AAA Financial aims and metrics

Financial aims and metrics

Clearly defined methodologies for measuring the effectiveness of corporate venturing (CV) are imperative for longterm programme sustainability. Validation of any organisation’s accomplishments against a plan is just good business sense. However, it seems many colleagues struggle with defining and tracking the effectiveness of their CV programmes.

How many times have we seen at innovation and CV conferences the question of how you measure CV effectiveness make many highly experienced CV professionals squirm their seats? No need to squirm folks. In this article

I will offer some insights on instituting CV measurement methodologies and metrics, and related complications, I have observed in the industry and which we have refined over the past 14 years at the Panasonic Venture Group.

Basic tenets of business management advocate the principles of setting objectives and metrics in advance of launching business endeavours and then regularly tracking the results. Objectives need to be achievable, metrics need to be representative of those objectives and management must be accountable for the outcomes.

Accountability is feasible, and useful, if objectives are clear and if metrics are evaluated. And monitoring our results throughout the process, not just at the end in hindsight, will enable us to make course corrections as needed to reach our ultimate targets.

In applying these management principles to corporate venturing, there are some complications that will emerge.

The first is that in developing the unit’s objectives, you realise there may be multiple stakeholders to which the CV team is accountable.

If you have just one stakeholder, then setting objectives is a bit easier for you. But for the rest of us, we need to balance the objectives of sponsors, disparate business units, administrative organisations, review committees and others. And the corporate venturing group also has stakeholders outside the corporation, especially their portfolio companies and co-investors.

The various stakeholders need to be acknowledged by all involved with the organisation, and an understanding of the group’s obligations and priorities to each stakeholder should be articulated before proceeding to define the objectives and the appropriate metrics of the CV unit.

It is at this point that the most familiar complication arises. A successful and sustainable CV programme almost always has two broad objectives – strategic and financial – which are not always consistent and some times difficult to define.

These two macro-objectives co-exist because investment capital is utilised as a means to provide the corporation access to start-ups with the intent to achieve strategic benefits through an alliance.

Therefore, there are financial objectives, and respective metrics, in regard to the investment capital deployed – funded alone or alongside financially- driven angels and venture capital firms (VCs) – and there are strategic objectives pertaining to the proposed alliance between the two companies.

While I will describe methodologies for financial and strategic outcomes each on an individual basis, which should be implemented diligently, CVs might also consider establishing and reporting an aggregated return metric (ARM).

The ARM will include financial return metrics combined with strategic return metrics, including both qualitative and quantitative metrics.

Financial objectives are easy to understand, so we will start with that. Well, maybe not so easy for corporations. For VCs, it is straightforward since their fund investors, the limited partners (LPs), are seeking the highest risk-adjusted venture investments.

But for CVs, the investor is the corporation (whether as an LP or direct from the balance sheet), and while producing high internal rates of return (IRRs), a measure of annual performance, may seem to be generally welcome, most corporations are not financial investment companies and therefore their shareholders expect management to achieve earnings through operations and not by betting capital on venture start-ups.

The point here is that scale of capital matters, meaning that too much financial return, or substantial losses, that seriously affects earnings results is not advisable. Corporations need to balance the amount of capital deployed in venturing proportionate to annual free cashflow so as not to create issues with shareholders.

Although some CV groups’ financial returns may not match the very top-tier, financially-motivated VCs’ returns – and it could be argued that with strategic results the priority corporation, it is difficult to attain VC-calibre IRRs – CVs should still apply financial metrics for their programme.

If no financial return metrics are established, then the group will probably not be managed as a venture investment organisation for sustainable success, but is instead more likely to be run as a pet project fund and in the end the capital will be wasted.

The common financial return metricsfor corporate ventureinvesting are:
l Return of capital, plus a cost-of-capital rate.
l Return of capital, plus a cost-of-capital rate, plus the operating expenses of the CV unit.
l Percentage IRR (time-based cashflows) or cash-oncash multiples (on invested capital), plus the operating expenses of the CV unit (or management fee).

Earlier I touched on accountability, which is important in managing a corporate venturing team. Rewarding the venturing team for good financial performance for which they are accountable is also vital for attracting and retaining venture-experienced professionals.

I strongly recommend companies implement a carry-like bonus compensation package reflective of their financial objectives that is similar to the carried interest model used by VCs, in which the venture partners in aggregate qualify for payouts based on the portfolio’s financial returns – for example, 20% of profits. Likewise, a bonus tied to strategic metrics, which I will discuss in the next article, should be considered. Such a reward plan will align the team and the company’s common interests.

Another matter CVs need to be aware of is the "portfolio effect" of venture investing – financial returns will benefit a critical minimum number and balance of investments that a CV fund needs to generate positive returns from the portfolio. If a corporation makes too few or too concentrated investments over a period of time, its financial returns will be impaired.

One final point about financial objectives for CVs is that targeting good financial results are not only beneficial to the corporation but also positive for the start-up.

Selecting good companies is the first part of producing favourable returns, but also continuing to support portfolio companies with followon investments is an essential part of venture investing, not only to provide the startup with the capital it requires over time, but also to position the CV potentially to generate positive returns onthe additional capital deployed.

And at times it can be essential to protect your investment rights, such as with pay-toplay situations. Do not abandon your portfolio companies after the corporation’s strategic returns are fulfilled as that may not only affect your portfolio financial returns, it will affect your credibility as a long-term, trusted venture investor. If your reputation becomes tarnished, it will reduce your dealflow and you will not have opportunities start-ups in the future.

The venture world is a tight-knit community where your dealflow sources, your co-investors and entrepreneurs are continuously observing your actions. So be vigilant in your role as a committed and respected venture investor to preserve your place in the venture community.

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