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Quantifying Strategic Value in Corporate Venture Capital

Quantifying Strategic Value in Corporate Venture Capital

Way back in 2006, Bill Aulet, now Managing Director at the Trust Center for MIT Entrepreneurship, invited me to be part of a panel discussion on corporate venture capital (CVC) as part of the 9th Annual MIT VC Conference. Bill gave a wonderful and detailed presentation, showing how CVC worked, adding the financial returns to strategic value. His model suggested that the financial returns might be insignificant compared to the strategic impact for the greater corporation. In the spirit of his pre-panel suggestion to be contentious and confrontational, I spoke up: "Bill, that's a good model if you want your CVC to fail."

Now of course I didn't mean to mock Bill's excellent presentation; in fact he seemed delighted to enter into a spirited discussion on the topic, and the audience loved it too. No, what I meant was that a CVC must show quantifiable value to its corporation in order to continue to exist. So many CVC groups have existed for a brief time only to be shut down because they could not quantifiably defend their existence.

The easiest way to quantify the value of a CVC group is to show financial return. This has to be financial return on its own investments, not greater sales or profit for a business unit which may be enabled by the CVC's investments; the BU in question will claim those for itself! Unfortunately, venture capital is a game for the patient, not for those publishing quarterly reports and looking for an impact on share price. In the cleantech and materials spaces, investment holding periods of around 7 years tend to be the norm. Consequently, a lot of CVCs have been set up and dismantled again in under 7 years, with failure to deliver a financial return as a root cause.

Of course, financial return is only part of the equation, but how can you quantify the overall strategic value if your BUs are going to claim any monetary component for their own? Should you count deals closed? That might lead to making sub-par investments just to hit the target. How about Fair Market Value? It's the standard for the VC industry, but in tough economic times, public comp-derived FMV will decline even when a portfolio is performing well. Unfortunately, tough economic times are when most CVCs get shut down.

Another obvious metric is dealflow. How many new companies can you review? The answer is almost infinite if you don't take quality or strategic fit into account. After all, if you're satisfied with the level of information on a start-up's website, it may take you only a few minutes to enter that into your CVC database and count it as another "deal". Keep it up and a single person could enter a few thousand "deals" in a year. Keep that up and the CVC will get shut down for sure.

So, quality is important – you can't just go for numbers. But how can you measure the quality? One way is to implement an endorsement system; this is what BASF and others use. In this system, a deal requires an endorsement from the head of a BU before the CVC group can move forward to investment. These endorsements can't be casual or else the people in the CVC will use their personal connections throughout the organization to get people to endorse deals "as a favor". No, the endorsement has to mean something, say perhaps a commitment to working with the start-up in some concrete way like a joint development agreement.

Of course, just because you got an endorsement doesn't mean the business relationship between the start-up and the BU will go well. While that is really beyond the scope of the CVC, CVCs will find they get judged on that basis, even if it's not overt. It's hard to imagine a BU will be quick to endorse another deal if its last endorsement resulted in disaster. If the CVC wants to survive, it should do everything it can to support the relationship between the start-up and the relevant BU.

To compare to financial terms, deal flow numbers can be likened to revenue, a "top line" number that is important, but only tells part of the story. The number of deals that get endorsed is analogous to gross profit, from which you can derive your "profit margin", which in this case is a measurement of overall deal quality.

Several CVCs partner with funds such as Pangaea in order to get access to world quality dealflow, even though their principal business model is usually direct investment. Pangaea has been investing with a focus on advanced materials since 2001, and we've developed relationships with over 120 universities and research institutions in order to watch and advise the best innovators, in advance of making an investment. It would take many years for a new CVC to develop a comparable network and corresponding dealflow. By partnering with a fund, a CVC can cherry-pick the most strategically relevant start-ups and technologies from a vast pre-screened dealflow. This not only increases their "top line" dealflow number, but does so in a way that increases the chances of getting endorsements, and thereby its quality metric.

I'm encouraged by the recent surge of new Corporate Venture Capital groups and hope that the lessons learned by existing and past groups can help most of the new CVCs to exist long enough to realize financial returns. In the meantime, hopefully these and other techniques can help them to quantify their strategic value.

General Partner, Pangaea Ventures Ltd. Keith has been making cleantech and advanced material venture investments since 2001, having managed Mitsubishi Corporation's Canadian VC activities and BASF Venture Capital America out of Silicon Valley.View Keith Gillard's profile on LinkedIn

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Guest Wednesday, 24 April 2019