Comment from Patrick Flesner, partner, LeadX Capital Partners, and Stephan Bank, partner, SMP
Many executives that want to initiate corporate venturing activities already struggle answering the question how to set-up a CVC organisation for success. The six guiding principles described in this series of articles are supposed to help answer this question.
Guiding Principle 5: invest on market terms
Corporate venture capital (CVC) units are usually set up in order to generate strategic value for the given corporation and – given these strategic goals – it seems that CVCs are sometimes willing to pay more for a stake in a company than traditional venture capital firms are willing to pay. The median pre-money valuation of late-stage deals with CVC involvement has consistently been higher than VC deals without a corporate investor.
The problem with investing on above-industry-standard valuations is that traditional VC investors who also want to invest are often kicked out of the investment process since they cannot invest on comparable terms without giving up the chance to make the required return on investment. If the respective CVC unit becomes known as an investor willing to “overpay”, other VC funds may avoid sharing dealflow and co-investing with this unit, which will have a material negative impact on the CVC, at least in the long run.
Above-industry valuations may also backfire on startups when they need to raise funds again but cannot find external investors willing to invest on an even higher company valuation.
Last but not least, paying a high price naturally reduces the return potential. And if a CVC unit fails to also generate attractive financial returns it may lose its internal right to play and may be shut down sooner than later.
We therefore believe that the long-term CVC success chances are better if a CVC unit acts like traditional VCs and invests on market terms.
Patrick Flesner’s high-growth handbook FastScaling is available here.