Corporate interest in building companies is back in vogue. It is no longer enough for large companies to just invest in startups in the hope it will make them more innovative. More corporates are seeking to create their own startups as part of their overall venturing toolkit.
Thirty-seven percent of corporations do venture building alongside taking minority equity stakes in startups, according to Global Corporate Venturing’s most recent annual Keystone survey of corporate venture capital units globally.
For corporates that have developed strong intellectual property, building a venture on the basis of that IP is a good option, said Lina Arbeláez, head of Decarbonisation Ventures at mining company Anglo American, speaking on a recent GCV webinar held in partnership with law firm Fenwick & West.
“If you are a fast-paced corporate developing lots of exciting, potentially useful IP, you probably have an advantage to spin that out and monetise it instead of keeping it on a shelf,” says Arbeláez.
“On the other hand, you may have lots of operational experience and you have identified technology gaps or inefficiencies that need closing,” she says.
Despite the allure of venture building, it has a reputation for being costly and having a low success rate. There are few example of corporates that have done it well.
Webinar participants included venture building practitioners SC Ventures, the investment arm of UK-headquartered Standard Chartered Bank, and US venture studio AI Fund, as well legal experts at Fenwick & West.
Here are tips they shared on how to do venture building well.
1. Figure out if you want to build ventures yourself or use an external venture studio
There are many different ways to do venture building. Some companies use external venture studios while others chose to build ventures internally. Anglo American does both: it uses external venture builders that scout opportunities to build companies, but it has also spun out a couple of technologies in the mining sector.
SC Ventures builds ventures internally rather than use external venture studio providers. These ventures are set up as separate legal entities inside the bank.
For companies that want to build ventures, figuring out which model to follow at the start is important, said Jonathan Sagot, partner at law firm Fenwick & West. “Once we understand the strategic goals of our clients, we can then help them pick a structure, navigate and deploy that structure effectively to align with those goals.”
Corporations run into problems when they are not clear on what model to follow and have not thought through how to hire and compensate employees. “If you haven’t spent time talking to people who’ve thought through these issues and who’ve lived with it, how are you supposed to know?” says Sagot.
2. The venture studio model
For corporations that do not have internal expertise in building companies, using venture studios is a good option. The AI Fund is an example of a US venture studio that partners with corporates to launch companies based on artificial intelligence. The team of AI experts works with corporates to understand how AI can solve business problems that corporates are facing. The venture studio then creates AI companies based on a solution to these problems.
Corporates typically co-invest with the venture studio in these new companies, but it is flexible if the corporate doesn’t want to commit capital at the beginning.
“Sometimes companies don’t have many resources to allocate to a particular project. In which case, we’re fine doing the bulk of the work and the corporate can make a decision whether they want to invest later on,” says Eva Wang, partner and chief operating officer of AI Fund.
“Some corporates prefer to be a cofounder and come in at the very early stage and contribute a lot of their resources and sometimes their assets. It depends on each corporate’s preferences,” says Wang.
3. Building ventures internally
Other large organisations chose to build businesses inside their companies. SC Ventures has a venture building operation that sits alongside an investment arm that takes minority equity stakes in startups. The bank set up a holding company structure in the parent company to house the 15 ventures it has launched. Gurdeep Singh Kohli, head of SC Ventures, says it is important to set up the right legal structure if you plan to build ventures internally.
“These are not internal projects,” says Singh Kohli, of internally built ventures. “They are set up from the get-go as ventures and are legal entities. These legal entities are under different brand names and are therefore under a different governance and board structure,” he says.
4. Hiring external people versus relying on internal expertise
Most venture building practitioners say you should hire people externally to lead a new venture. While corporations have internal domain experts, it is only a small section of people who can lead a company, and mostly, they do not exist inside large organisations. “We lean on the studios to recruit,” says Arbeláez, of Anglo American. “That’s a really niche group of people that have the profile to be a founder. I don’t think you will find many of those within a large corporation or those that have been there for years and years.”
AI Fund does a lot of work validating a business idea before it recruits someone to lead the company. After hiring a founder, it will do additional validation work before deciding to invest. “Before we make a decision to fund or not to fund a company, it’s best to do it in partnership with the future co-lead of the company,” says Wang.
Others recruit some internal talent to new ventures. SC Ventures encourages its banking employees to join its businesses because of their expertise in financial services. It also hires external people who can bring commercial and technology expertise. The key is to have a team with a diverse way of thinking, says Singh Kohli.
“I know of many examples where people who may not have any experience in a particular sector can do very well, because they bring fresh ideas. But as you mature, your understanding of how to operate in a regulated environment and how to operate in the institutional environment becomes very critical for success,” says Singh Kohli.
5. Figure out the cap table
Working out the right way to share the ownership of the new venture is key to attracting venture capital investment. In the venture studio model, it is typical for the studio to take a slightly higher stake than an accelerator because of the work that it does in forming an idea for a company and validating it, says Sagot, of Fenwick & West.
Venture studios typically receive between 10% and 20% of common stock in a fully dilutable cap table, says Sagot. The studio also typically sets aside an equity incentive pool for future hires in the range of 10% to 20%. The rest of the equity, typically between 60% and 80%, will go to the cofounders of the company. Venture studios should expect to receive more shares when they invest in the startup they are incubating. This can bring venture studios’ ownership to around 40%.
“We think these are critical guideposts for venture studios. This goes to the ability of the startups to get funded by VCs in the future,” says Sagot, who adds it is important for venture studios’ shares to stay below those of the cofounders. “Generally, that means that we are telling our venture studios to keep their overall stake, both the common stake and their investment stake, at 45% or less.”
In the case of internally built ventures, the cap table could look quite different. If the mothership is investing a lot of money into a venture from pre-seed to scale and has contributed to its success by bringing access to clients and establishing governance, “then it is fair to say the parent or the studio has the majority stake in the venture,” says Singh Kohli.
If a corporate is seeking to bring in strategic investors into a venture it has built, the common presumption that the founder should have the majority of the equity is less valid. In the case of SC Ventures, which seeks strategic ventures for its banking-related startups, the emphasis on the founding team owning a majority stake is less important.
“If you are bringing in another bank in the mix, or if you’re bringing a third corporate in the mix, I don’t think they’re pointing a finger to say no, but I’m investing in the founder team,” says Singh Kohli.
Watch the full webinar below.
This webinar is part of GCV’s The Next Wave series of webinars. We run a webinar on the second Wednesday of every month, alternating between advice for CVC practitioners and deep dives into specific investment areas. Our next webinar will be: Collaborating with startups – CVC platforms or venture clienting? Register here to secure your place.
