Why now may be the time to start a corporate venture fund

Executives who are trying to launch a fund should identify the capabilities, products or markets that are missing in the company’s portfolio and understand how CVC can help fill these gaps.

For example, a global industrial automation and electrical equipment company was interested in a specific technology, but had to decide whether to incubate its own solution from scratch, invest in the startup company or buy the startup outright. After establishing an initial partnership with the startup, the team opted to first make a small investment to signal its support and maintain insights into the technology. Over time, the company became convinced of the technology’s legitimacy and potential value and leveraged its existing position to buy out the equity stake held by a major VC in that particular startup.

Leadership realized that the CVC investment offered more optionality down the line for areas the company was interested in exploring. It could get involved with concepts much earlier in the process and become comfortable with them over time, rather than taking on substantial risk from the onset by buying the startup or using the company’s internal incubation program. Today, this Global 1000 company now has a broader $500m CVC fund based in Silicon Valley. The company has been building a portfolio of startup investments with a focus on energy management, e-mobility, intelligent industrial automation, robotics and cybersecurity, aligning with the parent company’s future growth strategy.

Characteristics of successful CVCs

Although their structuring can vary, successful CVCs tend to share similar characteristics. They are typically staffed with dedicated investor talent, based out of Silicon Valley or other startup hubs. They have dedicated funds to invest over a period of multiple years, and they establish clear goals for their capital, with both strategic and financial metrics that will be used for measuring success. Showing clarity and gaining early alignment on these goals and metrics can help win CEO and board support that will last, long term, even through management changes and strategy shifts.

Many corporate investors often struggle to penetrate deal syndicates and in some cases are viewed as “dumb money” by traditional VCs.

Therefore, CVCs should try to find ways to differentiate themselves in the venture market. First and foremost, they should try to distinguish themselves from the “tourist CVCs” — corporate venture funds that are “playing VC.” There are many defining characteristics of tourist CVCs that need to be avoided:

One financial services CVC became well-regarded in the CVC community when it helped two-thirds of its portfolio companies establish commercial relationships. The CVC accomplished this by establishing parent-startup collaboration platforms internally to engage executives and founders and create incentives for both sides to enhance the value of their partnership. Those platforms produced several new offerings, including a B2B payment automation service.

CVC funds can proactively screen, filter, engage in due diligence, close the deal and capture value from the startup investment until it exits the investment.

Companies can leverage a variety of techniques to identify investments, but one effective method involves proactive outreach to entrepreneurs and other VCs that are active in areas where the fund is focused. This is an area where CVC advisors can help by leveraging their networks to provide access to those VCs and entrepreneurs that companies may not otherwise be able to reach.

This active search for investments can even pay off in indirect or adjacent areas that the company did not originally consider to be a priority. In one instance a multinational corporation with a core capability in sensor technology was introduced to a startup in the robotic delivery space, which was adjacent to one of the company’s core lines of business. Through the diligence process, the company learned that the startup was already using its sensors in an autonomous vehicle, which led to not only an investment, but also to a strategic partnership between the two firms to develop sensors and related technologies for a future delivery robot.

Successful CVC funds generally have some autonomy or internal processes to help enable fast decision-making, meaning that a startup investment can be approved within days, not weeks. This is critical, because if a CVC is seen as dragging its feet on one deal, it may not be able to get into the next one.

Some CVC funds take a more hands-off, purely financial approach, while others actively build networks among portfolio companies to spark inspiration, skill building and collaboration. Some engage their own R&D organization on specifically defined collaboration projects with startups to drive business.

If the goal of the CVC fund is to fill strategic needs and capture synergies between the parent and the startup, it will be important to involve executives from the core business, whether to suggest gaps where CVC investment may be needed or to work closely with founders to build new offerings.

Successful CVC funds invest in startups that fall into clearly defined focus areas for the company — ones where there is an operating model and infrastructure to capture synergies and value between the startup and the parent company. The value creation logic should be a part of the screening, due diligence and exit strategy.

In another case, a global financial services company established a CVC fund to participate in disruptive technology plays in the sector to grow the business and hedge risk early on. Given the strategic focus of the CVC, it was important to establish links and accountabilities between the company and the startups in the fund. Business executives from the company were involved in “venture days” to screen potential investment candidates and take accountability for potential learning or partnership opportunities. While the focus of the investment is in financial services, the fund invested in direct-to-consumer companies early on to learn how customers buy in digital ecosystems and ultimately applied these learnings to the company’s financial services offerings.

In order to foster cooperation between the core business and the fund, CVCs may also deploy an internal communications plan to share the benefits that corporate venture investing has for the business.

Boards need to become comfortable with a portfolio approach that hedges risks and expands returns, and they should reflect this comfort in communications with stakeholders. Working with seasoned advisors who have deep knowledge of venture capital can help improve the hit rate of the CVC and increase the overall success of the fund.

While traditional VCs typically care solely about financial outcomes, CVCs have additional strategic returns to track. In other words, successful CVCs can speak to their return on innovation, not just their return on investment.

Strategic success for CVCs may be measured in several different ways, including:

• The number of deals in strategic focus areas sourced or evaluated
• Financial impact (i.e., EBITDA or revenue growth) as the result of investing in a startup
• The number of business units engaged in pilots or commercial relationships with portfolio companies
• Knowledge transferred from the startup investment to the CVC fund (and, subsequently, to the parent)

Financial metrics for CVCs can include:

• Multiple of invested capital
• Individual portfolio company return on investment
• Portfolio internal rate of return (IRR) vs corporate ROIC (return on invested capital)
• Portfolio IRR vs. median VC fund returns
• Pull-through revenue (i.e., incremental revenue in core business driven by startup and vice versa)

Five key takeaways

1. Be clear about your financial and strategic goals and design the CVC accordingly.
2. Aim for early wins that accelerate your rate of learning.
3. Silicon Valley needs more than your money: while dedicated capital is important, being able to tangibly add value to startups is crucial to get into top deals.
4. Measure the return on innovation (the strategic value) and not just the ROI.
5. Integrate your corporate venture activities into a wider corporate innovation and digital transformation strategy.