There is much talk about the conflict between strategic and
financial objectives in corporate venturing. These apparently
opposing objectives are portrayed as an unavoidable
feature, resulting in an insoluble problem that can at
best be managed but never fully overcome. At its worst,
the venturing unit can develop an acute form of corporate
schizophrenia and become destined for a short and
unhealthy life.
With restorative therapy, however, corporate venturers
can regain clarity of vision and a chance for longevity. They
have the opportunity to use their unique advantages to
demonstrate that investing in early-stage companies can
be highly profitable.
The initial step in the treatment is recognising that the
supposed conflict between strategic and financial objectives
is largely illusory and results from two misconceptions.
The first is the belief that there is strategic value
that cannot or does not need to be translated into financial
return. Related to this is the mistake of using the parent
company’s cost of capital as the basis for stipulating a targeted
rate of return. This can be termed the “fallacy of misplaced
cost of capital”.
This thesis rests on a bold statement – the success of
any strategic decision can and should be judged by the
return it generates. A corporate venturing unit may be
established with a set of strategic objectives ranging from
gaining access to novel technology, tapping into adjacent
markets, developing alternative business models or making
minority investments as a prelude to a takeover by a
business unit of the parent. These are all valid strategic
objectives. The challenge is how to determine whether
they are successful.
Broad strategic options are difficult if not impossible
to value. How does one value gaining access to a new,
unproven technology? How does one quantify the benefit
of entering a new market or developing a new business
model? Valuing strategic objectives can be attempted
only if they are broken down and expressed as specific
investment propositions. They can then be analysed and
assessed employing the same process used to make any
discrete investment decision.
Financial return is the one clear, objective standard that can be used to judge the success of any business strategy over any length of time. Without setting return tar-
gets, the corporate venturing unit is more susceptible to
shifts in the parent company’s strategy, often precipitated
by a change in senior management. Short-term changes
in strategy are not conducive to the health of a corporate
venturing unit, which requires a persistent clarity of purpose
and a long-term operating plan.
Corporate venturing is sometimes viewed as a form of
outsourced research and development, the success of
which can be judged by the quality and quantity of new
ideas it produces rather than the financial return that might
flow from the creative output. This way of thinking is akin
to the erroneous notion that intellectual property has intrinsic
value apart from any cashflow that might be generated
from its deployment.
New ideas can be exciting and it may be easy to be
persuaded that a brilliant idea could be worth billions.
The ultimate reality, however, is that no technology has
long-term value unless it can produce a sustainable cashflow.
All forms of intellectual property, including brands,
trademarks, copyrights and knowhow,
only have enduring value if
they become part of a profitable
business.
Similarly, however successful
the corporate venturer may be in
discovering or creating new technology,
products, markets or business
models, his or her efforts will
fail if they do not lead to profitable
businesses. Strategic initiatives
have scant relevance if they do not
produce profits.
Like any venture capitalist, the
corporate venturer needs to balance
nurturing early-stage businesses
with applying hard-nosed
judgment. When an investee company
no longer looks capable of
delivering an adequate return, it
should be killed. The corporate venturer should have the
authority to terminate unsuccessful investments without
second-guessing whether the investee company should
be kept alive because it is “strategic”. The corporate venturer’s
authority, of course, can be maintained only if it
records some successes.
The corporate venturer’s mission is to make money by
making good investments. By using its parent’s assets to
add value to its investments and by helping create successful
companies that are relevant to its parent, the corporate
venturer can demonstrate corporate venturing at its
best.
So what returns should the corporate venturer target?
The simple answer is that the targeted return should be
the expected market return commensurate with the risks
undertaken. If an independent venture capitalist would target
a 10-times return on an investment, then so should the
corporate venturer. A corporate venturer may talk himself
into targeting a lower return because the investment meets
a strategic objective, but if an investment does not stack
up, determining it to be “strategic” does not make it any
better. It only raises the question of whether it is a good
investment.
The corporate venturer may believe a lower return is
justified because the investment can be derisked through
access to the parent’s assets or network. A similar issue
arises in corporate mergers and acquisitions. An acquirer
may be tempted to offer more for a target company
because it believes it is able to enhance the value of the
target after it has been acquired. While it is often stated that
a company should not pay for value it brings, it is generally
accepted that as long as the expected return exceeds the
company’s cost of capital, the acquisition is justified.
If the corporate venturer is investing in start-ups or earlystage
businesses where the risks are high, the required
rate of return should reflect this. The fallacy of misplaced
cost of capital is the assumption
that the corporate venturer needs
only to achieve a rate of return that
the corporation targets on acquisitions
or investments in established
businesses.
By targeting high returns, the
corporate venturer will have the
best chance of achieving success
over time, as the occasional
exceptional return will more than
offset the more frequent losses.
The irony is that venture capital
returns have generally been abysmal.
Only a handful of independent
venture capitalists have achieved
returns commensurate with the
considerable risks of investing in
this asset class. It is no surprise
that the overall venture capital
market has contracted sharply during the past five years.
Corporate venturers have a huge advantage over independent
venture capitalists, which enables them to take
a different approach to negotiating investments. Because
of the added value it can bring to the table, the corporate
venturer can argue that it should get a better deal – that is,
pay less for the investment. Rather than targeting a lower
return because of its ability to derisk an investment, the
corporate venturer can turn this logic on its head. Higher
returns should be achievable precisely because of the
value it can add.
As independent venture capitalists bow out of the market,
corporate venturers are stepping into centre stage.
Corporate venturers can create a new venture capital paradigm
if they can avoid the delusion of conflicting objectives
and vigorously pursue the one clear goal of venture
capital investing.