Corporate venturing units aim to help their parent companies find highly profitable new projects, spot promising technologies before competitors do, and collaborate with the best new thinkers in their field. But to score these kinds of wins, companies must organise their VC efforts with an eye to the delicate balance between entrepreneurial finance and organisational reality.
Our analysis* suggests companies that are not doing that may be undercutting themselves. Specifically, we study the compensation awarded to corporate venture capitalists (CVCs) and its implications to investment practices and performance, using data from more than 13,000 venture capital rounds during the 1990s.
A typical independent venture capital fund raises money from pension funds, universities and wealthy individuals, and then invests the funds on behalf of those investors. The VC’s compensation scheme usually consists of the “2 and 20” – that is, an annual 2% of the total assets under management plus 20% of profits.
CVCs, in contrast, invest their parent company’s money and often receive just a salary and maybe an annual bonus. In a famous example from the 1990s, a German software maker paid straight salary to the head of its Silicon Valley VC unit even though he racked up a 6,000% return on the company’s $25m portfolio.
We find that CVC compensation schemes can have a critical impact on performance. On average, the rate of successful portfolio exits for CVCs is similar or higher than that experienced by independent venture capitalists (IVCs), probably due to a CVC’s ability to leverage parent-firm resources, industry foresight, and customer and supplier networks.
However, the CVC-IVC performance gap is sensitive to CVC compensation schemes – it is large when CVCs receive performance-related pay, and diminishes substantially when they receive little or no incentive.
What explains the performance differential? Detailed analysis of investment practices reveals that, on average, CVCs shy away from risk. We observe that corporations invest in more mature and potentially less risky ventures than IVCs do. In addition, deals involving a CVC unit are associated with a syndicate size that is 49% larger than those with IVC participation alone.
These patterns persist even after controlling for units’ objectives (financial or strategic) and other corporate characteristics. Interestingly, in the presence of performance-related pay, CVCs engage in practices that differ only slightly from that of their IVC counterparts.
Put differently, CVCs who receive more performance-related pay partake in deals that look a lot like the ones conducted by IVCs – these CVCs invest in earlier stages and make their investments through smaller syndicates.
When setting CVC compensation schemes, corporations should be aware of the implications. Awarding high-powered incentives to a handful of individuals may run contrary to corporate culture, but failure to compensate for success may prevent the corporate VC unit from fulfilling its potential.
* Entrepreneurial Finance Meets Organizational Reality: Com- paring Investment Practices by Corporate and Independent Venture Capitalists.