However, that is not the case. I will explain.
As part of due diligence, a skilled venture capitalist confirms market demand by talking to a startup’s potential customers. Sector-focused investors can quickly get a feel for what customers in their sector are interested in and what they are leaning into from an investment standpoint. So, at least for a first cut, involving management in the selection process is not necessary.
Not only is it not necessary, it actually can lead to worse decisions. One of the main reasons to set up a CVC is to help the corporate’s mid- and senior management recognise innovative startups, access them, interface with them and absorb that outside innovation. So why expect them to be good at it from day one?
In practice, inexperienced innovation teams often spend too much time engaging with immature or – to the eyes of a skilled venture capitalist – obviously fatally flawed startups. They waste time, money, and, worst of all, the attention of the business lines, souring them on startups in general.
Once the CVC has winnowed out nine out of 10 (or 19 out of 20) potential investments, there’s definitely a place for the line management to vet the solution in greater depth.
How is fiscal oversight managed? When a corporation allocates $50 million or more than $100 million to a project, it is only natural that they want oversight. In this case, it often means that senior management wants to sit on the investment committee and approve investments.
But these senior managers often run multi-hundred-million dollar divisions where their “day jobs” always come first. Asking them to find mutually convenient time to meet to review a $1m deal is a recipe for delay. Plus, when a fund has a reputation for moving slowly, the hot deals pass them by.
A smarter balance between speed, flexibility and oversight is to allow the CVC to make routine investments, subjecting only especially large follow-on investments for approval by senior management.
In theory, investing off the balance sheet from budgeted funds should be as effective as committed capital within a formal venture capital fund structure. In practice, it rarely is. Budgets get cut, routine approvals become bargaining chips for corporate horse trading, investment committee members push for pet projects, in addition to potential acqui-hires (hires through acquisition). Creating an arm’s-length contract that obligates them to meet capital calls and also creating governing documents that clearly establish the fund’s mandate and general partners’ sole authority to make investments, up to a certain threshold, insulates the CVC from these pressures, empowers it to operate on par with traditional venture capital funds and enables it to attract top talent.
Another more subtle reason for an arm’s-length fund commitment is to avoid failing by success. When a venture team has a large exit that makes the partners some of the most highly compensated people in the company, there can be a lot of pressure from line management to renegotiate that deal. Since salary is easier to cut than carry, top venture capital talent often shy away from CVCs.
First published by Hive