Changing investor attitudes are creating an opportunity for CVC

The way that shareholders assess the value of large, listed companies is changing— and in a way that can bring the corporate venture activities of those companies to much greater prominence. It creates the opportunity for CVC activity to evolve, once and for all, from a cyclical activity that is pursued mainly during the good times, to one that is truly core to the parent’s business.

There are three notable ways in that we can see shareholder attitudes changing. First, the significant rise in environment, society and governance (ESG) investing is increasingly recognised as “nothing special”. It is simply long-term investing, as London Business School professor Alex Edmans points out in one of 2022’s most acclaimed finance research papers. Underlying ESG is a fundamental technology enabled transformation in investment industry stewardship and valuation practices, as I wrote about in this article for institutional investors. This can easily be extended to human, organisational and innovation capital factors, including the collaboration behaviours at the heart of CVC.

Secondly, small companies are increasingly recognised as central to large company growth, innovation and sustainability. Large companies are starting to tackle Scope 3 emissions — those that are produced by suppliers and customers, up and down in their supply chain. This is bringing into focus the value of the overall relationships big corporates have with the smaller companies in their networks.

Finally, listed equity markets are facing a “breath-taking” decline in relevance and require a reset to make them more vibrant marketplaces, as Andy Griffiths, executive director of Investor Forum, a UK industry body for institutional investors, explained in his recent annual review, summarised by the FT here. This opens investors minds to new ways to assess and support their large company investees.

More relevant ever than before — and more resilient?

CVC units need to take advantage of these changes. For the first time after four cycles since the 1960s, CVC proved more resilient than financial venture capital — having seen much less of a market pullback in 2022 than the VC sector overall. Corporate-backed VC deals fell just 2% in 2022 vs a 25% fall for venture capital overall. Some 19% of start up fundraising deals in 2022 had corporate backing and a record number of new corporate funds were created.

There is also clear evidence of a transformation in the depth and relevance of CVC capabilities. In a recent GVC webinar, for example, Chad Bown of BP Ventures explained how the unit distinguishes between investments that are informed by the major group’s strategy and aim at operational delivery and those at an earlier stage which are designed to shape future strategy. CVCs are coming up with smart ways to manage board roles and conflicts. To accelerate development they are also funding pilot projects between their portfolio companies and parent company business units directly. From the perspective of SMEs partnered with major companies, such entrepreneurial procurement is hugely valuable, especially in hard deep-tech innovation where it is almost always essential.

Evidence from past economic cycles shows that investment at inflated peak cycle values can still lead to highly successful long-term outcomes where the conditions for “productive bubbles” are satisfied, as Bill Janeway argues. He highlights the potential of sustainability oriented investments in the last bubble to have productive outcomes over time.

Complementary bottom up evidence suggests the companies that came out best in the long-term are those who maintained or increased their investment in startups in a disciplined way during downturns . Some suggestions were provided in this recent GCV webinar. They included the need for bold but attainable goals, typically a 10% increase in parent revenue in under 10 years according to Alex Mahr of Stryber the venture building consulting firm (or 1% per year), rising to 25% in the case of Debbie Brackeen of CSAA Insurance Group. Capability building and a portfolio approach also matter. Linda Yates of Mach 49 particularly stressed the importance of separate reporting metrics to show a CVC’s potential value.

Moreover, major shareholders are focussing on Net Zero transition plans. Innovation capabilities such as CVC and support for small companies – including faster payments —  influence nearly all sustainability outcomes and should play a central role.

Hurdles to overcome

CVC activity will, however, face many more questions as the cycle moves down. Year to date CVC rounds and values in Q1 2023 have both declined. The recent crises at Silicon Valley Bank and Baillie Gifford’s technology fund have shone a spotlight on the unpredictability of technology company values, as has Elon Musk’s more than halving of Twitter’s valuation. Investors are increasingly sceptical of the tech sector — as this FT article demonstrates — and will have little patience for investing in technology for technology’s sake. Moreover, CVC arms have traditionally struggled to secure shareholder attention.

Furthermore, only a minority of CVCs (14%) have the capability to generate value sustainably from their CVC arms, according to a recent McKinsey review. There is also a mismatch in expectations, between investee start-ups, who nearly all expect their CVC investors to provide market access, and the actual intentions of CVC investors where only half have this intention. In addition, 70% of CVCs are sporadic in their investment, an approach that correlates with poor returns. In the background is evidence from GCV’s own review which suggests that half of CVC arms have less than 30% of their committed capital reserved for future deployment, leaving them dependent on their parent Boards’ and group level shareholders’ future decisions.

While CVCs have never been in a stronger position, they remain highly vulnerable to parent companies questioning or shutting them down. Even though a one point improvement in long-term growth is much more valuable than a one point improvement in margin, cost cutting is invariably selected over investing in growth at this stage in cycles.

Driving fundamental change

As CVC is a highly visible and potentially easy to explain contribution to growth, now is the ideal time for CVCs to deepen capabilities and step-up communicating to boards and shareholders about the long-term value CVC creates. In fact, this could be a collective project by the CVC community.

The elements of doing so might include the following:

• Case studies of industry segments showing winners and losers in creating value, how they have used CVC and how it has contributed to growth
• New ways to show overall relationships between large companies and SMEs, highlighting CVC’s role as an integrator of innovation activities, in the context of wider entrepreneurial procurement and parents’ support for their SME ecosystems
• Pay-offs from past pilot projects and early-stage investments covering financial consequences and contributions to sustainability, also how disengagement is managed positively
• How parent groups assess their innovation portfolios and communicate their growth, sustainability and value potential to investors
• • How valuation methodologies are applied in practice to CVC, including real option methods (ways that value the flexibility of future decisions to expand, defer or abandon projects, which are particularly relevant to novel activities)
• How board and HR teams assess and promote the depth of partnering capabilities and cultures
• Ways corporate communications is used to brand the parent as a development partner of choice – competition for partnering often means the “winner takes all”

The target would be to use these demonstrations to encourage the leading investment and data organisations to apply the models developed for impact investment to evolve new ways to understand and support innovation investment.

The initiative would be an ideal way to unify companies and investors through their shared interest in building sustainable long-term value.

Greg Watson is the founder of Partnership Capital, a long-term innovation investment initiative to test the importance of partnering and active stewardship for development stage deep-tech companies