By: Campbell Lockhart / Rick Wielens
Although plagued with mixed opinions that are influenced by mythology surrounding the investment industry, corporate venturing is finally resurfacing as an important component of the corporate innovation toolbox. As companies reassess the contribution that corporate venturing can make to their innovation objectives, it is critical that the fundamentals of corporate venturing are understood. This article addresses a number of important points to consider when applying corporate venturing in a global innovation strategy.
In a recent article published here at InnovationManagement.se, Joachim von Heimburg made a plea for an increase in the adoption of corporate venturing as part of the strategic innovation toolbox. He advocated that the perception of corporate venturing success is highly dependent on expectations and on who controls and decides, stating that slow decision making is the enemy of corporate venturing. He argues that new skills are needed and ignoring this fact can lead to costly failure and disappointment.
Bearing the above in mind, we will take corporate venturing a step further and discuss how the following points can exert an influence when embarking on or developing a corporate venture program. These points include:
- What are the fundamental differences between corporate and conventional venturing?
- Why pursue corporate venturing?
- In what ways does corporate venturing contribute to the innovation strategy?
- How can corporate venturing be done?
- How can open innovation practices contribute to corporate venturing success?
The emergence of venture capital, along with the democratisation of access to information through the Internet, has contributed to the shift of the innovation power balance away from large corporations towards smaller, technology driven companies. This has generated mythology around investment banking, exemplified in some famous VC success stories, and was probably one of the reasons for the emergence of the first wave of corporate venturing. Results were very mixed with few successes and many deceptions. The new reality since 2008 is that it is very tough to raise capital from VCs and with the renaissance of corporate venturing these players are seen as « the guys with the money ». This is understandable given the levels of cash some companies have accumulated. But if corporate venturing is approached as a subset of venture capital, then many caveats should be observed, as objectives are not the same and in some cases they can diverge.
Why do corporate venturing?
Firstly, let us consider the Why of equity participation. Venture investments are almost exclusively made on the expected outcome of the exit. The finality of venture investments is to grow funds, and this performance is a function of profit and time; the famous internal rate of return or IRR. So a venture capitalist will always look how much the expected gain is and within what time frame (shorter the better but with a maximum of 5 to 8 years).
Although corporate venturing should and must take in to account financial return, if the corporate Why is exclusively governed by return it can lead to many disappointments. Corporate venturing must have an approach that is guided by the entry rather than the exit. Entry is about how an investment will fit within the corporate strategy and contribute to the growth of the company. Corporate venturing is an excellent tool for taking stakes in « high risk » innovation at arm’s length while retaining options for future technology exploitation. To make this work there has to be a tight connection between the global corporate strategy and the venture focus. If this does not happen then there is risk of alienation of the venturing activity by the operational innovation.
So why do corporate venturing? If this seems a simple question, then the replies are contrastingly complex. The first and probably the most prevalent reason is to take stakes, often minority, in technologies that are emerging but with a relative high risk. In other words, pay to play with options to acquire. This is an excellent method of opening and increasing strategic options without putting stress on the internal innovation plan. But the fit must be clear within the global innovation portfolio.
Providing a broad vision of technology domains
A second reason for corporate venturing is that it provides a broad vision of technology domains and guides where future trends and signals of change could be detected. This is not a negligible part of the benefits and should be thought through very carefully as it requires both depth and breadth in the scope. The third reason, but not the most important, is to grow financially. The final reason for corporate venturing is that typically the business units have a short term investment horizon, discarding the longer term investments. On the corporate organization level a central deliberate corporate venturing initiative can assure the development of long term innovation options to complete and complement the existing innovation portfolio.
Often internal innovation programs are under tension because of scarce resources such as people and funds, or overloaded from highly ambitious programs.
Therefore corporate venturing has these main benefits: technology stake holding, intelligence gathering and financial:where can this fit most effectively into the innovation toolbox and strategy? Taking as a given that the venture focus is aligned with the corporate innovation strategy, it is a fact that equity participations have the extraordinary flexibility to be positioned on the innovation scale by simply moving the cursor. Often internal innovation programs are under tension because of scarce resources such as people and funds, or overloaded from highly ambitious programs. Corporations are by nature risk adverse and the high risk bets within such an environment can be difficult to manage or even put the complete program in danger. Moving innovation options with this cursor allows fine tuning by mitigating and hedging bets.
Corporate venturing is at the heart of the high(er) risk options and effectively uncouples them from the daily innovation operations, allowing moving the investments in and out of the innovation portfolio at will.Corporate venturing allows the creation of a pool of latent innovation that can be absorbed within the company when the time and maturity are right, or alternatively be developed outside the company. In this way it is a bridge between organic growth and growth from acquisition. If the activity is converged with open innovation best practices, the approach provides a power-house of options to fuel the innovation portfolio.
Improving deal flow
Another aspect at the forefront of venturing, whether it is corporate or classical, is deal flow. Volume of deal flow is judged as an important metric as it is a means of maximising opportunity by providing a constant flow of options. It is clear that, as there is such a demand for financing, it is necessary to just publicize that you have cash to spend and there will be a flow of deals. The down side is the sheer volume of deals that this can generate which can be highly problematic as they have to be treated and replied to, consuming time and people. This then becomes a problem of quantity and where quality is of the essence of corporate venturing.
An additional challenge companies face is to connect corporate venturing to the innovation strategy. What are the future scenarios from which a corporation seeks options and how can these be communicated securely to the start-up and venture community.
That immediately opens up the discussion around confidentiality that can emerge in deal sourcing and this is particularly important in corporate venturing. It can be a daunting and often dissuasive task to sift through a lot of background noise in a timely manner to identify the real opportunities, and then ensure protection for future claims of confidentiality. This reinforces the productivity issue mentioned before, but then the bigger the deal flow you have the more intelligence you are receiving.
How can this issue be treated? The easy answer would be to send clear and concise messages to the outside world of what kind of deal you are seeking.Still, this does not necessarily filter out the noise as there is such a demand for finance that people will try anywhere. Also, by publicizing needs means that the corporate innovation strategy will be exposed to the outside world and, in consequence the competition, this is something that is not acceptable as competition can be fierce. This problem does not happen in classical venturing as they can clearly state their investment focus and criteria and where volume and access are a measure of the fund success and capacity to capture deals. In deal sourcing, corporate venturing finds itself somewhere between a rock and a hard place and it can be difficult decide how to handle this. This is where open innovation practices can bring methods and practices that allow targeted deal sourcing while protecting the corporate identity and innovation strategy.
Direct or indirect investment
The two main ways in which a company can be active in corporate venturing are through direct or indirect investment. Both have their merits but also limitations.
Indirect investments are made by committing sometimes significant sums of money into reputed venture capital funds. The reasons for doing this are to subcontract the fund management to an experienced third party and thus avoid the direct expense and cultural problems of an internal venturing group. It also brings access to the mechanisms and practices of a profession that is very different from usual business. It is also seen as a way of accessing deal flow that has already been filtered and to have the option to make co-investments with the chosen fund. Given this, it should kept in mind that the investment decisions will be made independently by the fund.
The two main ways in which a company can be active in corporate venturing are through direct or indirect investment.
Although it might be an excellent way of spreading and mitigating risk, it does not necessarily provide an in depth deal flow as the venture fund will be reluctantor even restricted in sharing confidential information with the corporate partner. In addition,the divergent objectives of entry versus exit of corporate and classical venturing may not addressthe anticipated or expectedtechnological options. Finally, it also does not provide flexibility as it commits cash into a fund for a relatively long period in terms of corporate management.
Direct investment is done by the corporation taking equity stakes, often minority, directly into the capital of companies. To identify these it is necessary to have a dedicated professional venture team. Building and managing this team implies the management of deal flow as was previously discussed. Direct investment gives the advantage of being immersed in thedeal flow and a level of information beyond that of indirect investment. But it also exposes the corporate to levels of confidentiality and responsibility that can be avoided through indirect investment. The principle advantage of direct investment is the level of information and the breadth and depth of the options that the corporate partner has. It also allows a more flexible management of funds as they are not committed to an investing third party for a long period. From the point of view of direct investment, decisions should be made on the merits of the entry and not on the expectations of the exit.
Life cycle stages
Often corporate venturing asks the question of what stage in a technology development life cycle to make the investments in. Corporate venture investments are most frequently seen in early stage companies, or series A or B. This can often be at a point in time where the investment is founded on proximity funds, angels and seed funding. The risk is high, but the expectations are even higher. Thus, to make investments in early stage are by definition high risk and corporations are by nature adverse to this. The other end of the scale is to take stakes in companies that are further down the track of development, where VCs have built the business.
But it should always be kept in mind that VCs are seeking exit and this can sometimes take time and is not necessarily aligned to corporate venturing objectives. The advantage of later stage is that the risk can be to a certain extent measured. Again, connection with company strategy and the innovation roadmap will guide the corporate venture team to the optimal portfolio mix. Without this connection investments are likely to be made with exit options and it will be the VCs that are calling the shots. It is important for a corporate venturing organization to know how to interact, collaborate and syndicate with venture capital funds as these are a part of their ecosystem. But, all in all, there is no easy answer to the investment stage.
Open innovation goes hand in hand with corporate venturing
So in the end how can open innovation help in building a corporate venture portfolio? Firstly, open innovation is a strategy tool amongst other innovation tools, and goes hand in hand with corporate venturing. To apply open innovation is taking an unbiased approach of where to place scarce resources. By doing this it is possible to move out of a comfort zone where decisions will be made on conventional thinking and opinions and this will never challenge or encourage management to go beyond the trusted network. Open innovation can help build the strategic portfolio and place the innovation options within the most adapted innovation tool. Some options will be more amenable to corporate venturing than others and the approach of innovation portfolio analysis extensively used in open innovation, will allow to successfully apply the most appropriate innovation approach.
Open innovation broadcasting and crowdsourcing are excellent methods of opening up deal flow. It can be used to reach far beyond the trusted network and allow identification of trends, signals of change and industry white spaces well before they become visible in the usual circuits. Furthermore, open innovation practices allow corporations to explore areas that are highly sensitive and that are not yet on the strategy radar. By acting for corporate venturing, open innovation can gather specific deal flow without the corporation identity being compromised.
In conclusion, we believe that even if the finality of internal innovation programs and corporate venturing appearto be different, they have similar needs to be successful. Internal innovation calls on a constant flow of diverse options and opportunitiesthat are fed through a funnel to effectively accelerate the innovation platform. Corporate venturing requires relevant and quality deal flow to create a pool of latent innovation options that compliment and complete the internal innovation portfolio, bridging the gap between organic growth and growth by acquisition. Open innovation methods and practices have the capacity to generate this flow of opportunities for both approaches, allowing organizations to reach far beyond the usual suspects and to adopt an unbiased and open approach to innovation.
About the author
Rick Wielens, CEO, NineSigma Europe. Rick Wielens joined NineSigma in 2010 and is responsible for NineSigma Europe. Previously, Rick worked with his own company in open innovation and expert services mainly in the High Tech area in the Netherlands and Germany. Rick brings international experience working in Germany for SAP and in the Netherlands for Royal Philips Electronics in various roles and industries. Rick holds a M.Sc. in Transport Planning and Management from the Westminster University in London and a BA in Traffic Engineering from the University of Applied Science in Tilburg.
Dr. Campbell Lockhart, is Senior Delivery Director at NineSigma Europe. He has over 20 years medical device industry experience and 10 years in the investment industry as a venture investor.
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