And what CVCs need to do differently to get entrepreneurs to take their money
By Andrew Romans
Part 1 of a 4 part series on corporate venture capital (CVC).
I recently wrote a book on the topic of CVC – Masters of Corporate Venture Capital – where I interviewed over 100 active and former CVCs and then I wrote up about 50 case studies and interviews mainly from CVCs, but also some financial VCs, CEOs, bankers and lawyers with experience dealing with CVCs as investors.
I learned a lot from this process and I am convinced CVC will play a positive role in transforming not only individual corporates and startups, but also entire economies. Take China as an example and analogue to any other country. The arbitrage opportunity of low cost labor in China has already begun to move to India and Vietnam. I advise the Chinese to not resist this and let India and others take the low cost labor economy and China must re-invent its economy to look more like Apple, IBM and Goldman Sachs. That’s the future of China – not making low cost toys that say “made in China” and sit in your basement.
So how will China achieve this? What’s the 5-year plan to replicate a Silicon Valley or many Silicon Valleys in China? I think CVC can play a key role in this. CVC can save the world by transforming the product and service portfolios of their large companies and also driving the growth of a new population of innovative startups. Most large companies have some kind of R&D or IT budget to support their many employees and operations. Every company has technology in their company even if you manufacture doors, windows or tractors. You do not need to be a native technology company to have a tech CVC. If anything it’s the low-tech companies in China that should play an active role in CVC to transform their companies for survival and ability to thrive in a new higher tech economy. China needs technology and it needs it quickly. They can wait 50 years to organically grow a Silicon Valley, waste taxpayer money on ghost town science parks or they can follow a clear and simple strategy to get solid results instantly and use corporate capital rather than tax payer money and achieve their goals.
My advice is for these large companies, many of who are sitting on mountains of dollars, Euros and RMB, to allocate a specific percentage of their R&D budget to CVC. I would suggest they slice off 5% of this year’s R&D budget and dedicate that to invest into VC. Managers of the CVC if they know exactly how much “LP dollars” they have to invest each year over the next 10 years can then come up with a sensible portfolio strategy enabling them to achieve their goals while balancing risk and making sure the CVC is profitable. This is After 2 to 5 years their investments should start to pay back cash to the corporate from exits. Over a 10-year period the CVC program should be profitable and become a zero cost external innovation program that actually generates cash. One classic mistake corporates make with CVC is that they make a big announcement that they have launched their HP Ventures or Microsoft Ventures and then about 2.5 to 4.5 years later they officially close the program after becoming inactive with new investments. Then a few years later they resuscitate the CVC again only to be shut down yet again a few years later.
Make a commitment to invest for at least 10 years from day 1. If you commit at least 5% of your R&D or IT budget for 10-years, then you have a chance to turn the program into a profit center and it will last forever. This is not a 5-year China plan. This is a 30-year, a 50-year a 200-year plan and it will pay for itself if you stay in every vintage investing every year for over 10 years. It will bring technology to your company, drive M&A, make you competitive and global. You will see a real Silicon Valley spring up naturally without government backed empty startup campuses or government officials making VC investment decisions.
So how should corporates get started?
Step 1 is investing into independent financial VCs – Fund of Funds (FoF). Step 2 is to cherry pick the best deals that these VCs bring you and co-invest with them into the startups where you can create business partnerships and work directly with those startups.
This makes the most sense. Starting your own branded CVC as the first step is a mistake. There are a million factual reasons why this is true. I personally think there is often one individual in the corporate development team that wants to become a VC. They think if they make the investments directly they will generate a personal track record. Then leave the CVC and join a financial VC and get 2&20 compensation, which they probably would not get at most CVCs.
Each corporate should make a list of objectives and goals of why they want to operate a CVC. What is the number 1, 2, 3, 4, 5 goal? List them out and try and prioritize these. Is it to drive M&A and diversify the product service mix? Is it to drive innovation based on a shopping list of topics or is it to tap into innovation they never could have seen coming and add to their shopping list? Is it to protect them from disruption? Is it to access the latest innovation happening in Silicon Valley while the HQ of the corporate is located on the other side of the planet?
Make your list and get your CEO, CFO, CTO, Head of Strategy, Head of Corp Dev to all sign a piece of paper that becomes your constitution. Once that list of goals has been canonized you can form your CVC budget. Secure it for 10 years. Appoint the team as a mix of internal execs with mojo to get the support of the CEO and get the cooperation with heads of Business Unites (BUs). Hire external hires that are successful operators at independent financial VCs. Good luck offering them no management fee or carry and expecting to get good ones. You will need to offer compelling compensation to attract a VC that is not failing in the real VC jungle. Compensation is a major topic for another article.
Invest into financial VCs that provide the sector, geography and stage you want insight into. Only invest in General Partners (GPs are the VCs) that are willing to share real-time information with you. If you do not get access to the know-how and direct contact with startups then it’s all pointless and you are not achieving your list of goals. If the GPs don’t share information you will fail to get the direct investing side of your CVC operational.
Make sure the GPs show you each investment they make as real-time as possible and communicate with a target of generating a steady flow of partnerships with these startups where the corporates can become a customer, become a distribution partner, launch joint development projects, understand newly developing technology areas that were not on your shopping list. The corporate should try to help the startup and the innovation will flow. Some CVCs like Citi Ventures even have a post investment collaboration team whose job it is to try to help the startup after Citi Ventures completes the investment. This is a great way to get information flowing.
When you know that your corporate is about to become a huge distribution partner or turn a trial into a licensing customer agreement that is likely to help the startup knock down the dominos and become a very valuable business, you may want to make a direct CVC investment into that company at that point. Why not benefit from the value creation your corporation brings to the startup and make your CVC program very profitable? If a CVC gets on a good roll investing in hot startups they can unshackle the negative perception most of the industry has of CVCs and look like a hot VC that startups and VCs want to work with. SalesForce Ventures is a great case in point of this.
Back to the Chinese analogy, I think they should invest into VC funds in Silicon Valley, New York, London, Tel Aviv, etc where the best tech startups are. Then get partnerships with those companies to bring tech to China faster and then acquire these companies and integrate them. That’s how they will transform each corporate and the macro Chinese economy. Sure they should invest in some local Chinese VC funds where there are plenty of copycats and more and more native innovation. But it would be a huge mistake to reach outside of your internal innovation program – your R&D in Shenzhen – and stay in the same gene pool and invest your RMB into Shenzhen and Beijing VCs only. The point is to access the innovation where the innovation is and then create communications and partnerships.
Keep in mind there is a long list of reasons why the startups and financial VCs do not want CVC money. Many CEOs and financial VCs have vowed to never take CVC money again. (Fred Wilson’s famous quote on never, never, never working with CVCs ever again. https://www.youtube.com/watch?v=moVvNm09-oI) The reasons are many and I will discuss these and how they can be addressed in my next article in this 4-part series. If nothing else, when a startup publicly announces that they have raised capital from a large corporate that often shuts the door to doing business or selling the business to the competitors of that large corporation. A quick fix to this issue is for the corporate to invest into that startup via a FoF strategy and even work with their independent VC to invest via Special Purpose Vehicles (SPVs). Achieve all of your goals and objectives and remove the friction point by going through another VC. Use your brand when it helps you, not when it hurts you.
Since publishing my book on CVC in August 2016 I have moderated CVC panels at Rubicon Venture Capital events (my VC fund) and also at other events in San Francisco, New York, London, Istanbul, Moscow and Warsaw. These VC panels typically have 5 to 8 CVCs or former CVCs and have been a great way to further explore and get deeper into this fascinating and complex topic. Please contact me if you want to explore hosting a CVC event or learn more about launching a CVC. Andrew@rubicon.vc