What is Corporate Venture Capital?
A new trend that’s becoming popular for making direct investments in
Through a CVC program, you create a fund to invest in startups in the form of equity.
With this, your company becomes a shareholder in the entrepreneurial company as a way to keep a close watch on its developments and progress.
A CVC program is an in-house effort that allows you to seek (and be pitched by) startup companies with relevant technologies or business models in your business space.
It is startups, not large corporations, that usually redefine industries and change the ways of doing business.
Our corporations are usually slow, bureaucratic and careful, while startups are agile, creative and fearless.
By investing in startups, you can tap into that stream of creativity and energy and extend your innovation engines.
If well structured, a CVC plan should be a win-win for both sides: the startup gets access to funds and markets, while the corporation gets to expand its product portfolio with cutting-edge developments without the risks and costs of an in-house innovation effort.
Another benefit of playing the role of an investor is that you only bet on the companies that you like, and you also get to distribute money across a number of companies, some of which are competitors.
For example, through its Vision Fund, Japanese tech company SoftBank Group has made important investments in both Lyft and Uber, two companies that are fighting fiercely for leadership in the ride-sharing market.
Independent of who wins the ride-sharing space there is one sure winner: SoftBank.
A number of major tech and biotech companies already have a CVC division that actively looks for new startups to invest in.
In our experience, the skills needed to run a successful CVC effort are not commonly found within a business organization, so any company trying to start this kind of investment program may need to bring in new talent from the outside, most likely from the banking, venture capital or private equity worlds.
Goals of a CVC program
The objectives behind a CVC program are diverse, but they usually fall within one of two categories: they can be strategic in nature, or just based on a financial interest.
CVCs are considered to be strategic if what you are seeking is to better understand the innovation landscape in your operating markets, get early access to ideas that could create synergies with your in-house capabilities, or improve your competitive positioning in the long run.
Since the beginning of the twentieth century corporations have invested in startups as a way to improve their own businesses, but it wasn’t until the mid-1960s that the investment modality became popular.
Market research firm CB Insights reported that during 2017 alone Corporate Venture Capital groups provided over $30 billion of funding across 1,791 deals globally, a 19 percent increase with respect to the previous year.
Well known corporations that have an in-house CVC arm include Dell Technologies, Intel, Salesforce, Citigroup, Cisco, Comcast and GE, all of which have been very active over the last few years.
CVC investors usually provide seed (less common) and early growth (more common) funding, preferring companies with a proven product on the verge of an expansive phase.
The way in which most CVC deals work is through
These shares are usually issued in big chunks or investment rounds by the startup that’s seeking capital, and the corporation provides funds to the company in exchange for a portion of the shares, making the corporation a shareholder of the target.
Each CVC team has its own process, but a typical deal funnel starts with an initial interaction of some sort and a preliminary discussion, which then moves through different Due Diligence (DD) stages where all the assumptions and the startup’s information are validated, concluding with a final negotiation of a term sheet that defines the general terms of the transaction.
The non-written law in venture capital circles, known as the 10X rule, is that as an investor you get to see a hundred companies, invest in 10, but only one makes it big.
Typical terms that are negotiated in a term sheet include the type of shares that are being transacted, the number of shares to be issued and their unit price (the “size” of the round), as well as governance matters, pre-money valuation and the proceeds waterfall that will be in place in case of a liquidation.
In many cases, as an investor you may negotiate a purchase option with the target company that allows you to increase your equity position in the target if a series of pre-defined conditions occur.
That gives you a viable path to acquire a controlling stake in the target if at some point you see it as a viable move. That’s how Google Ventures’ early investment in smart thermostat company Nest became a full acquisition for Google.
If you later decide that the target company no longer represents a valuable asset, you can exit the company by selling your shares to other shareholders, or on the market if the company has already gone public.
One of the most sensitive matters when dealing with a potential CVC investment is the price tag that you put on the target company, or its Valuation as it is usually referred to, since in the end that number determines how much you end up paying for a given proportion of the company’s shares.
This valuation intimately depends on the views and assumptions that each investor has about the future of the company (for example, how much the business will bring in free cash flow every year) and it is subject to the appreciation and experiences of each evaluation team.
Seasoned investors will usually combine multiple valuation methodologies to determine a fair valuation, but in general, there seems to be a widespread preference around the use of “multiples” to compare the entrepreneurial company (which is still held privately) to a group of similar publicly traded companies.
Wu, Sun. Strategy for Executives, this book can now be downloaded for free here.
Wolcott, Robert C.; Bauke, Boris; Baier, Ronny. Technical Note: Corporate Venture Capital, Case Study. Kellogg School of Management. 2015.
Report: Global CVC in 2017: A comprehensive, data-driven look at global corporate venture capital activity in 2017, CB Insights. URL: https://www.cbinsights.com/research/report/corporate-venture-capital-trends-2017/
Weiblen, Tobias; Chesbrough, Henry W. Engaging with Startups to Enhance Corporate Innovation. California Management Review. Vol. 57, No. 2, pp. 66–90. 2015.