Over a dinner at Tilburg University recently, a select handful of corporate venturing leaders sketched out two matrices to explain why the industry is growing so fast. Such business school-style matrices have their flaws but can be useful pointers to trends in the market. In this case the four quadrants are fear, greed, leverage and equity.
The leverage-equity matrix helps explain why corporations are setting up venturing units at the start of an economic cycle rather than towards its high point and end.
This countercyclical activity reverses the pattern of the past 40 years, where corporate venturing units started just when valuations were highest and before they crashed, often leading to losses or writedowns that encouraged the whole programme to be closed.
One explanation for groups to set up as the global economy struggles to right itself after the credit crunch that started in 2007 is because, well, debt has been crunched and opportunities for it to grow by the same pace over the next few decades have been reduced.
The explosion of leverage over the past 30 years broadly drove returns for governments, corporations and individuals by magnifying small increases in equity performance or through tax breaks and using free cashflows to repay the interest and principal.
Leveraged buyouts went from borrowing one times earnings before interest, tax, depreciation and amortisation in the mid-1990s to three times – thanks to now-nationalised Royal Bank of Scotland for that innovation – and up to 12-times by 2007. Countries made unwarranted social security promises and set high pay levels for state employees, so mortgaging the future. Individuals ran up debt on credit cards and in loans and mortgages.
If the hypothesis is that debt growth will be constrained over the next few decades – still only a possibility given the explosion of effective gearing through derivatives – then the tool has become effectively commoditised. If you are a person, company or government at a particular stage of development, in a particular sector and region with a certain set of characteristics, then how much you can borrow
is fixed, subject to your own risk aversion or tolerance.
What drives relative outperformance in such conditions is the ability to boost equity, which can then be leveraged accordingly.
Hence we see more people returning to university or business school to improve skills and gain a higher salary – their own equity – or setting up a company in the quest for life-transforming capital returns. We also see governments considering how innovative their region is and what factors will drive jobs and growth. And we see corporations looking at their own innovation toolkits – such as joint ventures, partnerships, corporate venturing, incubation – for ways to survive and thrive in a globalised economy.
The halcyon days of the post-Soviet collapse, when several billion people from Russia, China, India and Brazil increasingly joined the free market world, are ending.
These countries are still in the market but are growing rapidly and providing competition to developed-market incumbents through their own disruptive innovations.
The fear-greed matrix explains which companies jump into corporate venturing and when they do so. In general, the early adopters of corporate venturing are driven by greed – often successful companies with free cashflow looking for profitable investments.
Other corporations have worried about whether to follow suit to avoid being blindsided by an innovation developed in this way, or they face a so-called burning platform as their core business is affected by competition, although this factor usually leads to large mergers and acquisitions as a shorter-term impact.
In multiple industries we have now reached a tipping point where enough early adopters have moved to encourage the mass to join – consultancy Boston Consulting Group estimates there are 9,000 businesses exploring how to set up a corporate venturing programme to join the more than 550 that have already done so.
Global Corporate Venturing has tracked more than 200 programme and fund launches over its first two years – an analysis will be with the six-month data review in the July issue so please add your thoughts.
Healthcare, this month’s featured sector, now has more than 100 active corporate venturing units with parents focused in the sector and many more from other areas investing in entrepreneurs targeting the sector as a way to break into the industry.
The exact aims and strategies of all these corporate venturing groups remain unique depending on their parent’s business and culture and the individuals involved in setting up and running the units, but the macro-drivers of growth in the industry, and its timing, appear to be clear.