVC programs, e.g. outsourcing, partnerships, autonomous wholly-owned entities. But one key element that too many companies overlook is ensuring their venture efforts are anchored in the company’s strategy and vision. Companies need to assess what kind of company they want to be in the future and imagine what that future can look like. Without taking stock of where you are and where you want to go, CVC programs could end up being good investments that do nothing to drive business growth.
2) Middle market companies
The seemingly relentless march of M&A in the last few years should have mid-sized companies more than concerned. As big competitors get bigger, middle market businesses will continue to lose market share and find it harder to garner the attention they need and deserve.
Given this environment, what some call coopetition also becomes more attractive and more critical. If you don’t have the money to enter a new market, invest in innovation or explore new opportunities on your own, it’s okay to team up with a peer. While this peer may be a competitor, they can also be a friend (see Frenemy) with whom you can launch a CVC program or start a joint venture. Such overtures may seem like a prelude to a merger, but they don’t have to be. Having a clear mission and charter for such coopetition will ensure all parties extract value and part amicably once the mission has been accomplished.
It’s also vital that even cash-strapped midsize businesses find ways to innovate intelligently so they can create new value for customers. Swinging for the fences won’t work in this economy, and not only can you not be all things to all people but you can’t even be a few things to a few people anymore. Your larger competitors have taken that right away from you. To take it back, middle market companies have to be disciplined in how they innovate, focusing on a few key areas where they’re credible. This may mean eliminating low margin or low volume products or business units to focus on evolving the core or doubling down on your real strengths — which are not always the strengths that are self-evident.
“Middle market companies have to be disciplined in how they innovate, focusing on a few key areas where they’re credible.”
When eliminating offerings, it’s important to see any short term revenue decline as an investment in the future. Everything has an opportunity cost, and the resources dedicated to an activity with no future can instead be used to launch initiatives that do. This process is often painful in the short term, but such discomfort needs to be interpreted as growing pains.
Midsize businesses need to exercise discipline in these uncertain times. They need to have the courage to say no to certain things and let go of others. They need to reflect on what their real strengths and capabilities are. Best-selling products and services are not strengths. Your strengths are the assets, attitudes and abilities that allow you to deliver those products and services. Your core business is not an offering, it’s a capability. To identify opportunities for innovation and growth, middle market companies need to step back and think holistically and strategically about who they are and what they’re capable of. What is your potential, and how do you activate it?
Despite the fixation on pitching angel investors and traditional venture capital firms (what I call Shark Tank Syndrome), Corporate Venture Capital offers startups an entirely different — and frankly more valuable — source of funding. CVCs are, in many ways, superior to traditional VC sources in that they are often accompanied by additional value-add in the form of domain specific knowledge and connections. This isn’t money that you have to deploy efficiently, it’s support that you can leverage liberally.
For startups in complex industries CVC can be particularly promising. Unlike a typical angel investor who may know little to nothing about your technology, business model or industry, a strategic investor will have an in-depth, often superior understanding of your market and your audience. Not only will CVCs be more likely to comprehend and appreciate your offering, but they’ll be able to help you perfect and launch it as well. Because CVCs often function as strategic investors, it’s important to clearly identify the synergies between your startup and their business. Beyond capital, how can they help you and how can you help them?
“Because CVCs often function as strategic investors, it’s important to clearly identify the synergies between your startup and their business.”
For startups that have already met their fundraising objectives, CVC still offers both opportunity and challenge. Certainly a CVC platform could facilitate an acquisition of your startup down the road. But industries often experience frenzied periods of consolidation only to hit a saturation point that brings M&A activity to a dramatic halt, e.g. the beer industry. When this happens, startups need a viable, scalable and sustainable business plan and market position to depend on. Moreover, CVC funds may already be invested in companies similar to your own. In this scenario, if Corporate Venture Capital isn’t helping you, it may be hurting you by reducing your overall chances of getting acquired by a strategic buyer in the future.
It’s important for founders to think about these various scenarios before they start spending money on product development or marketing. Your mode of operation should be strategic, not opportunistic. CVC can be a great source of funding, but startup should avoid building their entire business model and go-to-market strategy around attracting attention from incumbents, as some do thinking that CVC investment will lead to a guaranteed buyout in the future. Nothing in business is guaranteed, and despite the success stories you read about on TechCrunch or see on Shark Tank, nothing substitutes for sound strategy.