Betting Your Innovation Budget: Why Risk It On CVC? 

Corporate Venturing or “Strategic Venturing” is inexplicably on the rise. Last year alone, 107 CVC funds made their debut, with corporate investments climbing to a crazy $24.9 billion globally!

According to CB Insights, active CVC more than doubled from 2012 to 2016 - so why the huge growth? 

That’s not a rhetorical question… and it’s not something I will go on to explain in this article. I couldn’t if I wanted to. Because personally, I just don’t get it. 

I’ve worked as a VC myself, taken investment in my own startups, and advised countless startups as a mentor. Today, when I’m asked about venture investing by Executive Boards at huge corporations, my answer is always the same (though the level of awkwardness rises exponentially when it’s an activity they’ve already undertaken): Don’t touch it with a bargepole! There are better ways to waste your money, and a hell of a lot better ways to invest it in genuine innovation. 

When I flip it on its head and ask firms why they think they should do it, or why they do it already; they commonly cite the same core reasons: 

  1. “It’s strategic”: they believe they can invest in startups who augment their current business, thereby unlocking huge ‘strategic synergies’ when connecting their portfolio companies to the ‘mothership’. “Because we can invest strategically, we can increase both our probability of success and expected returns to the Group”     
  2. “There’s huge potential for return on investment, while hedging against the future”: here, the commonly cited stats of the VC world; “the top preforming funds have the potential to make 5-20x returns”  

Call me a cynic (and some of you may call me worse in the comments section below) but for me, none of these ring true. I can’t help but feel that those who champion the creation of a CVC fund from within an organisation must have a more personal cause at heart. I can’t see how it can be about furthering the company’s true innovation agenda i.e. creating a repeatable and transferrable organisational capability of continuous longer term renewal. 

When I’m at my most sceptical, the only conclusion I can reach is that they’re just after a more cushy job – a better Monday to Friday. The chance to drop the corporate tie, relocate to a nice new office in a startup hub, escape the daily corporate politics; all while still enjoying the comfortable base salary and plentiful mothership perks. I mean, don’t get me wrong; it’s probably a pretty smart move for the individuals, but I am not convinced it is smart for the corporation and their shareholders.

Here’s why I don’t buy it: 

  1. The odds are against you: 75% of all VC funds lose everything: I honestly don’t understand how CVC’s have succeeded in securing $50-100million to bet with on that probability - I could almost applaud them for their tenacity, but what I really want to understand is how do they justify this risk to the shareholders?  
  2. Deal Flow means more than just quantity of startups – it’s everything: yes, your company may be inundated with startup applications, and it can be all too easy to assume that deal flow simply wouldn’t be an issue with a big brand; but even if you have enough startups approaching you, do you have the top 1-2%, and will they let you invest? All VC funds are only as good as their Deal Flow, and for the best startups you’re competing with Funds which have spent years investing in their network for this purpose alone. Can you really expect to compete with the Andreessen Horowitz, Union Square Ventures and Sequoia Capitals of the world?   
  3. The odds of unlocking the strategic benefits of your investments are even lower than your chance of a positive IRR: in order to unlock the synergies with the big business, you need to wade back into the corporate treacle, fight your way through legal and procurement, and quickly find yourself once again reliant on the Business Units. Now you have to ask yourself if this startup is aligned to that BU’s strategic objectives, and its senior management KPIs; because if not, you can bet they won’t be giving you any of their resource any time soon, and worse, they may see you as a risk and actively block you. Also, in my experience, investments theses that aim to maximize ROI are rarely aligned to a collaborative innovation approach, seeking to realize commercial value from corporate startup engagements –apples vs. pears. Furthermore, one does not need to invest in a startup in order to run a successful commercially focused pilot – please can we expel this myth! Steve Blank spelled out even more of the challenges of unlocking startup-corporate synergies (admittedly in an M&A context) in this article 4 years ago - but corporates have yet to build the organizational capabilities needed to unlock potential synergies!
  4. You can’t target middle of the road returns: corporates often have a strategic investment mindset, thinking if they can achieve an average return of 2-5x then it will even out across the portfolio, giving them good net returns. But, as the power law of investing tells us, every investment you make has to, at least in theory, be able to return the entire Fund plus the expected IRR. VCs don’t just set a min. 10x target for every investment for the bragging rights, they do it because they know if they do succeed in getting a positive return on their Fund it will likely be from just 1 or 2 of their portfolio investments.
  5. Corporates don’t have the VC skill-set in house: you don’t have a top tier, proven VC talent sitting around in house - and if you believe you do, ask yourself, why did they move out of the typically much more lucrative VC world (see point 6) in the first place?
  6. So you try to hire in the talent: but you’ve got the wrong incentive structures in place! You need best in class talent to assess the startups, craft a successful investment thesis, make investments and manage your portfolio if you’re going to have any chance. In the open market, top talent expects 2% management fee and 20-30% carried interest. Typically, corporates do not feel comfortable offering this level of remuneration to their managing partners. So, you’re left with the Tier 2 Talent, competing against the odds already, but now you’re playing with the bench. 
  7. Even if you do succeed against the laws of probability; finding yourself in the top 25% of funds that deliver a positive IRR, the cash returned won’t be realised for 5-7 years; and by that point, the actual net profits generated are still going to be a rounding error compared to company’s total revenue – especially, when considered over a 5-7 year period! And that’s best case scenario; if you’re a little less lucky, you’ll quickly find you could have accrued more interest with a low-cost, well diversified index fund, or worst case, you’ve lost it all. 

For me, CVC is a bubble and the downturn is coming. Yes, a handful of the best CVC funds like Intel Capital and Qualcomm Ventures have and will likely continue to return positive IRRs – there will always be outliers. However, looking at the industry as a whole, I caution that the current level of corporate euphoria is a false positive that will be considered woefully misguided in the long run.

What makes it even more painful for me, is knowing how that money ($24.9bn) could have been invested in initiatives which really address the company’s underlying corporate innovation challenges. Instead, focusing on continuous longer term renewal, navigating disruption, identifying possible directions of growth before they become obvious, and creating structures to be able to do that in parallel with BAU.

By Jordan Schlipf


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