Financing Corporate Innovation - Moving Beyond Money

Investing in the Connected Industry differs from traditional VC investing, requiring a more active approach to maximize returns. As corporate investors emerge as a force within the technology investment and innovation landscape, they will also face specific challenges to convert capital invested into business outcomes.

The latest issue of Go4Venture’s monthly bulletin makes a compelling case that tech innovation financing is changing with “corporate and generalist investors here to stay”. It was a follow-up to their March issue, which mentions a “stampede of newcomers” into European technology investing. As proof, Go4Venture calls out not only the volume of investing – up 18% by value of large transactions (>= 10mn) compared to the same period last year – but also the large deals done by the likes of Softbank, Dell Technologies Capital, and Cisco.

There is no doubt that corporates are increasingly active in technology investing. Samsung committed USD 1.2bn in IoT investment and R&D last year; Hitachi committed USD 2bn to IoT. But it isn’t only the large companies that are buying or investing at a furious pace – even the new tech giants are busy, with 34 AI startups acquired in Q1 of this year.

Capital flows as a false proxy

However, does more funding really matter?

First, a little perspective. It is not uncommon for the private equity industry to measure itself on the amount of capital raised or invested. The latest annual report of European PE Activity, for instance, commits 18 pages to discuss fundraising, 27 pages to talk about investments, and a mere 12 pages to discuss divestments. Go4Ventures’ own analysis – while accurate on several counts – makes the same fallacious link between activity and outcome.

This is unfortunate. After all, we don’t measure a company’s performance by (e.g.) the number of people it hires or the amount that is spent. Rather, we look at top-line and bottom-line performance. Should the investment industry not be held to the same standard – to focus not on how much was invested, but how much was produced, either in financial returns or in strategic innovation?

Here, the record is somewhat less clear. The fact is that throwing more money at a problem does not always yield better results. For instance, the median US VC fund does not outperform public equity markets, undermining the investor’s case for VC investing. CVC involvement also affects the landscape - according to a Pitchbook analysis, since 2006 CVC funded deals have consistently been priced higher than deals with no CVC investor (see chart).

Innovation and early-stage investing

This is not the first time the emergence of corporate VCs has been considered remarkable. In 2011, 11% of VC financings had corporate participation – an industry high at the time. Furthermore, prior analysis suggests most corporate VC arms are not very long lived – their median life is traditionally around one year.

This time may certainly be different, not least because the pace of innovation and disruption is accelerating. This is particularly true in industrial technology innovation, where – as Go4Venture calls them - “the traditional technology players” are trying to catch up. However, if this has to be about more than just the amounts invested, then emerging corporate investors and innovators should anticipate three challenges with which they've historically struggled:

• ONE: In our conversations with numerous corporate VCs, the first common challenge is the uneasy alliance between the venture arm and the business units it is meant to serve. Helping reconcile their different goals and the pace at which they function goes a long way towards ensuring success. Most tend to solve this either by making the VC arm entirely independent (such as Robert Bosch Venture Capital or Vito Ventures), or by putting in place clear streamlined processes for interactions between the two.

• TWO: The second challenge most corporates face is being active at the early stages of a venture’s life-cycle.  At this stage, particularly around seed and series A, deal sizes are small and the supply particularly fragmented. With few exceptions, corporate VCs simply don’t have the ability to source deal-flow globally or take the high-risk bets that seed-stage companies imply. Ironically, this is where most technology and business model innovation happens – yet it remains a major blind spot for investors we talk to.

• Finally, the most active corporates do not rely on investing as their sole tool for innovation. Indeed, the vanguard are increasingly taking their innovation needs into their own hands. According to a BCG analysis in 2016, rather than relying on universities or entrepreneurs to turn new ideas into companies, they are setting the agenda and helping create new companies through a combination of corporate venture capital (40%), innovation labs (19%), and accelerators and incubators (44%). 
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Conclusion

As I had noted in a prior article, investing in the Connected Industry differs from traditional VC investing, requiring a more active approach. For the same reason, companies that seek innovation and strategic benefits from investing (e.g. seeding an ecosystem for their new platform) will require a more hands-on strategy. They will have to be more active and invest earlier in the innovation cycle – including helping seed their own startups, where necessary.

This need to be involved and creative will only be aggravated as later stage VC rounds get more competitive and both financial and corporate VCs struggle to secure deal-flow and the innovation insights that come with it. Witness, for instance, Bain Capital Ventures’ recent announcement that it will give money away to angel investors.

How does one, however, translate these broad challenges and guidelines into actionable decisions and what does it mean to be more active in the innovation cycle? Specifically for us, how does this affect the Connected Industry investment landscape? This is why we created Momenta Ventures.