Alex Dundson of SaatchInvest has asked the question: “What does corporate venture really do?” Corporate venture’s most useful role is a sensing function. It gives corporates a good roadmap for the future. This is the most important function, especially in times of technology change.
For opportunity spaces which are new markets or enabled by new technologies, firms can use corporate venture to understand the market with greater efficiency, nuance and less risk than other approaches.
Startups that are early in their journey are the best place to look to understand the future. Those raising their first meaningful funding rounds – series A – tend to do so four to seven years before mainstream adoption. Seed rounds happen 12 to 18 months before that. Entrepreneurs get their itch a year before that. As an example, Facebook’s series A was in 2005, Uber’s in 2011, Workday’s in 2005.
So you can get a five to eight-year heads up on what trends might be and how they might actually play out in the market. This is more effective than market research because research will struggle to get the timing of a trend right, its potential scale and how well founders are executing against it.
Trend forecasting will not get into the nuance of what it is to make them real, to turn them into viable businesses, to satisfy customers, to change value chains, to grow. This is something entrepreneurs must do as they build their businesses.
So I do not believe you can adequately sense the future with traditional research, trend forecasting or innovation tourism. You also need to play with “skin in the game” because most of the know-how discovered is held privately by the companies and does not show up in the pages of TechCrunch, let alone the Wall Street Journal, for years.
If you do not come to the table with dollars to invest, you cannot really participate in this innovation ecosystem. And if you are only observing, not participating, you will not really come close to understanding the space. After all, much of the detail and subtlety in an emerging space is usually privately-available information accessible only to people playing in the ecosystem.
And that understanding is both the thematic high-level understanding and a practical understanding of the operations, execution, culture, partnerships and talent required to succeed in these new environments.
Corporate venturing should deliver some kind of positive return on a portfolio of reasonable investments. So corporate venturing is top-tier consulting for free, or possibly for less. Over five years you will actually make money from your CVC efforts, so it may a negative cost to it.
Despite the recent growth in CVC, why don’t more firms undertake corporate venturing as a sensing activity?
- “Our balance sheet is too small.” Allocating a small portion of it does not provide enough capital to run a decent portfolio. You need about $40m minimum to run an early-stage portfolio. I reckon that about than 1% of your balance sheet should be allocated to corporate venture. That is a rough rule of thumb, it would be much lower for larger firms.
- “We cannot be Sequoia. Since we cannot be the best investors, we should not do it.” This a fallacy. No-one is asking them to be Sequoia. We are asking for a well-structured CVC activity focused on sensing the uncertain future.
- “Our cost of capital is too high, and we cannot make internal rate of return metrics.” This is overstated. We are only asking for a small portion of the investment pool. Does it really matter if cost of capital is higher than that of a financial investor?
None of these are real excuses.
The real issue seems to be that operational businesses are about minimising variance. Venture capital, or working with entrepreneurs, is about maximising variance – taking enough risk.
This is a clash of mental models or framing the problem, and operators often struggle to yield control of investment practices and mental frames in the ways that playing successfully in the venture ecosystem requires.
However, our turbulent future is less about minimising variance and more about exploring possibilities and helping to make it real. This is something for which venture is well suited.
This is an edited version of an article first published on LinkedIn.