I this post, I analyse some of the reasons why both Corporate Venture Capital and private Venture Capital investment continues to make sense during a downturn.
I was in San Diego back in 2009 to visit a start-up IT company called HealthFusion. The CEO told me about a new tablet that was being developed by Apple and how it would change the technology and healthcare world. His aim was to develop healthcare software for the iPad, his major priority at the time. Are you sure, I asked… Tablets have been around for years. He was sure, and he was right. Most importantly, he was right before everybody else. This was a company backed by Corporate Venture Capital and a privately-run VC fund.
What is behind California’s entrepreneurial spirit? What leads a large number of people on the West Coast to invest their time and energy in start-up companies? Some argue that Hollywood’s influence, that of a highly competitive, creative and innovative industry, has created a positive spill-over effect in California. Others point to Californian universities, that create a large pool of talent. Whatever the causes, the combination of venture capital funds and technology firms in California have created a number of clusters which produce recurring growth and profitability. Which takes us to the subject Corporate Venture Capital and privately run VC funds.
What can we learn from the venture capital funds behind successful technology companies? What makes these funds so resilient?
Why do those venture capital guys keep getting it right?!?
For years, venture capital funds have studied and sponsored disruptive innovation, with good results: after emerging in the middle of the twentieth century, venture capital investing has grown to the stage where venture-backed companies correspond to over 20% of US GDP today.
Larger firms have tried to emulate this success by organising their own Corporate Venture Capital funds. While this appears to make good sense, if we recall the mad times before the dot.com bubble burst in 2000, Corporate VC investments start to lose their appeal. In the late ’90s, Corporate Venture Capital was all the rage. Yet nearly one-third of the companies investing corporate funds in start-ups in September 2000 has stopped making such investments 12 months later. It is unclear, at least to me, whether a similar decline in Corporate Venture Capital activity has happened after the 2008 crisis. There is however evidence that Corporate Venture Capital continues to play a major role in the healthcare industry, at least in the US. The chart below (which was taken from a Forbes article) illustrates the substantial funds that can be deployed at present, by the main corporates investing in healthcare start-ups – north of US$2.5 billion:
Corporate Venture Capital continues to play a major role in healthcare
In any case, it also appears that venture capital investment run by private funds continues to make sense during downturns and may actually be a less volatile and ultimately safer form of investment. Why are privately run venture capital funds better positioned to handle change and adversity than most organisations?
Private venture capital funds are typically small places. This gives them an advantage over larger corporations: the ability to take risks and move quickly. While consensus and alignment can be difficult to reach in large firms, privately run venture capital firms benefit from being flat and nimble, with the ability to deploy capital fast. Even the largest VCs only have a few dozen investment professionals. What determines the VC’s profitability is the ability of these people to spot disruptive investment opportunities.By contrast, Corporate Venture Capital organisations still need to run their investment decisions past internal and sometimes external stakeholders. This could result in a comparative disadvantage in situations when a target company is growing fast and needs capital to carry out a decisive strategic move.
Investment professionals working in a private venture capital fund are usually involved in the management of portfolio companies. The fund’s strategy is tied to the strategy and success of its portfolio companies. This also means that investment professionals usually have the sufficient authority to make decisions, which may not always be the case in larger organisations.
For larger firms, investing in new technology and developing internal competencies makes sense even during a downturn. Yet, due to the internal dynamics of larger organisations, new investments are often seen as too risky in tough times. This is a dangerous path, as any company that closes the door to innovation may find out too late that it lacks the competencies to achieve profitable growth further down the road. The more optimistic companies that continue to invest in Corporate Venture Capital even in difficult times may be better positioned for future growth than their more risk averse competitors.
[Updated Apr 2012 by Hugo Mendes Domingos]
Innovation Models 