Large established firms increasingly rely on external sources for innovation. One way these firms are seeking to foster innovative activity is via corporate venture capital programs.
According to the National Venture Capital Association (NVCA), established firms invested more than US$4 billion in venture businesses in 2014, representing more than 10% of all venture capital investments in the US during the year.
There’s a variety of different corporate venture capital structures and practices, reflecting in part the diverse objectives of corporate investors, which often go beyond financial returns. For instance, companies like IBM and Cisco have used their venture capital programs to scout for possible M&A opportunities.
Established firms also use them to supplement internal R&D departments, exposing them to new technologies and ideas that complement future product development efforts. For others, venture capital programs can be a way to engage with and monitor new, disruptive products or technologies that could potentially pose a threat to their existing businesses.
The dual objectives of corporate venture capital programs – strategic and financial – offer more structuring options than are needed for independent venture firms. If you are thinking about starting a venture capital program at your company, it’s important to choose a structure that will align with your firm’s priorities.
We recently completed a research study exploring the trade-offs between setting up a corporate venture capital program internally vs. externally, as an independent unit outside the firm. We also looked at how different organisational and legal structures impact personnel policies and investment practices, which can ultimately facilitate corporate objectives.
Based on what we learned from our in-depth interviews with investors and investees in the US, Europe and Asia, here are some of the key things firms should think about when establishing a venture capital program.
Internal vs. external
In general, internal units, where the corporations invest off their own balance sheets, are more conducive to strategic investments that support the existing core business of the corporate sponsor. However they are often slower in decision making and subject to greater fluctuation in strategic direction and resource endowments, depending on the corporate sponsor’s financial health.
External units can be more agile in decision making and are more nimble and autonomous for exploring investments into new business areas or innovations that are potentially disruptive to the core business. One implication of this difference is that external units may be better suited for early stage investments where relevance to the core is sometimes unclear and there is uncertainty about the strategy and direction of the startup. They also tend to attract experienced investment managers and deliver both strong financial returns and strategic benefits to the corporate sponsor.
Consider strategic goals
Internal units are better when near term strategic goals are clear and require strategic investments to further these interests or where the external environment is unfavourable and the need for tight control of investment activity is paramount. In such cases, strategic considerations might override financial ones.
On the other hand, when there is less current strategic overlap between the investor and investee, measuring the outcome of the corporate venture capital program using financial gains might be more appropriate. This is more easily done through an external unit.
Focusing solely on financial objectives makes it very difficult for corporate venture capital units to compete against the more experienced internal VC firms that offer their managers greater incentives. The most successful corporate venture capital programs are those that can take advantage of the existing resources of their corporate sponsor as a key differentiator. Looking closely at opportunities for technology transfer between corporate sponsors and investees could possibly create value for both parties.
Developing an ecosystem
When used together with other tools (such as in-house R&D,M&As, strategic alliances), corporate venture capital programs can be excellent for developing an ecosystem. This enables the creation of proprietary partner networks or value chains, without the burden of integrating partners into the existing operations of the corporate sponsor. The sponsor can then retain influence through minority equity ownership. For example, Google, Motorola and Apple have used venture capital programs to help establish an ecosystem around their wireless and web activities.
The corporate venture capital model is still developing and less mature than the internal venture capital model. It took internal VC firms decades to establish their reputation and know-how in nurturing startups.
At the same time, an increasing number of corporate venture capital programs have moved from internal to external units in recent years, making it premature to draw definite conclusions on whether external units outperform internal ones. As new entrants typically adopt established industry norms, it will likely take many years for newly established corporate venture capital programs to determine the best organisational structure.
This article was co-authored by Paul Asel, Managing Director of Nokia Growth Partners.