VCs often pride themselves on their ability to recognise growth trends, so it should come as no surprise that many have recently commented on a major change in their own trade – the rise of corporate venture capital (CVC). From 2011 to 2016, the number of global active corporate investors has tripled to 965. Today, 75 of the Fortune 100 are active in corporate venturing, and 41 have a dedicated CVC team. They represent a growing source of capital as well, participating in nearly a third of all US venture deals and 40% in Asia. The growing role of corporates in financing entrepreneurship is undeniable.
While much has been written about the proliferation of CVC, its merits and challenges, I am interested here in the structures that increase CVCs’ likelihood of long-term stability and success. In 2006, Harvard Business School’s Prof Josh Lerner asked: “Does the venture capital structure matter?” The answer remains a resounding yes, and amid this rapid growth in CVC, the structures matter more than ever. Today, many CVCs have been structured with a critical set of features – returns-orientation, independent decision-making, strategic relevance and evergreen capital – that foster longevity for the CVC and trust with the startup community.
Modern CVC feature set
Returns-orientation: Many of today’s leading CVCs are structured with the clear objective of maximising financial return. With no potential for competing corporate interests, they can tell a simple and easy-to-understand story to the entrepreneurial community – we are aligned with you to grow shareholder value. On investment, they have no incentive to pay the “strategic premium” or add off-market strategic terms, like a right of first offer. After investment, they have no reason to force a one-sided commercial deal with the corporate parent at the expense of their portfolio companies’ limited time and energy. Aligned with other shareholders, these returns-focused CVCs can become preferred financing partners.
The benefits of a returns-orientation extend to the corporate parent as well. First, the CVC can be more accurately measured on its financial performance – more like an objective score on a maths test than a subjective letter on an essay. The parent, many of whom are publicly traded, can in turn quantify results to its shareholders. Second, when a CVC focuses on making returns, financial success is naturally more likely. As a potential profit-generator, the CVC can become insulated from the vagaries of annual budgeting; it becomes self-sustainable. Perhaps the most compelling argument for this feature is that financial performance is the single best proxy for strategic value. Although there are takeaways from failure, most corporates glean valuable, winning strategies from affiliations with successful companies. Empirically, in a study of 71 CVCs in the biopharma industry from 1985 – 2005, Georgia Tech professors Daniel Kang and Vik Nanda found that more successful investments had a meaningful positive relationship to more successful internal drug development. Great financial returns often go hand-in-hand with strategic benefit for the parent.
Accepting that a returns-orientation is foundational to a long-term aligned CVC, we must also recognise that incentives matter for orienting great investing professionals around returns and retention. Historically, CVCs have been challenged to retain partners, who may seek greater pay or independence at a traditional VC fund. A CVC partner’s time and energy should be aligned toward long-term value creation with carry-based compensation (a share of fund performance) that is consistent with traditional fund managers. Indeed, CVCs simultaneously act as fund managers, navigate what Josh Lerner calls the “tricky interface” between startups and large corporations, and serve as the parent’s ambassador to the entrepreneur and VC community. Exceptional investment talent can have a profound impact on the parent’s shareholder value, through financial returns, new business opportunities and insights from portfolio companies. Aligned with fund performance, partners are more inclined to achieve optimal outcomes for the portfolio and parent.
Independent decision-making: Autonomy from the parent helps CVCs quickly and nimbly reach decisions and employ in-house investment professionals. At many of today’s most active CVCs, such as GV – formerly Google Ventures – Intel Capital, SAP’s Sapphire Ventures, and Comcast Ventures, where I work, decision-making power rests with a set of dedicated investment professionals, not those busy running the operating business units. With the speed and agility of a small professional team, these CVCs can become more dependable decision-makers for the startups they evaluate and more trusted partners for their portfolio companies. Additionally, these teams either have or quickly develop expertise in the investment process – sourcing and evaluating investments, oversight of and value creation for portfolio companies, and the engineering of optimal exits. Efficient and experienced, these CVCs become trusted partners of entrepreneurs and fellow shareholders, with whom they can collectively grow the startup.
Strategic relevance: Investing in areas core or adjacent to the corporate parent’s interests enhances stability and returns for the CVC. This relevance means that there is a relationship between the target sectors of the parent and the CVC, not a limited strategic scope. This distinction is important because the disruptive forces upending traditional businesses may come from unexpected places. Less than a decade ago it would have seemed odd for a media-focused CVC to invest in an ephemeral, sometimes illicit, messaging app, but today’s media companies fear and envy how Snapchat has affected their core businesses. While the parent’s M&A and business development teams may focus, like car headlights, on line-of-sight strategic opportunities, CVCs scan the broad landscape, more like a lighthouse, evaluating a high volume of opportunities in adjacent sectors.
When executed well, strategic relevance facilitates a win-win-win involving the CVC, entrepreneur and corporate parent. For the CVC, relevance tends to enhance returns due to proprietary sourcing, diligence and post-investment value-creation. For entrepreneurs, the CVC’s relationship with the larger core business increases the likelihood of gaining a lucrative contract, distribution channel or unique domain expertise. The corporate parent also benefits from exposure to new partners, business models and talent. Indeed, a CVC introduces its parent company to talented entrepreneurs – relationships that would be difficult to foster without an investment tie. Practised over time, these dynamics spin a virtuous and accelerating CVC flywheel.
As this flywheel spins faster, a CVC’s value proposition grows. CVCs develop a stronger network of business leaders, greater credibility and deeper domain expertise in focus areas, like semiconductors (Intel), media (Comcast) and cloud software (Salesforce). In short, CVCs stick to their knitting. As one of the conduits between startups and corporations, they also can shepherd a commercial agreement or think creatively about how to leverage the breadth of corporate assets. See below a couple examples drawn from CVC websites and my experience with commercial value-add through investment:
• Comcast Ventures, after its 2009 investment in Vox Media – SB Nation at the time – was able to facilitate multiple collaborations between Vox and Comcast NBCU across editorial, advertising, content and technology. In 2015, NBCU strategically invested $200m in Vox.
• SoftBank Capital was able to create strategic value with its investment into Criteo, an advertising retargeting solution, when it facilitated a performance display marketing relationship between Criteo and SoftBank property Yahoo Japan. Japan became one of Criteo’s fastest-growing markets, and Criteo is now a $3bn publicly-traded company.
• Intel Capital helped portfolio company Virtustream, a large-scale enterprise cloud solutions provider, gain a test market within Intel, gain access to customers through Intel’s sales channels and achieve valuable product validation through the Intel brand. Virtustream was acquired by EMC in 2015 for $1.2bn.
Evergreen capital: An evergreen structure, in which capital is predictably available and has no end of fund life, enables a more active, resilient and patient fund. With large long-lived assets and predictable cashflow, certain corporate parents allocate a small fraction of annual cashflow to the CVC, concurrent with the annual budgeting process. This predictable commitment ensures the lights are always on, making the CVC a visible and dependable source of capital. This enhances credibility to the entrepreneurial community, deal-sourcing and evaluation capabilities and diversification across time periods. Partners in evergreen funds also spend far less time and energy fundraising than traditional VCs. Each serves to bolster financial returns and trust with the startup community.
Perhaps the great advantage of evergreen capital is its patience. While traditional VC fund lives are customarily 10 years – and many are expected to exit well before that – CVCs with an evergreen fund can invest in companies and sectors that need more time to mature. The globalisation of the internet, for example, is a trend that has been lucrative over the long run. Riding this trend, eBay held its stake in Latin American e-commerce powerhouse MercadoLibre for 15 years, as the startup grew its annual revenue from about $2m in 2002 to nearly $1bn today. Similarly, SoftBank, where I previously worked, has held its roughly 30% stake in Alibaba for more than 15 years as it turned an aggregate investment of about $200m into around $80bn. Where traditional VCs’ ability to hold would have been constrained by their customary 10-year fund lifetimes, these corporate funds were able to be patient for far longer.
Today, industries like virtual reality, internet of things and blockchain are still in their infancy, which perhaps is the reason why CVCs feel more comfortable wading in. With evergreen capital, a CVC can support companies and sectors through the lifecycle. Without an end of fund life or impending raising of new funds, they are less likely to trigger a premature sale or drip-fund to postpone an inevitable writedown. With investment horizons closer to that of the entrepreneur, the CVC is aligned to think similarly. The race for unicorn valuations – those above $1bn – has had perverse effects and devastating consequences, as Theranos illustrates. What entrepreneur would not want more time to grow at an appropriate speed?
CVC’s golden age
As the cycle inevitably turns, the winnowing of certain CVC experiments should not be confused with a permanent retreat from CVC. These experiments will be instructive to structuring CVCs in the future, as they have in the past. While there is no single panacea to structuring successful CVCs, the feature set of a returns-focused, autonomous, strategically-relevant and evergreen fund will undoubtedly improve outcomes and longevity. If optimised with these features, CVCs will benefit from their advantages – patience, domain expertise and commercial capabilities. CVCs, similar to the startups they back, have refined their pitch, honed their strengths and evolved their structures. After many attempts at take-off, CVCs are here to stay.
This is an edited version of a comment first published on Forbes.com