To what extent can corporate investors add value to portfolio companies?
This question is particularly important for a variety of reasons. First, promising new ventures exert considerable choice regarding their funding sources and, especially so, in the case of assessing the pros and cons of corporate backing. Second, prominent traditional venture capital funds (VC) prefer to syndicate with investors that can significantly contribute to the success of the new ventures, enhancing the likelihood of a profitable exit.
Yet there are pros and cons when corporate investors engage with innovative and dynamic growth companies and it is therefore important to understand how and under which conditions corporate investors actually add value to portfolio companies.
Recent empirical work, published in Financial Management by Vladimir Ivanov of US regulator the Securities and Exchange Commission, and Fei Xie of George Mason University, presents evidence suggesting that corporate investors – compared with traditional VCs – add substantial value to the portfolio companies. In particular, they analyse a sample of VC-backed initial public offerings (IPOs) and a sample of acquisitions of venture-backed companies to see whether corporate venturing (CV) backing affects the valuations at the IPO or the takeover premiums in case of acquisitions.
The results show that CV-backed companies are more likely to secure a successful exit and, perhaps more surprisingly, to receive higher valuations and acquisition premiums.
However, this is the case only when portfolio companies have a strategic fit – a strategic alliance or close business relationship – with the parent corporations of the corporate venturers. The strategic fit allows portfolio companies to benefit from the assets and operation complementarities of corporations – for example, market and technical knowledge, infrastructure for product development, and access to intra-firm information networks and market channels.
While such results provide a compelling case for the potential benefits of partnering strategic corporate investors, it remains unclear under which particular conditions corporate backing is beneficial.
Analysis presented by Haemin Park and Kevin Steensma in Strategic Management Journal provides some insights on this, as they specifically examine the trade-off faced by start-ups when considering CV funding.
“Corporate investors can provide complementary assets that enhance the commercialisation of new venture technologies. However, tight links with a particular corporate investor has drawbacks and may constrain new ventures from accessing complementary assets from diverse sources in an open market.”
Their analysis of 508 venture-backed start-ups in the computer, wireless and semiconductor sectors found that CV-backed new ventures were less likely to fail – bankruptcy, for example – and significantly more likely to go public under specific conditions, when they required “specialised complementary assets” and operated in a relative more uncertain environment, where start-ups cannot easily assess their future resource needs.
If corporates do not add significant value to their investee companies, where there is a clear strategic fit withthe parent company, entrepreneurs may opt more frequently for traditional VCs, since they have generally fewer strings attached and the path to exit – IPO, merger or acquisition – is significantly shorter than with the engagement of a corporate investor.
As a result, corporates need to compensate for some of their drawbacks when being involved with innovative growth companies and the best way to overcome this hurdle is to provide unique and superior value that traditional VCs may not easily match.