To make the most of their investment dollar, corporations must ask two questions: when should we invest in start-ups and how much?
Three points in time on a start-up’s evolutionary ladder must be considered in making these decisions.
The first stage is the “Discover” stage. At the very early stage, a start-up’s product or service is more dream than substance. The corporation has little leverage to offer in most cases – the entrepreneur just needs cash to vet his dream and test it with reality. The valuation volatility of the start-up is high because it faces an uncertain future, but the required corporate capital commitment is low.
At this point, the corporate venture arm should con- sider investing in the start-up through a partnership with an established VC firm that knows how to manage the risk. By becoming a limited partner in a venture fund, the corporation gets in on early investments, makes minimal capital commitments and mitigates high volatility by spreading it among 20 other limited partners.
The corporation can take advantage of the long-term historical rate of return enjoyed by VC firms and essentially gets a placeholder for a direct investment in a promising start-up. The corporation can also keep an eye on new developments to help find valuable new commercial technologies.
The second stage is the “Leverage” stage. As the start- up matures, the risk shifts from innovation to bringing a product to market, and the corporate investor has some leverage to offer. It can guide the start-up in how best to introduce its product to market and may also be able to provide manufacturing or distribution channels.
At this point, the corporation may also consider a direct investment in the start-up so that it can participate in enhancing its value. This also creates an opportunity for the two organisations to get to know each other and to start developing a reciprocal relationship and lessen the cultural conflict between the two companies. The corporation should tie the start-up to one of its business lines and rigorously track the progress of its investment.
The third stage is the “Integrate” stage. Once an entrepreneurial company proves there is strong demand for its product, the investment risk shifts to the quality of the start-up’s execution. The start-up needs to scale up operations and establish a strong market position.
At this point, the corporation has the most leverage to offer. If the start-up’s product appears to be something that could play an important strategic role at the corporation, it may be time for the corporation to consider buying the start-up outright. If there is an acquisition, it is important to integrate the start-up team into the corporation and hold on to the people.