How to benefit from strategic investments
Corporates run venture capital (CVC) units that conduct equity investments into emerging startups. The CVC units usually scout for and invest in startups in hopes that this will generate certain benefits for the parent corporation. Such benefits range from direct financial return to indirect strategic advancements, like market insights or technology access.
However, such strategic benefits do not simply emerge from a capital injection. For my ESMT master’s thesis Making corporate venture capital work and measurable, I explored both the additional activities investors undertake and the nature of the startups themselves to understand how investors could benefit from such a relationship – how an investor can capture and measure the strategic benefits of a CVC investment. Data was collected through interviews with thirteen investment managers from diverse major German DAX corporations and leading consultancies.
The interviews focused on CVC units and their investment processes to reveal, ultimately, the actions investors take during their startup engagement as well as their relation to the measurability of benefits received. Investigating such relationships can help investors learn which approaches work best and how a parent company can get the most out of their investments.
CVC units fall into two categories: exploitative or explorative. Neither category is mutually exclusive, or inherently better than the other. However, as the interviews showed, managing different CVC units demands differing strategies.
Mature players in close collaboration
Exploitative CVC units typically invest in startups that are closely related to their parent company’s core business and that can help improve existing designs. These CVC units have a strong connection to their parent companies and exhibit a high level of dependency. As a result, rather than investing in early-stage projects, exploitative CVC units tend to invest in more mature projects that demonstrate some degree of market readiness.
The interviewed investment managers underscored the importance of close operational collaboration between the CVC units, business units, and startups. The coordination of joint projects and partnerships serves to integrate innovative solutions from the startup into the business units, accruing learning effects and similar strategic benefits to the parent company.
This potential for collaboration is thus key to how an exploitative CVC unit must evaluate a startup for investment. This also means that exploitative CVC units must be aware of the challenges and developments in the business units, so that they can scout for startups accordingly.
Strategic benefits can also be gained without prior equity investment. As one of the interviewed investment managers stated, “If I really want to benefit from a startup, I have to buy the product and not the share.” They described a lean process that enables business units and startups to quickly become clients for a limited time, allowing the technologies and services to be transferred to and applied in the business units quickly.
Due to this high level of collaboration, the measurability of strategic return of exploitative investments is rather straightforward. Investors can define the objectives of the collaborative projects beforehand and compare these to the actual tracked impact of the collaboration.
Future players with strategic support
In contrast to exploitative CVC units, explorative CVC units invest in startups that bring new concepts to the table that are far from the parent company’s core business and offer future business potential. While parent businesses still have influence, these CVC units are characterized by a high degree of autonomy and a low level of dependency. The startups that they select do not necessarily share a direct market, product, or technology with the parent and are less connected to its current business needs.
Here, as the investment managers reported, explorative CVC unit activities are focused on consulting and supporting the startups in their growth. They provide these startups with resources, market access, and industry knowledge, and connect them to networks within and beyond the corporation. This means that many of these startups are far from market-ready when the initial investments are made. Thus, the benefits of such investments do not manifest for quite some time.
These early stages are time for representatives from the parent company to learn as much as they can about the new technology, together with the startup. While CVC unit experts may provide advice in building startup leadership teams, they refrain from interfering with the day- to-day activities. Taking board seats, building networks, and providing on-call support are better alternatives to intense involvement.
Without the high degree of collaboration that we see with exploitative CVC units, measuring the strategic benefit of investments by explorative CVC units can prove more challenging. The nature and evolution of these investments are a little more complex. However, taking board seats gives companies access to information that offers measurable insight.
As the study showed, the practice of CVC equity investments in startups can give a corporation a competitive edge when done right – both in financial and strategic regards. Different factors concerning the actions of the investing corporation and the nature of the startup influence the extent to which these benefits are gained and measured. Exploitative CVC units, with the strategic objective to improve the parent corporation’s core business, should encourage collaboration between the business units and the startup. Facilitating joint projects or enabling the purchase of products can help solve the current challenges of the parent corporation. Explorative CVC units, which seek investments in disruptive technologies and future market opportunities, should support and advise startups by taking board seats, providing expert advice, and building networks. Understanding the relationship between performance and investment activities is crucial to gaining the most strategic and financial benefits from CVC investments.