Corporate Venturing – An M&A Route to Growth and Innovation?
It was the email I used to dread. It always started something like this:
“We’ve been doing the corporate development work you asked for and have found this great company. It’s only been going a couple of years but they’ve developed some great new products that would fit straight into our range. Now all they need is investment and expertise to bring the products to market and scale up. We can add both those things – it’s the perfect opportunity.”
It is a difficult line to tread. Gently bringing an overenthusiastic general manager down to earth, without blunting the enthusiasm to go out and look for more suitable deals.
This might well have been a great opportunity, but no early stage venture is a sure thing, and as a company we were not set up to take those kind of risks. We were as far from an understanding of how to use corporate venturing as a route to growth and innovation as it is possible to get.
In this article Robert Kemp, Training Programme Director of The Merger Training Institute, and tutor on our Core Mergers and Acquisitions Skills training course, explores why large corporates are attracted to early stage ventures as a route to growth, how they mess up, and how to make it work.
Why Do Corporates Want to Invest in Early Stage Companies?
Innovation and Creativity
Senior management at most large corporates are highly skilled at squeezing predictable year over year growth in revenues and profits out of large, established operations. They know which levers to pull to optimise the performance of the machine. This is a valuable and vital area of expertise. It is not though born of an environment that rewards innovation, entrepreneurship and risk taking. By investing in early stage ventures corporate boards hope to refresh their companies with entrepreneurial drive, focus, creativity and energy.
High Return on Investment
Most corporate boards keep an eye on the venture capital companies that invest in their industries. They can see that these companies are making healthy returns on M&A in early stage companies. According to the Thomson Reuters Venture Capital Research Index, the US venture capital industry has returned at an annual rate of almost 20% since the mid 1990’s. How many corporates can claim that?
Accelerate New Product Development
It takes a great deal of time and effort to develop a new product or service, bring it to market, and find customers willing to take a risk on something different. By investing in companies that have already cleared those hurdles the corporate hopes to shorten the time it takes to bring new ideas to market. We explore the role of acquisitions in shortening time to market, and achieving critical mass, in the M&A strategy module of our Core Mergers and Acquisitions Skills training course.
In the first two decades of the 21st century giant companies such as Google, Amazon and Facebook rose from nowhere to dominate huge areas of the economy. This has not been a positive development for traditional retailers or the print media. Everyone remembers what happened to Kodak. Every Chief Executive wants their company to be the driver not the victim of change. To some extent investing early in companies with the potential to change the game is a defensive move. When Facebook paid $1 billion to buy Instagram the company was 18 months old – and had 13 employees. It was not bought for an immediate bottom line impact.
Why Do Some Corporates Mess Up Early Stage Investment?
Of course some large companies are very successful with early stage investment. We explore how they manage the process in the next section. Many others though are set up to fail before they start. My former employer was one of those.
A Cautionary Tale
A new Chief Executive had recently been appointed and was determined to find “new legs” for the business. With some justification he felt the business had become stolid and overly conservative. Thirty senior executives from the company’s global operations were treated to a weekend innovation workshop facilitated by London Business School, and then sent forth to transform their own areas of responsibility.
A few weeks later the Chief Executive brought an early stage opportunity to the attention of my Divisional Director. A five employee company with some innovative food coatings technology. We took the company under our wing, invested in a small factory and equipment, and put in place a professional sales and marketing team. In the second year the company achieved £1.5 million revenues. It had live projects with some of the UK’s largest food manufacturers and retailers. The only problem – every month the company made a small loss.
Each month the Chief Executive held a financial accountability review with each of his divisional directors. Yes, the same Chief Executive. Part of the control pack presented to the board by the Group Finance Director was a list of loss making companies across the global operations. Our tiny food coatings business was one of only three companies on that list. The food ingredients division was in fine shape. Growing sales and profits by 10% year over year. Every month though I heard the same thing from my Divisional Director:
We’re having a great year, but we spent 5 minutes on that at the accountability meeting, and the rest of the hour on that tiny food coatings start up that’s losing $10k a month”
Thankfully we were able to dispose of the food coatings business shortly afterwards as part of an asset swap with a competitor. They made a lot of money with that business.
What Are the Lessons?
Why do I tell this story? As an emotional release after years of carrying pent up frustration? Well there is some of that – but primarily to illustrate how many companies mess up early stage investments. They want to invest in early stage companies because they are agile, flexible, fast-moving and responsive. Then they subject them to their own company’s entrenched and bureaucratic operating procedures.
In many ways this is a clash of cultures. We explore difficulties with incompatible corporate cultures at some length in our Mergers and Acquisitions Due Diligence training course.
So How Do Successful Corporate Venturers Make It Work?
A Portfolio Approach
The first step is to understand, and accept, that most of the early stage ventures you invest in will fail.
Read that again: Most Will Fail.
Probably more than 90%. The math is quite simple. You invest relatively little in each venture, they are small after all, but the ones that fly quickly grow big enough to pay for the failures – and make a better return as a portfolio than your mature businesses.
The notable word is portfolio. There is no point investing in one or two early stage ventures. You will almost certainly lose every penny. Early stage venturing needs to be a part of a sustained approach to invest in 20-30 businesses at a minimum. With a professional approach, and a sensible amount of good fortune, that should be enough to find a few winners.
Keep Venturing Separate and Independent
Most large corporates have found that to tap this source of growth they need to keep their early stage investment programme operationally and culturally separate from the rest of the business. They do this in two main ways:
Corporate Venture Units
More than 70% of Fortune 100 companies now have corporate venture units. PepsiCo call their unit “PepsiCo 10” and aim to invest in 10 early stage ventures a year. The units are typically staffed by technologists, and investment managers drawn from the private equity world. The corporate systemisers – Finance, HR and IT – are kept well clear.
Direct Investment in Venture Capital Funds
An alternative approach is to tale large stakes in venture capital funds aligned to your industry. Johnson and Johnson and GSK each contributed $50m dollars into a $200m early stage pharmaceutical fund. Such large investments typically come with some measure of pre-emption right on eventual disposals.
So, Should We, or Shouldn’t We?
Absolutely yes, if you are prepared to accept the failures, there will be a lot of them, employ the right expertise, and manage at arm’s length.
Absolutely no, if you are contemplating the odd strategic deal to be managed within your existing corporate structure.
About The Merger Training Institute
We provide practical, in-career mergers and acquisitions training for boards, executives and professionals in global corporations.
Our short, intense M&A courses are designed for executives needing to understand best M&A practice or adding new M&A responsibilities to their existing roles.
The courses are taught by tutors with hands-on M&A experience gained as part of corporate management teams. As well as being academically rigorous they are rich with case studies and real-world examples based on our tutor’s practical mergers and acquisitions experience.
Our course participants come from a wide range of industries and roles including general management, business development, strategy, marketing, finance, human resources, operations and legal.
Our Mergers and Acquisitions Training Courses
Core Mergers and Acquisitions Skills Training Course
The Core Mergers and Acquisitions Skills programme (M&A training course) is a three- day programme that teaches all the commercial and technical skills you will need to confidently lead or support a successful M&A transaction.
Our expert tutors guide you through the M&A process from strategy and deal origination to valuation, due diligence, deal structuring, contract negotiation and post-merger integration.
M&A Due Diligence Training Course
The M&A Due Diligence Training Course is a two-day programme that offering a solid grounding in the techniques used by some of the world’s most successful companies to assess risks, evaluate synergies and confirm the strategic fit of an M&A target. The course is designed specifically for executives involved in corporate M&A.
Successful Post-Merger Integration Training Course
The Successful Post-Merger Integration Training Course is a two-day programme that provides a solid grounding in the post-merger integration techniques used by some of the world’s most successful companies to deliver value from their M&A transactions.
Across the two days of the course you move from the key decisions made in the pre-deal phase, through the critical first 100 days and on to full synergy delivery. The course covers the post-merger integration issues most likely to arise in each business function and the most important business processes.
Advanced Business Valuation Training Course
The Advanced Business Valuation training course is a two-day expert level business valuation training course that teaches participants how to prepare robust business valuations in the context of a corporate M&A transaction.
Our expert tutors move you past the stage of plugging numbers into a standard spreadsheet and help you explore how risk, synergies and the quality of the target company might impact its value.