Two Viewpoints on Corporate Venturing

In the 5/9/2001 issue of Red Herring, Harry Edelson, one of the most experienced VC's on the East Coast, is quoted extensively as a skeptic of major corporations starting their own venture initiatives. His reasons include the following:

• Corporate VC's are targets for litigation because of their deep pockets (even though corporations invest through a private label venture fund, which may in fact have some independent managers and some non-affiliated LP's).
• There is a “brain drain,” as successful investment professionals in the corporate venturing relationship are footloose at just the wrong time for the corporation i.e. when they have achieved significant returns.
• Infighting within the corporate hierarchy and distraction from internal R&D, as well as other problems.

All this leads Edelson to predict that, since “almost all of the corporate VC activities in the `60s, `70s and `80s are gone, it stands to reason that the corporate funds in the `90s will disappear in the next decade.”

But there is another point of view. Quoting from 'The Venture Capital Cycle' by Josh Lerner and Paul Gompers of the Harvard Business School, perhaps the best recent study of venture capital investing:

“Corporate venture investments in entrepreneurial firms appear to be at least as successful (using such measures as the probability of the portfolio firm going public) as those backed by independent venture organizations, particularly when there is strategic overlap between the corporate parent and the portfolio firm. Although corporate venture capitalists tend to invest at a premium to other firms, this premium appears to be no higher in investments with a strong strategic fit.”

Are Gompers and Lerner simply woolly headed academics? Is Edelson a parochial adherent to his own freestanding financial partnership method of doing business and nervous about having to overpay for corporate venture opportunities?

From my perch, I think corporate venturing will have much longer legs than the Xerox, Exxon, etc. partnerships that flamed out some years ago. First, as noted in another 'Buzz of the Week,' the rear view mirror into which the CEOs of major multinationals look is filled with the wreckage of companies that have failed to reinvent themselves. Dick Foster and Sarah Kaplan’s book, Creative Destruction, has some gloomy numbers for the managers of corporate assets who are inattentive to continued reinvention. And the notion that in-house R&D can routinely compete with results of the entrepreneurial spirits generated by early-stage, independent firms does not wash. If that were the case, there would not be enough product for VC's to invest in. Moreover, as noted in another Buzz, I think we are in the very early innings of a spectacular upsurge in useful and revolutionary technological developments. Finally, corporate venturing in the `60s and `70s was confined generally to companies whose principal place of business was in the United States. Venture capital is now a global game and many of the corporate venturers themselves are European and Asian multinationals, bound and determined to become players in Silicon Alley/Silicon Valley/Digital Coast/Route 128.

The resolution to this dispute is to recognize that the devil is in the details. There is nothing wrong with corporate venturing that intense and exhaustive attention to anticipatory planning cannot fix. One of the most successful funds of all time is Chase Capital, born as Chemical Ventures in the early `80s. It took just under three years to get all the details of Chemical Ventures exactly in place (I know, because I was the lawyer in charge of the project). It seemed at the time that Chemical’s management was indulging in overkill, as the participants debated long and hard over every aspect of the arrangements. As it turned out, the planning was very useful, and it certainly contributed in part to the success of the entire project. The major credit goes to the people involved, Steve Gilbert and Jeff Walker et al, but step-by-step consideration of the various alternatives had a good deal to do with the ultimate outcome.

I do a lot of work in the corporate venturing space these days and I am continually struck by the wide variety of alternatives being explored. While terms between the GP's and LP's of stand-alone venture funds are becoming standardized, corporate venturing arrangements must be customized to the particular environment. The questions that must be addressed include:

• Are the funds coming solely from in-house or are other non-affiliated LP's invited to the party?
• Are the managers graduates of the host corporation, recruits from the stand alone venture community or a combination of the two?
• Does the management entity employ the services of an experienced, semi-retired VC to serve as non-executive chairman of the investment committee to smooth out any possible misunderstandings between the corporate insiders and the entrepreneurial managers?
• Does the investor partnership ‘stick to its last,’ as Paul and Josh strongly suggest i.e., focus on investment targets in their own field of expertise?

There is a list of 20-30 questions of this nature that should be answered if a corporate venturing arrangement is to be a success. This can be a daunting task, but the results can be gratifying.

In short, I come out on the side of Gompers and Lerner and not Edelson, but I do not denigrate the points he raises. Only after the issues involved in corporate venturing are carefully analyzed and dealt with are the results likely to be profitable and rewarding.