Accessing Innovation: Corporate Executives In Unfamiliar Territory
Originally Published on Hive. This is the second post in this series by Andrew Ackerman. View Part 1 of the series here.
Because senior management may have a deep understanding of the sector and the specific needs of the corporate sponsor, it seems easy to assume that involving them in the selection process will help the corporate venture capitalist (CVC) pick the right startups to support? However, that’s not the case. I’ll explain.
As part of due diligence, a skilled venture capitalist confirms market demand by talking to a startup’s potential customers. Sector-focused investors can quickly get a feel for what customers in their sector are interested in and what they are leaning into from an investment standpoint. So, at least for a first cut, involving management in the selection process is not necessary.
Not only is it not necessary, it actually can lead to worse decisions. One of the main reasons to set up a CVC is to help its mid- and senior management recognize innovative startups, access them, interface with them, and absorb that outside innovation. So why expect them to be good at it from day one? In practice, inexperienced innovation teams often spend too much time engaging with immature or—to the eyes of a skilled venture capitalist—obviously fatally flawed startups. They waste time, money, and, worst of all, the attention of the business lines, souring them on startups in general.
Once the CVC has winnowed out 9 out of 10 (or 19 out of 20) potential investments, there’s definitely a place for the line management to vet the solution in greater depth… stay tuned for another in depth look at this topic in another part of this series.
How is fiscal oversight managed? When a corporation allocates $50 million or more than $100 million to a project, it is only natural that they want oversight. In this case, it often means that senior management wants to sit on the investment committee and approve investments. But these senior managers often run multi-hundred-million dollar divisions where their “day jobs” always come first. Asking them to find mutually convenient time to meet to review a $1M deal is a recipe for delay. Plus, when a fund has a reputation for moving slowly, the hot deals pass them by.
A smarter balance between speed, flexibility and oversight is to allow the CVC to make routine investments, subjecting only especially large follow-on investments for approval by senior management.
In theory, investing off the balance sheet from budgeted funds should be as effective as committed capital within a formal venture capital fund structure. In practice, it rarely is. Budgets get cut, routine approvals become bargaining chips for corporate horse trading, investment committee members push for pet projects, in addition to potential acqui-hires (hires through acquisition). Creating an arm's-length contract that obligates them to meet capital calls and also creating governing documents that clearly establish the fund's mandate and general partners' sole authority to make investments, up to a certain threshold, insulate the CVC from these pressures, empower it to operate on par with traditional venture capital funds, and enable it to attract top talent.
Another more subtle reason for an arm’s-length fund commitment is to avoid failing by success. When a venture team has a large exit that makes the partners some of the most highly compensated people in the company, there can be a lot of pressure from line management to renegotiate that deal. Since salary is easier to cut than carry, top venture capital talent often shy away from CVCs.
But structuring a CVC to be able to function as effectively as a traditional venture capital fund is only half the battle. The best startups have their pick of investors. How does a CVC make it so that it is a hot startup’s top pick? We’ll cover that in part three of the series.
By Andrew Ackerman, Managing Director of Dreamit Urbantech
Acknowledgments: I’d like to thank David Coats (Correlation Ventures), David Gerster (JLL Spark), Blake Luse(Ferguson Ventures), David Teten (formerly at ffVC and HOF Capital, ask him about his new fund), Linda Isaacson(FPL Global), Jill Ford (Toyota AI Ventures), Stacey Wallin (Numinus, formerly at BD Tech), Ameet Amin (Proto Homes, formerly at Colliers) and everyone else who contributed their thoughts to this article.