azeem.azhar

I was two parts astonished and one part unsurprised to discover that Google was going to get into corporate venturing.

The traditional case for corporate venturing–which is often based on solid academe (e.g. Block, Chesborough, Birkenshaw, Dushnitsky) goes like this:

• Not all the smart people live inside our company. There are tons of smarts outside our company and venturing or minority-investing will help us access this
• We can leverage our balance sheet without hurting earnings by taking small stakes in emerging companies
• As an quoted, operating company we can’t take the risks or afford the uncertainty that new ventures targeting new customer segments or using new technology create.
• Venturing is a cheap way for us to get a good sense of the dealflow in the market
• It won’t cost anything—even if we fail over several years, we’ll only have a writedown of a few hundred million dollars which in the scale of our company is nothing. And who knows, we might pick the next Facebook, er, Google, and then we’ll look really smart
• We need a full armory of innovation tools to ensure we continue to innovate. That armory includes innovation programmes, brain storms, partnerships, McKinsey, BCG, etc, etc and—of course—a venture program.
• The academic studies do support corporate venturing as a driver of value-add (as measured by Tobin’s Q)

It sounds pretty compelling.

The reality is the corporate venturing has a messy and generally ugly track record of sub-standard returns, poor portfolio selection and morale destruction. Why?

• Time frame : There is no escaping the J-curve. Returns look cruddy for five or six years even for a good portfolio. Companies get bored. CEOs get fired. And corporate venture funds die on the vine. Corporate Strategy Board research has shown that companies typically shut down their venturing efforts within four years of launching them—right in the depths of the J curve.
• Governance: Venture, by which I mean anything up to Series C funding, requires a peculiar acceptance of risk and uncertainty. Without this tolerance for ambiguity it becomes hard to be a venture investor. Companies do not have processes to deal with the investment discussion of totally fictional business plans where a variance of several hundred per cent (up or down) may be the norm. So the usual investment process within an established firm will fail to make good venture decisions
• People: Venture is about people. Brand can help. But it is ultimately about people. It would be amazing if a large company actually employed a great VC. I mean they might do but it is hardly likely. So unless you are prepared to look outside your existing talent pool, you are most likely to hire the wrong kind of  person.
• Incentives: All my carping about VC’s and their questionable value add aside, there is a bloody good reason why VCs are paid they way they are. It is hard to argue that ‘corporate VCs’ should not be afforded a similar remuneration curve.
• Other people in the deal: As one VC told me ‘I am sceptical of having those corporate duds on the board’—as a corporate VC, even a Google corporate VC, you’ll be seen as a corporate dud, who won’t be able to find the company for the duration at best, or, at worst, someone with an alterior motive. Adverse selection often ensues.

So how can companies devise venture programmes that work for their shareholders and not just for the execs who get to run the venture programs? (It is possible, although it requires a lot of thought.)

1. Objectives: A crystal clear picture of what will be different in ten years if venture program will be successful
2. Governance and non-repudation: Companies are fickle beasts as is their management. Commitment to corporate venture needs to be backed up by, well, commitment. In other words, an annual  discretionary drawdown from the balance sheet won’t suffice. A separate legal structure which penalises the company and its management for reneging early is essential.
3. People: People need to be vetted and hired as if you were hiring for a real VC firm. This means you may find some internal stooge for the job but they would need to be good enough to get a GP job at a real firm.
4. Incentives: Need to match the outside market. In 2006, one corporate VC arm told me that one of its partners had been paid €23m that year for a successful exit.
5. Separation of powers: To make the best fist of corporate investment, the company should have an internal group who job it is to promote investees within the bowels of the beast. This group should not be connected to the portfolio managers.
6. Focus: Series B or C is still early for a company fund. So start there.
7. Recognise that there will be lots of conflict around this decision and confront it.
8. Explain to shareholders why you are better off at deploying this capital in venture than them

In the end what drives success or failure of corporate vc is as much do with what drives success for failure of any new initiative within firms: politics, ego and incentives. Get those wrong and your shareholders won’t thank you for it.

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