Corporate venturers often invest in start-up companies to identify businesses to buy later.
In fact, according to a paper by David Benson of Brigham Young University and Rosemarie Ziedonis of the University of Oregon, 20% of acquisitions made by the companies with the largest corporate venturing operations were in businesses in which their venturing arms had previously invested. Benson and Ziedonis find a surprising pattern in these purchases.
In their article in Journal of Financial Economics, Corporate venture capital and the returns to acquiring portfolio companies*, they report that when companies purchased start-ups in their venture capital portfolios, shareholder value was typically reduced by $63m. This did not happen when the companies bought businesses in which they had not invested. In these acquisitions, shareholder value typically increased by $8.5m.
Why was shareholder value reduced when the companies purchased start-ups in their corporate venturing portfolios?
The authors examined whether the acquirers overbid because of competition, problems in firm governance or excessive chief executive selfconfidence, and did not find evidence to support any of these explanations.
Instead, the authors found that corporate venturing programmes housed in separate organisations tended not to experience a loss of shareholder value in their portfolio company acquisitions, but those programmes housed within the main organisation did.
This pattern suggests the explanation for the decline in shareholder value lies in the accuracy of the investors’ evaluations of the target companies. Benson and Ziedonis found the valuations of portfolio companies by autonomous corporate venturing units were less biased than those of internally-housed programmes and the autonomous operations did a better job of monitoring investments.
The authors attribute the superior approach of the more independent units to their greater exposure to dealflow and deeper finance experience.
In short, this research suggests that corporations seeking to acquire start-ups in which they make corporate venturing investments should consider setting up their venturing operations as independent business units.
* Benson, D, and Ziedonis, RH, Corporate venture capital and the returns to acquiring portfolio companies. Journal of Financial Economics (2010), doi:10.1016/j. jfineco.2010.07.003. The full paper requires subscription at www.sciencedirect.com or contact the authors: Rosemarie Ziedonis rmz@lcbmail.uoregon.edu and David Benson
david.benson@byu.edu