Competitive advantage through corporate venture capital

Corporate Venture Capital (CVC) exist as an alternative fundraising option for many startups. From a founder’s perspective, partnering with the right CVC fund can provide unparalleled leverage. From the corporation’s perspective, CVC provides a great opportunity to access new disruptive technology which could aid or threaten their primary market position, while also providing a vehicle to accelerate their own innovation strategy.

The rise of CVC

The use of CVC as a complementary tool in innovation strategy has been on the rise for the last 10 years. The percentage of global VC deals which included CVC investors has risen from 11% between 2012 – 2016 to 12% in 2018. CVC investments as a share of global VC investments has grown at a faster rate, from 20% in 2012 to 27% in 2017, showing CVC contribution to overall venture capital is significant. Perhaps the most interesting analysis has shown CVC investments in AI has multiplied by 10x, from $0.3 billion in 2013 to $3.8billion in 2017. The performance of CVC funds also mirrors the overall VC market success with 95% reporting positive returns in 2017.

What’s in it for CVC funds?

CVC has established its position as an important player within the context of VC and startup fundraising while also being a common feature of corporate innovation strategy. From the corporations perspective, there are three key benefits which justify the creation of CVC funds.

Access to new technology: Investments into early stage startups provide opportunities for incumbents to grow their technology portfolios, without the burden of internal R&D and operations. Microsoft Venture’s investment into Crowdflower had a clear strategic purpose of bolstering its AI capabilities.

Breaking into new markets: CVC also provides opportunities for incumbent corporations to enter new markets without the high sunk costs. Alphabet’s £358 million investment into Uber, and Carbon 3D, had clear strategic intent of entering new growth markets.

Invests to acquire: Often thought of as the primary reason for CVC, investing to acquire is a strong motive, however not usually the primary reasons. CVC funds such as Intel Capital have invested in over 1,500 startups but only acquired a handful.

What’s in it for startups?

Flexibility: From our experience, CVC funds provide greater flexibility and room for term sheet negotiations. On numerous assessments we have seen lower tier/mid tier CVC’s overpaying for deals, however top tier tech CVC’s such as Intel Capital and Microsoft Ventures do not have same issue. The last 10 years have also shown VC funds becoming more specific about their investment thesis and what they are looking for in a potential portfolio company, on the other hand CVC’s strategic and financial requirements are more malleable. This presents an opportunity for entrepreneurs to capitalise on the flexibility and the slightly reduced investment requirement of Corporate Venture Funds.

Leverage & resources: Startups are able to leverage the resources at the disposable of CVC funds, if the fund is integrated into the broader innovation strategy of the parent company. Startups can use accelerators, incubators and other focused development programs/resources from engineers to market analysts to help the growth of their firm. Crucially, startups will only be able to utilise the benefits, if the CVC fund is integrated into the firms strategic focus.

Too often CVC funds fail due to their separation of the parent companies core business. For innovations such as biotech which require critical mass for breakthroughs, Alvarez-Garrido and Dushnitsky (2016) find that CVC-backed biotechnology startups are more innovative than their independent VC-backed peers. The superior innovation performance manifests itself both in terms of startups’ scientific publication track record, as well as their patenting output. The preferential access to corporate advanced facilities, skilled R&D personnel, and manufacturing and regulatory know-how are critical elements to a startups success.

Sales, networks and introductions: Startups target audience will often overlap with the parent CVC’s networks and clients. Parent companies can play an essential role in brokering introductions with potential customers, leveraging a sales team which could include thousands of reps, an executive team with deep industry relationships and a management team who understand the challenges faced by different market segments. Last year, Intel were reported to have brokered nearly 5,000 engagements between Intel Capital’s portfolio companies and Global 2000 firms.

Laying the foundations for an acquisition: The total percentage of portfolio companies acquired by parent companies is minuscule in comparison to expectation. Intel Capital leads the pack for the total number of acquisitions of its portfolio companies, 12, with Google Ventures coming in second. Acquisition by parent companies are the exception, not the norm.

However, the support offered by CVC parent companies will lay the groundwork for a successful acquisition. Total acquisitions also give us an indication of how well each CVC is placing its bets. The common perception is that CVC funds are under less pressure to generate financial returns due to the healthy position of the parent company. The data would suggest regardless of pressure, top tier CVC’s are doing a good job in ensuring successful exits for their portfolio companies.

CVC funds regularly work with investment banks, whether it is the m&a division or corporate finance which mean they are a natural fit for making connections with them.

Corporate venture capital continues to make up a larger percentage of total VC deals. Founders should explore where there is sufficient overlap and shared strategic focus between the CVC parent company and the startup. Importantly, the benefits of CVC are only realised if the fund is integrated into the broader innovation strategy. Too often, CVC funds are reactionary and separated from the parent company’s core focus, resources and innovation strategy.