Comment from Patrick Flesner, partner, LeadX Capital Partners, and Stephan Bank, partner, SMP
This is the second part in a series of articles on corporate venture capital. You can read Part I here.
When establishing a corporate venture capital (CVC) organisation, setting a clear stage and sector focus is important. But executives should refrain from always asking for an internal businessman or woman that supports the investment and takes on the responsibility for a successful cooperation, a signed commercial agreement or that the investment create an immediate benefit for the corporation. Such requirements do not resonate with the fast-paced venture capital environment and limit the CVC potential to get a holistic view of industry trends and competitive dynamics in adjacent industries. Sufficient benefits will arise from a portfolio perspective.
Guiding principle 2: define a clear investment focus
As a corporation usually establishes a CVC unit in order to pursue both financial and strategic goals, the CVC unit’s investment focus needs to be determined early on.
Firstly, the corporation should define a clear stage focus for the portfolio companies it intends to invest in. It should be clarified whether the CVC unit can invest in early stage or late(r) and growth stage companies. Investing in early stage companies may make more sense if the corporation intends to learn about long-term industry trends. In contrast, investing in late(r) and growth stage companies may be the right choice if the corporation intends to focus on becoming a shareholder in potential game-changers and capturing value that the corporation is unable to capture itself. While it is also possible to combine these approaches and invest highly opportunistically and stage-agnostically, concentrating on a specific stage facilitates the development of a clear investor profile vis-à-vis other industry players. Developing a reliable investor profile proves beneficial especially with respect to deal sourcing. If founders and other VCs exactly know what the CVC unit is looking for and where the investment team has the greatest potential to create value for the startup, they are more likely to reach out to the CVC unit when it comes to raising funds. Should a corporation, nevertheless, intend to invest across stages, separate funds should be set-up for early stage, late(r) and growth stage investments and – potentially – buyouts, ideally with separate dedicated management teams with respective expertise.
Secondly, the corporation should define a clear sector focus. It generally makes sense to invest in companies active in the corporation’s field of expertise. On its home turf, a CVC unit can usually leverage the corporate assets, such as in-depth industry and market knowledge, access to sophisticated research and development departments, a large and established customer base, brand association and access to a marketing network. At the same time, a clear focus on the corporation’s primary field of expertise facilitates evaluating investment opportunities and changing industry and market conditions.
However, the investment scope should not be too narrow and also allow investments in adjacent industries and startups without a clear and immediate potential to cooperate with the sponsoring corporation. A more complementary and extensive investment focus helps the investment team get a more holistic view of overarching market trends. Past experience shows that disruptions and potential disruptors for a corporation’s core business as well as business opportunities that help develop a corporation’s core business often emerge from adjacent industries. A good example of a corporation that has repeatedly disrupted adjacent industries and continues to disrupt industries is Amazon.
In contrast, corporations that approve an investment only if the startup provides an immediate benefit to the respective corporation, a signed commercial agreement between the corporation and the startup or an internal businessperson that supports the investment limit their CVC success potential. In big corporations, employees sometimes go through the ranks if they do not make mistakes, an environment that does not encourage risk-taking. And a risk-adverse environment may discourage employees from supporting startups and taking on the responsibility for a successful cooperation. Further, a request that a commercial agreement be in place before an investment is approved does not resonate with the timelines in the VC industry. In the fast-paced VC ecosystem, startups that thrive get term sheets after weeks rather than months that are often needed to sign a commercial cooperation agreement.
In order to be successful, corporations may therefore ask for a clear cooperation potential, but refrain from requesting an immediate benefit, signed commercial agreement or internal sponsor. While this may entail that not all portfolio companies end up meeting the cooperation or other benefit expectations, this approach will allow the CVC unit to live up to the VC ecosystem requirements and create benefits for the corporation at least from a portfolio perspective.