Corporate Venture Capital (CVC) is more popular than ever before. However, many CVCs fail to meet their objectives, either strategic or financial. As part of a series of articles on the role of CVCs in the fintech ecosystem, this first blog examines the reasons for establishing a CVC fund, common pitfalls and key factors required for success.
This blog has originally posted at Holland Fintech.
Corporates nowadays use a variety of innovation instruments to accelerate growths. These instruments include open innovation, incubators, accelerators, corporate VC and other similar variants.
For instance, the consumer business giant Unilever uses both the Foundry and CVC model to stimulate innovation. Unilever Ventures, founded in 2002, acts as the Venture Capital and Private Equity arm of Unilever. It invests in promising startups with commercialized products, technologies or business models, to scale and grow the businesses. While Unilever Foundry, launched four years ago, is a platform to identify innovative technologies and partner with startups to experiment and pilot new technologies. Successful startup partners from the Foundry platform may further receive growth financing from Unilever Ventures.
Siemens is another example company that leverages different venturing models. Siemens operates an independent venture arm, Next47, to invest in disruptive innovations in Siemen’s strategic innovation fields. The company also leverages an open innovation platform, Siemens Technology to Business (TTB), which builds partnerships with startups to drive innovation. The mission of Siemens TTB is to identify groundbreaking early stage technologies and to provide them with the route and resources needed to commercialize success.
Overall, CVC remains the most popular outside-in innovation tool. According to CB insights, 1,067 corporate venture capitals (CVCs) actively invested in 2017 in total and among them, there are more than 180 new corporate VC funds invested, representing 66% growth compared to the year before. CVCs invested actively across a range of industries or technologies last year including fintech, digital health, AI, blockchain, food and more. Following KPMG’s Pulse of Fintech Q4 2017 report, CVCs are active in fintech and participated in 19% of all global fintech venture financings in 2017, compared to 16% in the previous year and only 9% in 2012.
CVC has become a mainstream innovation tool to complement R&D efforts. It plays an important role in connecting corporates with external innovations through joint developments, partnerships, venture investing and acquisitions. The imperative for a corporate to run a successful corporate VC fund has become more important than ever.
Rationale for Corporate Venturing
There are three main reasons for corporates to establish a corporate venture fund:
1. Innovation radar: keep an eye on the outside innovation landscape and identify interesting and radical innovations. For example, one of the objectives for Citi Ventures is to seek innovative ideas and bring outside perspectives into Citi by actively monitoring and connecting with the startup landscape. City Ventures also makes minority investments in five defined investment areas. However, Citi Ventures does not require exclusivity and acquiring portfolio companies is not their end goal.
2. Innovation accelerator: accelerate developments of the ecosystem that is paramount for success of new products or technologies of the corporate parent. For example, Intel Capital launched a fund in 1998 that invested in startups that would speed the entry of Intel’s new generation semiconductor chip into the market1by stimulating the chip ecosystem. Contrastingly, Philips Electronics failed to successfully market its high-definition television in the 1980s despite technology breakthroughs. Because the complementing innovations, such as high-definition cameras and transmission standards to make high-definition TV work, arrived too late2. Specifically, for the fintech ecosystem, financial institutions should be wary of investing in end-user products and capabilities only, while the finance technology infrastructure fails to keep up with the standard required and subsequently thwarts the speed of innovation for the overall ecosystem.
3. Innovation acquisition: identify strategic partners for business units and potential acquisition targets. For example, some of the investments made by Cisco Investments (Cisco’s corporate VC arm) later turned into Cisco acquisitions and were integrated in the organization. Cisco Investments invests in strategic areas that are important for Cisco’s business in the long run beyond current businesses. These investments give Cisco an advantage in acquiring them later and be the first mover in nascent and emerging industry segments.
By investing early in the startups, financial institutions can obtain insights into these players and gain an advantage in acquiring the companies should they become game changers in the future. Financial institutions can also jointly develop the businesses with the startups when they become investor and clients. In turn they can accelerate the growth of the business and benefit from higher valuations.
CVCs are usually set up independently from their corporate parent, allowing for flexibility, speed and separate ROIs to define success. Objectives of corporate VCs usually are both strategic and financial, while the majority are driven by strategic goals (e.g. Citi Ventures and Unilever Ventures) and the others are more financially-driven (e.g. GE Capital and Sapphire Ventures (SAP)). Despite the popularity, many of the CVCs, including even some of the funds launched in the 90s, have difficulties in defining the right approach and KPIs to run CVCs to maximize value add to the parent organization.
Common pitfalls of Corporate Venturing
One common obstacle is that CVCs are often challenged by the parent on results already after 2-3 years of establishing the funds. Some funds were closed down shortly if financial results did not meet expectations, or if strategic goals were unmet. Nevertheless, CVCs are intended to make investments in the medium to long run, with investment horizons varying by early-, expansion-, and growth-stage. Early-stage investments could take around 7+ years to maturity and exit. Expansion-stage investments, depending on whether the startup has a proven product, technology or business model could take 4-6 years to exit. Finally, only growth-stage companies that are more mature require the shortest exit time, typically 2-3 years3.
Thus, the long-term commitment required from CVC model sometimes conflicts with the typical corporate business cycle and ROI requirement that tends to favor shorter-term results. It also conflicts with the average tenure a corporate executive stands on an internal position. These discrepancies contribute to corporate VCs setting unrealistic goals at inception of the fund and subsequent failure to meet performance expectations.
Another common challenge is that corporate VCs sometimes lack a clear approach in identifying investment areas, which results in making scattered investments. For CVCs primarily driven by strategic goals, investments should focus on the parent’s strategic areas relevant for today’s business. Investments should also extend to areas where the future is heading towards and where the corporate does not yet have a presence that can affect the company in the long run.
Finally, knowledge gained in the corporate VC arm is often kept in isolation and insufficiently transferred back to the parents. If one of the KPIs for CVC success is to gain insights from the portfolio companies, they should be connected to the business units regularly through dedicated channels. For example, one design is to have dedicated relationship managers responsible for the portfolio companies to connect with business units, partners and the ecosystem.
Achieving successful Corporate Venturing
Depending on the objectives, strategic or financial, or both, the measures to define success for CVCs vary. Traditionally, CVC is considered an important outside-in innovation engine. It is set up to invest in strategic areas for the parent in the long run and financial goals are secondary. Most CVCs are also not very competitive compared to conventional venture capitals in achieving superior financial returns. Accordingly, the success of CVCs can be measured on the number of corporate parent acquisitions, strategic acquisitions, IPOs, products or technologies integrated and by other means.
To run successful CVCs, first, setting clear and consistent objectives are essential. Are the goals primarily strategic? If so, does the fund aim to understand particular emerging markets better? Or to market sense of the startup landscape and not intend to acquire the portfolio companies? Or does it aim to invest in startups with potential acquisitions and integration in mind?
Second, long-term commitment is a prerequisite. Unlike acquisitions, the purpose of CVC is to augment R&D efforts and stimulate innovation in the long run. Third, investments should closely align with corporate parents’ strategic ambitions, both for current businesses and beyond. Fourth, corporates should have realistic expectations on financial returns. They should develop criteria and incentives consistent with the objectives.
Compared to CVCs in the technology sector (e.g. Intel Capital, Cisco Investments), CVC arms of financial institutions are overall very young. Citi Ventures was founded in 2010 and a few Dutch banks launched their CVC arms only in the last few years.
To run successful CVCs, it is important for banks to clearly define their objectives. They need to set up the right team aligned with these objectives and create a structure that enables sharing of knowledge and acquisitions with the parent company.
Source: 1) Corporate Venturing by Josh Lerner, Harvard Business Review Oct-2013; 2) The Wide Lens, a new strategy for innovation by Ron Adner, 2012; 3) Evangelos Simoudis’s blog: Re-imagining Corporate Innovation with a Silicon Valley perspective. Blog post 14/02/13, Corporate Venture Capital’s Role in Disruptive Innovation Part 2: Will the Big Numbers Result In Big Success this Time?