In this series of articles, we look at the continued rise of corporate venture capital, and examine some of its unique features.
Corporate venture capital (CVC) generally describes the practice of large corporates making minority investments into start-up and scale-up businesses, often by participating in equity funding rounds alongside traditional venture capital investors. CVC isn’t a new phenomenon – corporates have been putting their money to work in this way since at least the 1960s – but the last decade has seen a surge in the number and size of investments being made, and that trend seems set to continue. In the last five years, the number of corporate venture deals completed globally almost doubled, and the amounts invested more than tripled. The value of corporate venture deals completed globally in 2017 is estimated to be around $31 billion.
Why is corporate venturing on the rise?
There are plenty of reasons why large corporates might want to get involved in venture capital:
- Returns can be very attractive: this is why venture capital firms exist, after all. For some corporates, this is the primary driver, and their CVC units are simply a means through which they can pursue exceptional returns by putting relatively modest amounts of surplus cash at risk. CVC units of this nature are often set up with a high degree of independence, and can be externally managed.
- Embrace the challenge of disruption: mature businesses in many sectors are facing existential threats from disruptive technologies or business models. These disruptive forces tend to spring up out of start-up scenes like Silicon Valley, London and Berlin, where small companies are making use of the relative abundance and availability of capital to innovate and experiment at an incredible pace. It’s not surprising that large corporates want to connect with these companies at an early stage. This gives them the opportunity to see what’s coming next, and potentially consider acquisition targets at an attractive price point. We can contrast this with the more traditional strategy of pursuing big-ticket M&A at the point that these challenger companies have already become a real competitive threat.
- Seed the ecosystem: the primary objective of some CVC units is simply to encourage and facilitate innovation, collaboration and growth within their own sectors. These CVC units will often operate or be affiliated to “incubator” or “accelerator” programmes. These programmes provide start-ups with a package of capital, mentoring/training, co-working space and business support services, during an intense period of business planning and development which acts as a springboard for their next phase of growth. Many corporates have successfully used their CVC units in this way to become innovation hubs, giving them unparalleled visibility and influence over the future direction of their industries.
- Externalise innovation: competitive pressures naturally lead large companies to focus on ever greater efficiency in the execution of their business models, and on the systems and processes that support this. This isn’t always a fertile platform for creativity and innovation, or an attractive environment for creative or entrepreneurial personalities. Some large companies recognise and accept this, and look to their CVC units to provide a pipeline of opportunities for collaborations and/or acquisitions, with a mandate to deliver the “next thing”. With R&D budgets at large companies increasingly under pressure, we’ve observed this model of externalising innovation becoming increasingly popular.
- Refresh relevance and boost profile: for many large companies, there can be a significant PR dividend from participating in, and being seen to work alongside, early stage, venture-backed companies. Of course, this also works the other way round, with start-ups benefitting from an early endorsement by a key player in their industry. CVC units will often attract or reassure other co-investors, because they have the technical knowledge (as industry players) to verify whether a start-up is really onto something valuable. Interactions between large companies and start-ups, with CVC acting as the interface, can be mutually beneficial from a cultural perspective too, with each organisation able to learn from working practices and approaches at the opposite end of the growth spectrum.
Of course, the above objectives are not mutually exclusive (or exhaustive), and many CVC units will have two or more them at the core of their strategies.
In our experience, the most successful CVC units are those that are 100% clear about which of these objectives they’re pursuing. By contrast, those that are more likely to struggle in this highly competitive landscape will often tend to have a vague notion that CVC “is a good thing to be doing”, or the solution to a bunch of problems, without having crystallised their thinking into a clear set of investment criteria and goals.
The number of companies looking to get into CVC has increased competition for the best investment opportunities, putting upward pressure on valuations. This creates a trap for CVCs who enter the market without a very clear sense of what they are – and, equally importantly, are not – looking for.
Companies who decide to set up a CVC unit often then find themselves at the start of a steep learning curve, as they work out a way to converse with start-ups and entrepreneurs in a language that both parties can understand. There’s also sometimes a gulf between the expectations and goals of each party that needs to be crossed in a thoughtful way. In the next article in this series, we’ll look at some of the challenges that these early interactions present, and suggest some ways in which they can be overcome.