What CVC can learn from product-market fit analysis

I come from a more traditional VC background but I have recently been spending more time with people in the corporate VC industry. One statistic I came across really shocked me: the majority of CVCs fail to make it beyond three years.

On paper a CVC should be the ideal investor. They know the market intimately, have robust and far-reaching contacts and credibility, and have deep enough pockets to continue to fund a startup as it navigates the tumultuous pathway to success. CVC-backed startups should have an unfair advantage. And yet, according to Global Corporate Venturing’s research, over two-thirds of corporate-backed startups fail, and 50% fail within only three years.

So what is going wrong? Or more importantly, what can be learnt and done better? As I began investigating, my past experience working on product-market fit at companies seemed to offer some clues.

I come from a technical background, a mechanical and electronics engineer by education. After graduating, I spent over five years as a technology consultant for global brands covering many different sectors, which was great. Still, I often disagreed with the focus of the work. I would be asked to make products cheaper, for example, as a solution to falling sales. It always felt like a band-aid rather than a solution to the cause of declining sales.

It would have been better to ask why sales were declining. Why didn’t customers like the product? Was it just the price? Were there better alternatives? Unfortunately, few companies really investigated product-market fit fully.

Projects sometimes faltered, and some were halted altogether. In post mortem, despite the thousands of problems we had faced during the projects, the real reason for the project stopping followed common themes:

• Failure to understand product-market fit — without product-market fit, the odds are severely stacked against you from the start.
• Failure to understand the incentive structure of your stakeholders. You think you know what they want, but that is either wrong or has changed.
• Failure to set aligned targets — partially linked to incentives, but are you working toward a common goal within an agreed and realistic timeframe and budget?
• Failure to deliver on stakeholder management. Companies are like families, there are lots of conflicts, alliances, goals and barriers all happening in a sea of information. Making sure that you know who your stakeholders are, you know what they want to achieve, and you know how to communicate progress, issues and goals is essential.

There are some interesting parallels to CVC:

Product-market fit

In investing, product-market fit is the number one reason startups fail. Building confidence in a startup’s product-market fit is essential before investment. Scaling and converting that product-market fit to revenue will massively improve their ability to secure a substantial Series A and, ultimately, their chances of success.

Corporates are in a strong position to assess and access the market to test product-market fit for a new technology or service. They know all the pitfalls that await the startup if it is to scale. They are acutely aware of the hurdles the startup will need to overcome and the importance of less sexy things like corporate governance, regulatory approvals and compliance.

Gurdeep Singh Kohli, a founding member of SC Ventures, a venturing unit of Standard Chartered Bank, told a recent GVC Next Wave webinar how he drives the importance of governance home to founders. It can feel cumbersome and even unnecessary early on, but it is an investment that can pay dividends later. When you finally put your product in front of a large bank, you don’t want them to shoot you down because you are not compliant or don’t have robust governance.

Incentive structures

Agreeing on targets is essential to aligning incentive structures and cementing buy-in at the most senior level. Buy-in includes an agreement on the timeframes for delivery, budgets, resourcing and focus. The natural short-term ups and downs of business (especially if publicly traded) can skew decision-making towards short-term results. This is especially true when times are tough. Therefore, CVCs should aim to deliver a significant potential competitive advantage to the corporate within 3-5 years.

Competitive advantage can mean several things, but one way is to have a startup supply its technology to the corporate or to be in the market so that its value can be seen; it gets it off the paper and into the real world.

Portfolio companies will struggle to bring benefits to the corporation if they are not equipped to integrate with the larger business. Discovering this early can also dramatically improve the startup’s chances of scaling.

At a recent CVC event hosted by Scott Law of AWS, I was introduced to their work to help startups improve their tech stack and integration. The programme (in partnership with FireMind) specialises in testing company technology integration for VCs and CVCs, mainly for data and AI companies. They run a short series of workshops where they perform a deep dive analysis on the startup’s tech stack and how it can integrate with the corporations they are likely to have as customers. This can help a startup highlight and solve technical risks much earlier in its development. Furthermore, it is often free.

Set bold targets

At the GVC Next Wave event, there was another interesting discussion about the importance of goal setting and how you need to make sure they are clear but also challenging, especially for venture-building units. If your achievements don’t move the needle for the corporate, you risk being shut down.

Stryber’s Alex Mahr discussed the goals being “an at least 10% addition to corporate revenues. Anything less than that, and the corporate parent may simply not take the venture building project seriously.” Debbie Brackeen, who built Mobilitas as an internal venture at CSAA, the 100-year-old US insurer, had an even more ambitious target: “Create another $1bn in revenues within ten years.” That was a 25% increase in sales, and Brackeen knew that more than just investing in external startups would be needed to reach it, so she felt the only way was to build in-house. Mobilitas has been operating for four years and is well on its way to delivering against its target.

Without bold targets, the fundamental impact of venturing may never be noticed.

Stakeholder management

Everybody who deploys capital that isn’t their personal wealth has to deal with stakeholders, often many. It is inevitable.

The limited partners in your fund come from varying backgrounds, with differing industry expertise, investment experience and aspirations for the capital they have placed under your management. It is the same, if not even more complex, for corporate venturing.

It is critical to secure access to capital for a period long enough to reach your bold targets. Having that capital locked in allows you to have a longer-term investment mindset which, ultimately, is what’s needed to succeed in venture.

It is crucial to communicate, especially with your tier 1 stakeholders, but consider also how to communicate and secure champions with your tier 2 stakeholders in the wider business. Let them engage with the great thing you are building, get them enthused, and let them see how it can benefit their areas of the company or just the business as a whole. They might also offer up insights and value that previously may have been overlooked.

Consider the frequency of your communications; it can seriously impact the behaviour of investors. One interesting study was on the difference in portfolio composition between equities (higher performing but less stable) and bonds (lower performing but more stable). As the reporting frequency increased, the ups and downs of the equity’s price movements pushed investors towards the more stable bonds. As the reporting frequency dropped, they increased equity weighting (which has better long-term performance.)

Another intriguing study by Kraft et al. in 2014 investigated companies’ investments before and after the mandatory change to quarterly reporting. They found that: “a statistically and economically significant decline in investments following reporting frequency increases. We conclude, based on our collective analysis, that the decline in investments is most consistent with managerial myopia.”

I recommend pushing for less frequent reporting, an annual report with quarterly industry insight. People tend to believe that more information is always better, the science doesn’t agree.

Rome wasn’t built in a day

So what does the future look like for corporate venture capital? We are at a time when venturing could make some of its most significant leaps forward. Markets remain depressed; the S&P 500 swung 25% from its 52wk high, and the FTSE100 is down 17% from its 52 wk high. SVB Global went into administration and some of the most valuable tech companies are laying off tens of thousands of workers and seeing over 90% of their value washed away overnight.

But as the old saying goes, when there is blood on the streets…it’s time to invest in innovative new startups. For CVCs to prevail, they need to invest for the long term, agree (from the outset) on bold targets, and confirm the commitments (capital, time, resources etc.) and the timeframes for success.

Their combination of patient capital, deep industry knowledge and insight should become a startup’s unfair advantage.

James Sore is an early-stage venture capitalist, entrepreneur, and engineer.