Corporate-backed accelerators and venture capital funds (CVC) play a prominent role in today’s tech ecosystem. They invest billions of dollars in startups, accounting for a growing share of venture capital deals, and with good reason. Many corporations have switched gear and no longer remain reactive as small, nimble technology startups attack and disrupt their business models and practices. CEOs understand that corporate venture capital is an effective way to scan the environment for new technologies that either threaten or complement their core business, and helps them to obtain critical knowledge about potential competitors, future alliance partners and acquisition targets. They also understand that by developing ventures that provide complementary products and services they can build demand for own their products and services. Such strategic benefits are as important to corporate investors as achieving financial returns.
A number of success stories prove the point. Dating app Tinder emerged from an accelerator program within Barry Diller’s Interactive Corp, expanding the reach of the company’s market-leading online dating business to a new demography. Qualcomm Ventures has managed several billion-dollar exits whilst boosting demand for their technology. Google Ventures, Intel Capital and Salesforce Ventures are well-established powerhouses competing successfully for the hottest VC deals, affording their corporate backers a continuous window into innovation.
From the perspective of a founder, understanding the different tactics corporations employ to pursue their innovation agenda is important to assess the viability of corporate venture capital as an alternative to traditional, institutionally-backed VCs. Some excellent academic work has been done on corporate venturing over the past few years, highlighting both the benefits and drawbacks of different approaches. If a few critical conditions are met, corporate-backed investors can add tremendous value, and achieve superior returns for all stakeholders. The best corporate-backed investors are extremely skilled in picking the most valuable ventures due to their in-depth knowledge of markets and technology, and related ability to perform superior due diligence at a lower cost. They provide market access, and the endorsement of the future viability of a venture can be critical in the early stages of the customer development process. But for every success story cautionary tales abound, so entrepreneurs who want to harness the benefits of CVC need to perform their own due diligence carefully.
Whether or not a corporate-backed investor is a good fit boils ultimately down to two questions – are your financial and strategic interests aligned, and can the investor deliver on the promise to provide game-changing resources beyond capital to improve the probability of your success? A key to answering both questions affirmatively is a good understanding of the internal organization of the investor and the relationship with the sponsoring corporation.
There are three critical stakeholders in the organization that matter to the founder – (1) the CEO, (2) the internal ‘champion’ who acts as the interface between the C-suite and the founder, and (3) middle managers controlling strategic assets the startup wants to benefit from. Understanding their respective agenda and the constraints within which they operate is critical to understanding whether or not your financial and strategic interests are fully aligned.
As the interface between the C-suite and the founder, the corporate innovation champion fights the internal war, acting as the high protector, political fixer and mastermind behind the innovation strategy. That person may be a general partner at a corporate venture fund or a board member with an innovation remit. To be successful, they need to have the CEO’s ear and should be a respected organizational veteran with a large internal network (counting among them the company’s middle managers who control resources critical to the startup’s success) to understand and master the internal politics. They should be incentivized to take risks and tolerate failure as a necessary by-product of the innovation process. From the perspective of the founder, a critical part of the due diligence is to understand whether the champion has all the necessary qualities and incentives to succeed in this crucial role, enjoys strong C-level support, and can rally the support of middle management in the core organization to deliver value to the startup.
The capital itself can come in the form of a direct investment or through a separate investment vehicle with varying degrees of separation from its corporate backer. As a founder, it is important to understand the inherent constraints of these different ways of provisioning capital. And you need to consider the potential trade-offs between the proximity of the corporate venturing unit to the core business, and its subsequent effectiveness to deliver the desired strategic benefits to a startup. The severity of this trade-off is determined by the startup’s ability to access and influence the three main stakeholder groups, and whether the corporate parent succeeds in ensuring everyone’s incentives are aligned.
A formal separation between the core business and a corporate venture capital arm in which the corporation acts as a traditional LP can have a number of benefits. Ring-fenced funds, if appropriately structured, are less susceptible to the pressures of quarterly earning calls. When times are tough and investments need to be scaled back, corporate innovation initiatives that are not sufficiently ring-fenced are often highly vulnerable. Greater isolation from the core business and its desire to protect its franchise also prevents individuals with ulterior motives that run counter to those of the entrepreneur to capture corporate investments. A more formal separation can also prevent misaligned incentives between the champion and the founder, as corporates may feel less compelled to take measures to maintain pay uniformity and avoid inter-departmental jealousy. Such internal conflicts are, however, difficult to eliminate in the relationship between the champion and middle managers in the core business, who (often rightly) feel they are contributing to the success of the corporate venture arm. Founders should spend time to understand the internal dynamics of an organization to obtain the necessary level of comfort that the corporate VC can really deliver the promised resources and strategic benefits despite such challenges.
Corporate venture capital can doubtless deliver real benefits to founders, and effectively compete for the best venture deals. Empirical research has demonstrated that corporate VCs can deliver superior returns. Accordingly, founders should not dismiss corporate advances out of hand, but carefully consider what they stand to gain beyond capital, and whether the organization behind a corporate venture arm is likely to deliver these benefits. Understanding the role of the corporate innovation champion and the qualities that render him successful in aligning with and advancing the interests of the founder is critical. Equally important is a nuanced understanding of the formal relationship between the corporate VC and its parent company. Both influence how stable the commitment to the founder is when the going gets tough at the parent company, and therefore whether a tie up generates superior results for all stakeholders involved.