Corporate Venture Capital: An Untapped Weapon
by Jim Breyer, Bruce Golden and Eli CohenPublished
in the Spring 2001 issue of Leadership Opus
for distribution at the World Economic Forum
Over the past four years,
every chief executive and business leader has
been hammered with exultations to operate at
Internet speed and get digital or get dead.
Large corporations have tried to become intrapreneurial,
to become innovation factories, and to ideate,
in this quest to become lean and mean. While
corporate venture capital programs have achieved
some success in boosting innovation within large
companies, most corporate venture capital programs
would be more effective if companies thought
creatively about where and how to use them.
Corporate venture capital
is the practice of making investments in start-up
companies, especially those that are a strategic
fit with the large company's business. Too often,
corporate venture programs have become separated
from corporations' core businesses and have
focused on returns. While the public market
rewarded this behavior, the party now appears
to be over and a hang over will set in for many.
The knee-jerk reaction may be to cut off or
slow the programs.
This is exactly the
wrong thing to do. Instead, companies should
re-examine their venture programs to ensure
they are getting the most out of them. Venture
investing, done correctly, is an important way
for companies to increase their leadership role
in their respective industries. Further, as
technological change continues to accelerate,
corporations will need to use technology to
unlock the considerable assets they already
possess. In this article, we'll explore best
practices in corporate venture programs, and
we'll explore how and why companies can expand
their focus to valuable internal projects.
Best Practices in Traditional Corporate Venture Capital
We believe that being New Economy has less to
do with what you do - whether you make potato
chips or computer chips, or whether you express
output in megawatts or megabits - and more to
do with how you do it. The most common characteristic
of companies that are defining the new economy
- many of which were already thriving when the
first Web browser was downloaded - is their
primal need to be at the center of innovation
in their industry.
To satisfy this need,
a company must become a hub for innovation,
and that requires the appropriate spokes to
reach outside the company. Corporate venture
capital is one of the most important spokes
available. Through connecting the resources
of a big company with innovative startups, a
great corporate venture unit can foster industry
trends and help create significant new products.
To reach these levels of performance, we recommend
benchmarking the best. Some important practices
we've observed include the following:
1) Create a Balanced
Scorecard. A corporate venture unit should be
evaluated on a balanced set of objectives that
cover financial returns, discovery of innovative
technologies, creation of relationships with
entrepreneurs and expansion of markets for existing
products. Such a dashboard encourages the leaders
of a corporate venture fund to engage in the
right long-term behaviors and diminishes the
impact of market swings.
2) Role Model Involvement.
Through direct and visible involvement, senior
corporate executives can turbo charge their
companies' impact on venture investments. Specifically,
senior executives should identify the appropriate
business teams within their companies that should
be working with start-ups. Then they should
facilitate cooperation between the teams and
the start-ups. This does not mean that senior
executives mandate that their companies become
customers of specific start-ups. The value is
in ensuring the start-ups have the opportunity
to win business on their own merit.
3) Integrate the Venture
Team. The corporate venture group must have
frequent access to and credibility with the
CEO and CFO of the company. Most importantly,
the venture unit must be able to communicate
areas of interest to outside venture firms and
to start-ups, and it must have the ability to
make decisions quickly.
4) Focus on Being a
Great Partner. Corporate investors learn the
most, and start-ups gain the most, when a corporate
investor is active in the development of the
company. Importantly, corporate investors can
start by ensuring that they have a streamlined
process for making business arrangements with
their portfolio companies. The longer it takes
to negotiate a distribution or licensing deal
or the more onerous the terms (such as unreasonable
exclusivity), the more the value of a corporate
investor diminishes.
Finding Good Investments Where You Don't Expect Them:
The vast majority of corporate venture activity
is aimed at young start-ups outside a company.
This is important, and best practices like those
above are worthy of study and emulation. But,
it's amazing to us that so many companies focus
exclusively on external start-ups for their
venture activity and ignore some of the most
compelling opportunities to create new businesses.
These businesses lie in the considerable assets
- brand, scale, people, technology and patents,
and financial strength - that would greatly
benefit any start-up. Further, within a company
sit the very people and ideas that can reinvent
the way the company does business.
For the most visionary
companies, corporate venture programs have expanded
to creative investments that start inside their
companies. Specifically, we are talking about
technology and internet-related carve-outs.
By a carve-out we mean more than a tracking
stock. A carve-out is an independent company,
created and capitalized by a parent corporation
and outside investors. Unlike a spinout, the
parent company remains the most significant
investor and maintains tight operational links
with the carve-out.
Carve-outs are not for
everyone, particularly those who wish to rush
through key issues or attempt a quick flip.
In fact, the public markets have shown a disdain
for technology assets that are spun out carelessly.
A carve-out is a serious investment that requires
significant work up-front and a great deal more
to make it successful. By constructing a carve-out,
a company is effectively exposing its assets
(human, financial, technological) to the marketplace
in which all venture-backed companies operate.
Here, the carve-out will have to find investors,
win customers and recruit talent. It will do
so with a transparent P and L and a requisite
focus on cash flow.
For those willing to
subject their ideas to these mortal tests, carve-outs
can offer the best opportunity for a company
to capture value. The following examples show
the advantages of this approach.
McDonald's has assembled some of the world's
most impressive skills in purchasing and logistics.
In the early part of 2000, the management of
McDonald's saw the opportunity to apply those
skills to reshape the company's operations using
the Internet. It also felt that its clout and
market power could dramatically impact any business-to-business
(B2B) exchange in the food service industry.
The company faced a
range of choices from simply buying Internet-based
software for supply chain management, to investing
in start-ups in the field, to going it alone.
In the end, McDonald's chose to carve out its
Internet operations and several staff members
into a company capitalized by itself and Accel-KKR.
The new company, eMac Digital, quickly made
its mark on the industry. Together with Cargill,
Sysco and Tyson Foods, it created the Electronic
Foodservice Network (eFS) to reshape the supply
chain in its industry. With the McDonald's volume
flowing through the eFS, the eFS is guaranteed
to bypass the illiquidity that has plagued many
such exchanges.
The creation of eMac
Digital enabled the speedy creation of the eFS.
McDonald's felt that in order to use its expertise
and its size, it had to find a way to work with
other restaurant companies and service providers
on a neutral platform. The presence of outside
investors and the intent to keep eMac independent
and potentially eventually take it public convinced
Sysco, Cargill and Tyson they were working with
a company (eMac) intently focused on the success
of the eFS.
EMac Digital is going
to be the technology and operations leader for
eFS and for other initiatives in the food service
industry. So, McDonald's needed a way to attract
people (both from inside and outside McDonald's)
who could run a technology company. The creation
of eMac Digital gave the company a currency
to do so, and partnering with Accel-KKR gave
the company access to rich networks of executives.
Because a carve-out requires the same nurturing
and coaching as any start-up, experienced and
relevant outside investors are critical. While
the fit is clear, the agreements must be considered
carefully and great trust is required. The financial
investor generally allows the parent company
to maintain more control than founders generally
enjoy in a venture deal. Likewise, the parent
company generally gives the financial investor
more operational control than their ownership
stake would normally indicate.
The parent company and
financial investors must anticipate and address
important issues before the company is created.
What access will the carve-out have to brand
names and intellectual property? How far will
the carve-out go in working with the parent
company's competitors? How active will the parent
company be in financing the carve-out? How will
this effect employees at all levels that stay
at the parent? For example, when Wal-Mart created
Wal-Mart.com, it knew that a key to Wal-Mart.com's
success would be leveraging the 100 million
customer interactions that take place each week
in Wal-Mart stores. Therefore, it made sure
to give store managers a share of the upside
of Wal-Mart.com's success so that they did not
see it as competitive.
Partners in Transformation
Venture Firms and Corporations
Those who pick up the challenge to lead the
new era of corporate venture investing will
reap incredible rewards to accompany significant
work. As capital has become a commodity, being
a hub for innovation in your industry and starting
your own carve-outs will be clear differentiators.
The forward thinking
members of the venture capital community realize
that there is a great deal of power in cooperating.
Venture Capital is facing many challenges -
scaling a heretofore cottage industry, mixing
specialization with flexibility, and globalizing
- that were met by world-class companies over
the last decade. Venture firms and corporations
can learn a great deal about critical topics
from one another.
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