Is The Current Market Cycle A Golden Opportunity for Corporate Venture?
Corporate Venture Capital has a bad reputation in the startup world. While there are some notable exceptions, this reputation is all too often well deserved. The best startups have their choice of investors and corporate venture funds are rarely at the top of that list and as a result even the best CVCs sometimes don’t get the opportunity to invest in those top startups. But recent economic conditions have dramatically reduced the supply of venture capital so this could be a golden opportunity for CVCs to get a seat at the table.
Why CVCs often cannot access the best deals
The reason CVCs have this reputation is manifold. Well intentioned but time intensive approval processes mean that CVCs often move slower than traditional VC funds. Misguided attempts to wring every bit of strategic advantage out of a deal often lead to offers with strings on them (e.g., rights of first refusal) often make taking strategic money feel like a deal with the devil. Even simply dealing with corporate legal departments who are more used to dealing with contracts, joint ventures and (perhaps) M&A deals line with typical early stage financing lead to over engineered term sheets that are often overcomplicated and ill-suited to the tasks at hand.
And the results show up in the returns. Although returns data for CVCs are notoriously difficult to compile, unpublished analyses by Correlation Ventures show that dollar-weighted (by round size), realized, cash-on-cash multiples for all U.S. venture financings in companies exiting, were 2.2X for all financings vs. 1.8X for all financing with at least one CVC participating.
The usual explanation for this is that CVCs invest for strategic reasons so are less price sensitive. So all other things being equal (viz., exit values), if the valuation at the time of investment is higher, returns on exit will be lower.
While there is no doubt good anecdotal evidence to support this thesis, there's one big flaw. If CVCs are offering startups higher valuations, wouldn't startups prefer to have them leading their rounds?
I suspect that the truth is a little more subtle. If CVC's negatives are causing the best startups to ignore those investors then CVCs are fishing in a shallower pool to begin with. In that case, the average quality of an investment made by a corporate venture fund will be lower simply because the top performing startups have opted out.
How can a CVC capitalize on the current situation?
Even with increased receptivity from startups, if a corporate venture fund continues to operate as business as usual, it will miss out on this golden opportunity. So here are a few things that a CVC can do to fully exploit the situation.
- Be prepared to deploy smaller "runway extension" checks… but with built-in upside
Normal rules of thumb around raising in increments of 18 months of runway and typical round sizes do not apply now. Startups approaching the end of their runway whose investors cannot or will not fund them are not only willing to take investments that buy them another 6 months but actually may prefer it since valuations are significantly lower now than they were just a few months ago… and hopefully will be higher once the immediate crisis has passed. Furthermore, in the current economic environment even startups with a healthy runway may want 24+ months of runway to compensate for potentially longer sales cycles and may be interested in reopening their recent round to top up.
But lower check sizes mean lower ownership stakes and conventional VCs often have ownership targets so it can be hard to bring them in for these rounds. CVCs can often be more flexible this way. Plus, they can have their cake and eat it too: While CVCs should generally minimize non-standard terms, now is the time to ask for super pro rata rights. Write that check for half the normal size… but ask for 2x pro rata rights into the next round.
As a fringe benefit, if the corporate parent is under pressure to reduce costs, the capital efficiency of this approach lets the CVC “do more with less.”
- Be prepared to move quickly
It's not unusual for a CVC to have to get C level approval for even small investments. And these executives are often dealing with $100M issues so it's not surprising that it's difficult to get on their calendar for a $1M check.
So now is the time to ask for a streamlined approval process. Explain the new strategy of smaller investments for super pro ratas and impress on them the narrow window to take advantage of this opportunity (a k.a. FOMO). Push to get temporary discretion to deploy investments below a certain amount without full investor committee approval.
In the long run, CVCs need an appropriate level of discretion in order to compete with traditional VCs. Fortunately, if you successfully deploy into high quality startups without the myriad of unspecified disasters that management fears occurring, you will be in a strong position to make the case for making this authority permanent and for raising the discretionary threshold.
- Be prepared to pilot quickly
While some CVCs invest well before the startup’s product is ready to be deployed with the corporate parent, most are looking for pilot-ready startups to provide more immediate strategic impact. From the startup’s perspective, the promise of pilots is a CVC’s most valuable assets. Unfortunately, they all too often fail to live up to this promise.
There are many reasons these pilots fail to happen, beginning with the damning fact that it is exceedingly rare for line management to be bonused or promoted based on the number of pilots they engage in. So if their compensation isn't on the line, any initial excitement soon peters out as managers return to business as usual.
But for now, temporary enthusiasm will do. Reach out to the business managers who will be needed to conduct pilots. Impress upon them the nature of the opportunity ahead and how they're going to be able to partner with the highest quality startups. Stress the high level management attention that these pilots are going to garner. For now, build a band of believers who are genuinely excited about the innovation opportunity and work with them to identify projects (e.g., new construction projects slated to begin in the near term) and assets (e.g., stable multifamily rental properties with smart, tech friendly building managers) that might be available and pilot-ready.
If all goes as planned - and with a little bit of luck - the early successes from pairing top quality startups with this informal group of self-motivated managers will create the credibility needed to push for the greater structural changes that are ultimately needed to for a CVC to thrive in the long run.
Right now, the door is open to to CVCs as it has rarely been before. With a the right strategy and small changes to how it does business, this is a once in a generation chance will not only rack up a few key wins but will also be the catalyst to change the game with the corporate sponsor and lay the foundation for a stronger, healthier, corporate venture fund.
Don't blow it.
I often speak with dozens of colleagues while conceiving of and writing articals. I’d like to thank David Coats (Correlation Ventures), Raj Singh (JLL Spark), Jeanne Casey (Nuveen), Momei Qu PSP Capital), Mike Mannix (Band Capital Partners, Coril Holdings) for their data, ideas, and feedback… and apologize to the many others I may have forgotten to credit by name.
About the author:
Andrew Ackerman is a recovering consultant turned serial entrepreneur turned early stage investor. He has invested in over 75 startups, including over 30 prop- and construction-tech startups while running Dreamit Urbantech. He is currently a Strategic Advisor for Second Century Ventures, consulting for large corporations on innovation and venture strategies, and is a frequent speaker and contributor to Fortune, Forbes, CREtech, Propmodo, Builders Online, Multifamily Executive, AlleyWatch, et. al.