Corporate venture capital funds, or the investment of corporate funds in outside startups, emerged as a key line item for CFOs to manage in recent years.
According to CB Insights, there are about 1,300 CVC funds worldwide, and they invested $28 billion in startups last year. That's up from $16.7 billion invested in the previous year.
"Having a CVC fund is a way to make sure your company is relevant in the next five years," said Richard Morris, a former CPA who is now a partner at the law firm Herrick Feinstein LLP in New York City.
CFOs are key players when a company establishes a CVC fund because they are an integral part of allocating the money required to invest. "CFOs are often involved in the conversation of how to fund innovation broadly, how to structure and agree on the objectives to form CV initiatives, and how to compensate the executives that lead the CV fund," said Bryan Pearce, an EY partner and Chartered Accountant who is the author of The Innovation Paradox report.
Constructing a CVC fund
Caterpillar Ventures is one of the newer players in the CVC world, having plunged in at the beginning of 2015. The company currently has five direct investments and three fund investments, and it partners with several of the main financial investors in the San Francisco Bay Area, said Michael T. Young, CPA, the director of Caterpillar Ventures. The investments include an Uber-like construction equipment company called Yard Club.
"Companies that have a venture fund can do better than those that don't because the company with a venture fund is planning and participating in industry disruption through new products, services, distribution channels, and processes," Morris said.
Yard Club, for example, works with Caterpillar's dealers to help Caterpillar rent out more machines. "We believe that if we can help them rent their machines and make them more productive, they will buy more machines from us. As well, the more the machines are operating in the field, the greater the parts revenue opportunity," Young said.
A CVC arm is an important way for CFOs to access innovation. "You want to drive the change in your industry that works best for your company rather than being passively subject to it," said Pearce, who is the global leader of EY's Venture Capital Advisory Group. "Imagine if your company developed the better app, the better website, or distribution channel for your industry."
How much should you invest?
The amount of money that's used to fund a CVC arm depends on what a company wants to cultivate in the long term. "Most CFOs would likely fund the CVC fund from their R&D project development funds," Morris said. "Evaluate what other companies are allocating to their CVC funds in your industry. You can also lower your financial investment by having your CVC division partner with venture capitalists and private equity firms that relate to your industry."
To measure the success of a CVC fund, it's important to establish milestones so that fund accomplishments can be judged based on preset metrics, Morris said. According to Pearce, three commonly used criteria are (1) financial return from the investments, (2) number of innovative companies the CVC has connected with, and (3) placement of new technology to enhance the firm's products, services, or business processes, although the priority of these varies among corporate sponsors.
"If a CVC investment doesn't pan out, it doesn't mean the investment was a failure; it's part of a larger process in which you still get return from the information your CVC staff has gathered," Morris said. "It's also valuable to know what doesn't work in your industry. A failed CVC investment is just R&D."
As with any business endeavor, there are challenges to operating CVC funds. Christopher Golden, CPA (inactive), is president and CEO of Keystone Business Group LLC, a management consulting company that, together with Sterling Select LLC, a venture advisory and development platform of Sterling Equities, operates an outsourced CVC operation and service business. He cautioned that internal CVC arms can have limited development capabilities and be encumbered by financial risk.
"There's often a conflict of priorities and operating requirements when an individual business unit has venture capital control," Golden said. "We have seen situations where otherwise viable venture development opportunities were lost because of internal conflicts including differences over acceptable levels of risk, staffing and compensation standards, quarterly performance priorities, and the relative size of projects. Unless a CVC fund has the proper operating support system, it can be challenging to prepare startups and their young entrepreneurs to be acquired."
Here are some final tips for managing a successful CVC fund.
Allow the CVC team autonomy. "Good corporate venture teams do well when they have the authority and independence to move at the rate of speed that the entrepreneur is moving," Pearce said.
Cultivate funding that is not bound by the company's normal budgeting process. "Our goal is to manage it as a four-year fund, not by an annual amount," Young said. Also: "It's never our goal to dominate the investment in a certain venture," he said.
Maintain staffing continuity. "If there is no continuity because corporate points of contact for the entrepreneur get promoted, for example, then it's hard for the entrepreneur to navigate the corporation," Pearce said. "A CVC team maintains continuity for the innovative entrepreneur."