Cyril Vančura, Class 15
Since 2012 the success of the traditional venture capital model has been questioned—with titles like “Is Venture Capital Broken?”1 and “We Have Met the Enemy…And He Is Us”2 setting the tone—while the number of corporate venture capital (CVC) groups has dramatically increased. With 210 new funds and units launched since 2010, taking the total to more than 1,000 according to Global Corporate Venturing,3 CVC is a strong component in the startup and innovation ecosystem. In 2012, CVC units accounted for 8.2% of total venture capital invested and participated in 15.2% of all financing rounds, according to the National Venture Capital Association (NVCA).4 Participation is particularly high in certain sectors: CVCs participated in 20.5% of investments in the industrial/energy sector,5 for example.
CVCs are in a good position: equipped with technical and market expertise, as well as customer access through their respective corporations. With the venture community undergoing substantial changes and many institutional investors having difficulty raising new funds, the role of CVCs will only increase in importance.6
Having been immersed in the technology innovation ecosystem of Silicon Valley for the past seven years, and the last four of those on the CVC side, I set out to understand whether and how different CVC groups are capitalizing on this trend. Interviews with 20 U.S.-based CVC groups showed that overall, the CVCs seem to be working on becoming viable partners of entrepreneurs and VCs—but work remains to be done around aligning the respective goals and incentives.
In this article, I present the results of this research and argue that setting up strict financial goals and incentivizing the CVC management accordingly is the best practice. Such policies are, in the long-term, beneficial to the CVC group and result in a more sustainable program. Unfortunately, only a few groups interviewed have established such metrics and the respective corporations, in many cases, lack the necessary understanding of the impact.
Requirements for a Sustainable CVC
Based on my data, I identified three requirements for a sustainable CVC: strategic goals, continuity, and financial sustainability. CVCs are usually already strong in the first, and the second can be addressed relatively easily, so I argue that the third requirement is the most critical.
First, unlike the sole focus on financial returns common to institutional VCs, most CVCs also have to deliver on strategic goals set by the corporation. This notion was casually framed by one interviewee as follows: “Over a ten year horizon, if we only break even on the money, but prevent our corporation from paying billions for an acquisition because of a missed technology trend, the strategic value is ridiculous.”7 A survey by NVCA published in 2012 shows that a strategic focus is core to 95% of the surveyed CVC groups.8 Furthermore, about 75% of surveyed CVC groups value delivering on the strategic interest as high as or higher than delivering financial returns. This finding aligns with the results of my interviews with 20 U.S.-based CVC groups, primarily focused in the technology sector: only four CVC groups valued financial returns higher than strategic value. Nevertheless, delivering on financial goals is not mutually exclusive with delivering strategic value. As one participant concluded, “Only in a subset of cases can you argue that a company which went bust three years after you invested added a lot of strategic value.”
Second, venture capital is a rather small industry where much depends on a good reputation and personal referrals from trusted sources; any investor, institutional or CVC, should strive to become a reliable and sustainable partner to entrepreneurs, startups, and other investors. Consequently, a first prerequisite for establishing a successful CVC program is continuity with regard to strategy, investment focus, and the core team. Even though this topic was not specifically addressed in my interviews, this necessity seems to be recognized in the CVC community. Groups are often set up with the combination of a core team that does not go through the corporate 3-5 year job rotation, and people who gain experience at the CVC for a limited amount of time as part of their career development. The core team is essential to assure continuity for the external team (entrepreneurs, portfolio companies, VCs, and CVCs), as well as for the internal network of the respective CVC group.
Third, CVCs (especially when investing in early-stage technologies) must be in the game for at least as long as the life of the companies they invest in (an average of more than eight years). Long-term sustainability in a corporate setting can only be achieved if the unit is not losing money over a longer period of time, as corporations are often quick in cutting loss-making programs during times of crisis. As one participant characterized it, “Things don’t stay strategic for very long if they don’t give you the financial performance.” On the other hand, CVC investments without strategic goals (i.e., only for financial goals) are not sustainable either, as the CVC group usually only contributes marginally to the bottom line and the risk-reward profile of such investments and limited liquidity of the assets does not fare well with most corporate mindsets. Hence, as stated in “Advice for Corporate Venturing,” CVC programs that lack strategic goals are also close to the axe in times of financial stress.9
Key Requirement for a Successful CVC: Financial Sustainability
Today’s CVC groups need an operational model where financial sustainability is achieved in order to avoid the fate of previous incarnations and to enable them to survive cycles. When taking into account a management-fee-like structure and some overhead for corporate controlling, the necessary target approaches a net IRR of 10-15%. When looking at the performance of the VC asset class in the first half of the past decade, however, such performance would put CVCs into or close to the top quartile—a fairly high bar.
Currently, financial goals are not always a priority. Only about 70% (14 out of 20) of CVC groups had established measurable financial goals (see figure 1); “Do not lose money” was not counted as viable financial performance goal in the ecosystem. It should be noted that in some cases the CVC group had to drive the process of establishing such goals or self-impose them on the group, due to the lack of corporate understanding of the VC process.10
|Goal||Respondents in personal interviews|
|“Do not lose money”||3 (15%)|
|“Be sustainable” (IRR 10-15%)||8 (40%)|
|IRR > 20%||2 (10%)|
|Compare to institutional VC (e.g. Cambridge Associates)||4 (20%)|
Figure 1. Results of personal interviews with 20 U.S.-based CVCs regarding financial goals of respective CVC group.
Significantly, most of those groups with established financial goals were close to or higher than the above-mentioned bracket of sustainability. However, achieving such performance is very challenging and setting goals that are too high and unrealistic mostly results in failure of the CVC program.
One alternative to setting fixed financial goals is the comparison to a peer group, such as venture capitalists in general or other, more sophisticated benchmarks derived from VC/CVC performance in certain industry sectors. However, only 20% (4 out of 20) of the respondents mentioned that the financial performance of their program is compared to the VC peer group. The Cambridge Associates benchmark,11 for example, is useful for CVC units investing across a broad range of industry sectors. All of the CVCs using peer benchmarking have been around for more than a decade, indicating that this approach can lead to a program with continuous support from the corporation, and experience leading to best practices.
Where financial goals are in place, establishing financial incentives for the CVC management can sharpen the focus of the team and help achieve financial sustainability (i.e., help make good deals). It would also help to attract talent from the broader VC ecosystem; as one participant mentioned, “We cannot build a world-class team without compensating them similarly as their peers around the board table.” Nevertheless, only a small fraction (10%) of the interviewed groups had a carried interest or similar incentive structure. In most other cases, the established incentive was similar or equal to a corporate bonus structure, with limited to no connection to the performance of the CVC’s portfolio.
The Value of Educating the Corporations
Very few CVC groups interviewed mentioned that their respective corporation understands venture capital (only 6 of 20). In fact, most interviewees (14) stated that the corporate management needs to be educated—sometimes on a continuous basis—about venture capital. This is a quite sobering finding, and could in some cases prevent a CVC group from exploiting their full potential. The problem at hand is that VC and startup innovation focuses on break-out success rather than incremental innovation, but measuring a startup in a corporate fashion against quarterly performance indices usually provides little value at an early stage. With this lack of understanding at the corporate level, the CVC might be driven toward investing in incremental innovation.
In the long term, CVC groups need to find an operational model that ensures sustainability based on financial returns, without neglecting the strategic goals of their corporation. Despite the value of financial goals and incentives, it must be recognized that a large value-add for outside partners of a CVC is the corporation standing behind it. Therefore, the successful CVC group must bring strategic value to both the corporation and the startups.
Best Practices Going Forward
At least one CVC unit participating in my research has chosen a financial goal derived from the risk-adjusted cost of capital, and uses a carried interest structure to incentivize the CVC management. As the group is only a few years old, time will tell whether this financial goal will be achieved. But from their interview I learned that despite this focus on financial returns, the group has established a good reputation within the corporation with regard to bringing strategic value and is highly regarded.
I hope that this data and analysis lead CVC groups and corporations to consider an educated and balanced approach of including both strategic and financial goals in corporate venturing. In the current ecosystem, CVCs—including new entrants—have the chance to establish themselves as viable and long-term partners. May many of these new entrants seize this opportunity, enabling a vital and thriving innovation ecosystem of startups and corporations.
Cyril is a Senior Investment Director at Robert Bosch Venture Capital GmbH (RBVC) based in Stuttgart, Germany and has recently moved there after several years with Bosch’s venture team in Palo Alto, California. He is involved in all aspects of the investment process and responsible for shaping the investment strategy of RBVC in the enabling technology search area, which includes Human-Machine-Interface technologies, software topics, and wireless systems. Before joining the venture team, Cyril was at the Research and Technology Center of Robert Bosch LLC in Palo Alto. Cyril holds a Diploma (M.Sc.) and Ph.D. in Physics from ETH Zurich, Switzerland.
1 Scott Anthony, “Is Venture Capital Broken?” Harvard Business Review Blog Network, 7 June 2012.
2 Diane Mulcahy, Bill Weeks, and Harold S. Bradley, We Have Met the Enemy…And He Is Us: Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and the Triumph of Hope Over Experience, Ewing Marion Kauffman Foundation, May 2010.
3 Toby Lewis, ed., “Corporate Venturing Participants Near 1000,” Global Corporate Venturing, 9 April 2013, para. 5.
4 National Venture Capital Association, Corporate Venture Capital Profile Through 2012 Q4 (Excel spreadsheet, 2013), “CVC by Year and Quarter” tab.
5 National Venture Capital Association, “Corporate VC Sectors” tab.
6 James Mawson, “Corporate Innovation Catches the Eye,” Global Corporate Venturing, 28 April 2013.
7 i.e., ridiculously high.
8 National Venture Capital Association, Corporate Venture Capital Group Survey, 5 April 2012.
9 Mike Brooks, “Advice for Corporate Venturing,” Global Corporate Venturing, April 2012 issue (subscribers only).
10 Unfortunately, confidentiality agreements prevent me from illustrating these points with more specific examples.
11 Cambridge Associates LLC, U.S. Venture Capital Index® and Selected Benchmark Statistics, 30 June 2013.