Steer Clear of Corporate Venture Capital Pitfalls

Why do CVCs so often struggle, and how can you ensure that yours thrives and becomes a major innovation tool? One of us (Ilya) works with business leaders around the world on applying the Silicon Valley venture mindset to large companies’ corporate innovation and CVC strategies and has discovered a stark truth: A lot of companies don’t actually understand how CVCs should be designed, monitored, and evaluated. To shed light on this chaotic world, we conducted confidential, in-depth interviews with leaders of 164 CVCs around the globe about their decision-making processes and the factors behind their successes and failures.4

For these CVCs, which constitute about 80% of all active CVCs in U.S. S&P 500 companies and over a third of all large global companies, we also manually collected and analyzed a range of data, including their investments and co-investors and the backgrounds of their investment team members. The result is the first comprehensive look at the field. It has helped us identify major questions that leaders should consider when launching CVCs and illuminate best (and worst) practices as they proceed.

We also observed that no two CVCs are organized the same way. Whereas a typical pair of institutional VC firms could be seen as apples of different varieties, two CVCs are more like a carrot and a watermelon. Six of every 10 CVC leaders we interviewed said that the senior executives at their parent companies do not understand the norms of the venture space, the nature of startups, or the way they work together. These leaders lack the venture mindset. This is one reason why, in many cases, CVCs have foundered.

Another issue is that CVCs are often structured in an ad hoc way. They often don’t have a natural home within the parent company and can report to a startling variety of bosses. (Our sample found over a dozen different options, including CFO, chief operating officer, head of innovation, head of strategy, head of business development, and even general counsel and head of investor relations.) Yet the internal organization and decision-making processes of CVCs are critical to their success. In this article, we provide corporate leaders with a practical checklist to use in crafting and evaluating their units.

One important lesson we’ll discuss is that decisions should be internally consistent. In our sample, they rarely were. For example, if the strategic objective is to create new growth engines, the investment approval process should not require a startup to partner with a business unit or obtain a business unit sponsorship. Business units tend to be biased toward supporting projects that produce short-term cash flows or help their core operations rather than identifying new, potentially disruptive business models and products. Likewise, if the CVC’s mandate is to invest early in valuable technologies that can disrupt the core business, an investment committee that comprises executives with vested interests in the status quo should not have veto power.

A CVC unit is not just another R&D or M&A department. Its design should reflect specific corporate strategic objectives. Here’s how to thrive in this vital, but often chaotic, space.

Learn to Think Like a VC

Venture investors — backers of early-stage, high-growth companies — have to think differently to survive and succeed. The companies they invest in take longer to mature than the typical corporate project, and they are high risk to be sure, with up to four of every five flaming out and only 5% becoming runaway successes. Needless to say, successful VC investors are not people who are desperate to minimize their loss ratio. Despite the high failure rate, their returns are the envy of the financial world.

Most corporations, however, do not tolerate much risk. One of us (Ilya) shared some VC insights on dealing with the high failure rate with the CEO of a large company. The CEO then turned to the head of the company’s CVC initiative and asked about the failure rate of their own portfolio. “We have not had a single failure yet” was the proud response. Unfortunately, that meant the CVC wasn’t taking risks. It was investing too conservatively and sacrificing the opportunity to partner with industry disrupters and deliver what the CEO truly wanted. This reflected an anti-VC mindset. As we often tell corporate leaders, if at least 30% of your portfolio companies don’t fail, you’re likely investing too conservatively. A memorable assertion from Alex Rampell, a partner at the venture capital firm Andreessen Horowitz, is that errors of omission are much more painful in the VC world than are errors of commission.

CVC leaders we interviewed described how top executives’ failure to understand the venture space could be problematic. “From the corporate standpoint,” one participant told us, “people don’t understand that you do need to pay to play, and they don’t understand that startups have a burn rate and spend money and that you have to keep the lights on.” Many people we interviewed said their role often involved bringing people up to speed internally. “It’s been an interesting challenge for me to educate the people who are lifers at the company,” said a CVC leader in the consumer goods industry. “They don’t have the time to spend on this, so they’re trusting us as subject-matter experts for this initiative.” But when these ill-informed executives play an active part in the investment selection process, it does not bode well.

Another defining characteristic of the VC space is that most startups raise multiple rounds of funding. In fact, the more successful a company is, the more likely it is to come back for more money to scale up quickly. The initial funding is just to get startups to the next set of milestones; at that point, investors will know which of their portfolio companies are the most successful, and they can double down on those smart bets. Perhaps the worst outcome for a startup is to reach all of its early goals only to be told by its main investor that the strategic priorities have shifted and that there’s no more money coming its way. Negative signaling like that can be fatal to a startup’s ambitions, leading outsiders to speculate that the inside investor has quietly noticed some red flags.

Companies with a true venture mindset support the follow-on rounds of their successful portfolio companies. If CVCs face corporate constraints or don’t have the resources to move forward, innovation could be dead in the water.

Define Your Objectives

Start clarifying your approach to CVC by answering these interrelated questions. Everything else will follow.

Should your mandate be strategic or financial? About a quarter of CVCs are heavily or exclusively driven by financial objectives. If you’re thinking of traveling down that road, ask yourself how well your team will be able to compete with the best institutional VCs — and what advantages it will have over professional fund managers. Don’t be surprised if the answers turn out to be “It can’t” and “None.”

Does that mean you should go in a diametrically different direction? The short answer is no, though just over half of CVCs we examined have tried. “When we were founded, measures of success were 100% strategic,” one interviewee told us. “In fact, my CFO said, ‘I don’t even want you to financially track these investments — I’ll write every investment off as an R&D expense the day you close the transaction.’” The CFO, no doubt, knew that direct CVC financial gains tend to look tiny on corporate balance sheets and don’t even warrant a footnote in a P&L statement. But going all in on strategic goals could be inefficient too, because neglecting financial performance will likely lead to strategic failure anyway. CVCs fulfill strategic goals when they identify and partner with companies driving massive change in their industry, and those companies also tend to be the most successful financial performers. Investing in startups that are bound to fail is obviously not a win from any angle.

What’s the relationship between your company and its CVC investments? Think of your CVC’s potential investments as three layers of a pyramid: the parent’s core business, an adjacent space, and new domains. Where would your CVC unit be most helpful? Global companies differ dramatically in their approach, depending on industry development and the competitive landscape. About one-third focus on the core and never invest in new domains; another one-third never invest in the core. Wherever you decide to invest, your choices should drive many of your subsequent decisions about how your CVC is designed and, in particular, who approves those investments. If you choose to diversify, be specific about the fraction of the total portfolio and effort going into each layer.

JetBlue Technology Ventures (JTV), a CVC arm of JetBlue Airways, takes a multipronged approach, investing 40% in the core business, 50% in the adjacent space, and 10% in new, disruptive areas. And it evaluates the investments across those spaces based on different metrics, which is key. For example, the impact of near-term investments is measured by specific contributions to cost reduction or customer service improvement. As JTV founder Bonny Simi pointed out, “If you don’t show some relevance in the near term, you may not be around in the future. You need to make sure of that or investors are going to start asking questions like ‘Why are you spending money on these crazy things?’”5 Investing in new domains can also open up useful channels of information. As Simi put it, “What if Hyatt had a board seat at Airbnb when they were first getting started?”

How long is your time horizon? More than half of the CVC leaders reported having short-term objectives and being evaluated on a short-term basis, often quarterly. This approach can be counterproductive. One leader ruefully observed, “This is where CVC is so funny to me, because to really do true innovation, you have to have a super-long-term horizon, but in reality, we have a super-short-term horizon. The long term is sacrificed for those short-term needs.”

Focusing on the short term just doesn’t mesh with the life cycle of startups, which is why most VCs judge their investments’ performance over a decade or longer. When one of us (Ilya) analyzed all U.S. VC-backed unicorns (companies with a reported valuation over $1 billion, most of them very successful startups), he found that on average it takes them nine years to go public or get acquired after their founding. Even for late-stage VC-backed companies, the average exit time frame is close to five years.6

Management teams of early-stage companies know that a strategic corporate partner could be of immense value in achieving success, as long as their partner is not on a super-tight time scale. Yet only one-quarter of CVCs are evaluated on a long-term basis of five years or more. By not setting expectations for time horizons in the CVC on a basis separate and different from other corporate time horizons, parent companies shoot themselves in the foot. If CVC executives know they will be evaluated on a quarterly basis, they are likely to invest in companies with the minimum amount of risk and limited upside potential, which likely isn’t what their venture’s creators had in mind. Short-horizon thinking could be detrimental in any domain but is particularly inefficient if you invest in a new, disruptive space. Once the timeline is extended, CVCs can invest in riskier, long-term projects, which often generate the most strategic and financial return.

Decide How You Want to Control Your CVC Unit

In our experience, most CVCs have an awkward relationship with the mothership. Here are some questions that will help clarify boundaries and accountability.

Should your company create a separate CVC unit? Most CVCs are organized as separate units, with the head responsible only, or primarily, for the group’s activity. However, 27 CVCs in our sample were embedded into other structures — typically, corporate development or M&A groups — and didn’t function as clearly delineated units. Fourteen of them didn’t even have a single full-time employee. If your objective is for the CVC to build your near-term core expertise and support corporate development tasks, that arrangement might work. But don’t expect to invest in truly disruptive companies or to get invitations from institutional VCs to participate in the most promising opportunities.

How strong is the organization’s budget commitment? Companies differ wildly here. At one end of the spectrum, 30% of global CVCs in the sample were set up as a completely stand-alone fund with a pre-committed fund size and a pre-specified investment horizon for the next several years, often with the parent corporation as the only investor (that is, a limited partner). Often these funds are organized like institutional VC funds. At the other extreme, 27% of CVCs were completely opportunistic: They had no preapproved budget allocation and had to seek special approval for each investment they made. Then, floating around in the middle of the spectrum, 16% of the CVCs had a single-year budget allocation, reviewed and renewed annually. In other words, most CVCs lack full-scale, long-term commitment from their corporate sponsors. Parent companies might think that flexibility is beneficial, but weak commitments can destroy a unit’s standing, hamper investment objectives, and foment distrust among other investors and startups.

Lack of commitment also makes it difficult for CVCs to secure a successful pipeline of strong portfolio companies. And, again, since many investments are pooled with other investors, invitations to the best deals won’t be forthcoming. That’s particularly likely if a separate budget approval must be requested for each follow-on investment. The head of one CVC shared the kind of story we have heard too often. Her CVC made numerous successful investments in a specific space, based on strategic directives from the CEO suite. Then a change in CEO led to a pivot; the unicorn investments were orphaned due to a lack of funding and were later liquidated at a huge discount and with no strategic benefits to the company.

To whom should the CVC unit report? CVC unit bosses are overseen by a dizzying variety of executives. Moreover, many respondents indicated that their reporting structure has changed repeatedly over time and has often been driven more by the interests and talents of particular executives than by their formal responsibilities. The reporting structure should be consistent with the CVC strategy mandate. If your objectives are long term and you intend to benefit from investing in new domains, it’s likely best to spin out a stand-alone unit that reports directly to the CEO or chief strategy officer.

As for the most inefficient reporting structure, there’s a lot of competition there: Heads of corporate or business development who pursue short-term objectives and are driven by similarly short-term metrics might prevent CVCs from thriving. CFOs are, by design, risk-averse, and — particularly in publicly traded companies — might be guided by short-term results and goals. Finally, putting the CTO in charge really makes sense only if the CVC is just a window for internal innovators to take a peek outside.

The ideal is a structure that encourages innovation and tolerates risk. One CVC leader, Claudia Fan Munce, who was the head of IBM Ventures for many years, confided that her biggest challenge was “not invented here” syndrome. She would present an amazing startup, and the technologists inside IBM would say, “We can do it much better ourselves.” Perhaps they could, but it wasn’t among their top hundred priorities, so it never got done.

Get the Investment Approval Process Right

Most CVC units have a two-stage process: The CVC team considers whether to bring a deal forward to the parent company, then the parent company’s internal investment committee (IC) makes the final decision. With the exception of fully stand-alone funds, only two CVC units among the many we studied had the authority to make new investments of nontrivial size without IC approval. Moreover, most ICs are composed of parent-company executives with veto power, which is invariably an inefficient setup, as we will see. Three questions for corporate leaders to ponder:

How long should it take to make an investment decision? Corporate bureaucracy is plodding and often a bad match for the brisk heartbeat of early-stage companies. Many CVC leaders complained to us that internal decision-making was so slow that they missed out on high-quality deals. One CVC leader insisted that the IC’s decision must come within 48 hours so that his unit could compete for the best opportunities.

Who should be on the IC, and what role should they play? The most interesting data point might actually be who’s not on many ICs: In 6 of 10 cases, they don’t include a single CVC team member. The job titles you will most frequently see on the committee are CFO (57% of cases), CEO (43%), business unit representative (35%), general counsel (18%), and head of strategy (17%). Our sample found over 50 different titles in the mix — and that’s for a median IC with just four members.

Appointing parent executives to your IC can help expose them to a flow of relevant external innovations they otherwise might have missed. But that benefit comes with severe drawbacks. Do IC members — executives of a company with revenue that is often a hundred times the CVC budget — have the time and incentives to dive into the details of what might seem to be trivial financial decisions, especially if the same IC is also in charge of approving small venture investments and large M&A transactions? Do they possess sufficient knowledge to evaluate cutting-edge startups outside the company’s core? Are their incentives aligned with the CVC’s strategic objective?

Think about adding external IC members — an institutional venture investor or a representative of another CVC, say — who can provide independent insights without the baggage of internecine politics or conflicts. One way to protect your reputation as a partner to startups and other venture investors while avoiding unwanted escalation of commitment is to demand that a follow-on investment be led by a new, reputable outside investor. This tactic is common among institutional VCs.

How is the IC voting structured? At 43% of CVCs, ICs require unanimous agreement to proceed with an investment (that is, everybody should be excited enough to vote yes); at 30%, it’s a majority, and 14% require consensus (that is, effectively, nobody says no). As the median number of parent executives on an IC is four, the chief, though often unintended, consequence is that these executives act as gatekeepers who simply retain a veto right on investments. Just one skeptical executive can often scuttle a deal. In some cases, such as heavily regulated industries, this makes sense, but many voting structures are counterproductive.

Is your IC just rubber-stamping? The IC just rubber-stamps investments in about a fifth of the cases, its approval taken for granted. Does that mean that the inefficiencies go away? Unfortunately, no. The inefficiencies are just hidden away. In all of these cases, we found that venture team leaders “socialize” the deal with IC members and proceed with a formal vote only after getting their informal sign-off. That often means they wind up with run-of-the-mill consensus deals.

Do you need an IC at all? The IC can be a useful, and necessary, tool for CVC oversight. However, consider differentiating between decisions on individual investments and portfolio-level allocation and strategies. Unless the CVC unit is created to facilitate specific near-term impact goals for the existing business, think about delegating individual investment decisions — especially smaller ones — to the venture team, with clearly defined criteria in advance if necessary. Encourage the CVC team to draw on your company’s expertise when evaluating deals, but don’t stand in the way of their convictions or knock their incentives off course.

In the short term, the venture team could be most helpful by delivering cutting-edge information about industry trends, so insist on thoughtful presentation on the deal flow such that the team does not feel the need to socialize the investment (or opportunity). Leaders could also consider turning the veto rule on its head. Usually, we think of senior executives as stopping investments from occurring, but in some cases, senior executives with a longer-term company vision might overrule the venture team’s decision not to pursue a particular investment — or direct it to seek a similar opportunity. This is how Nagraj Kashyap designed the decision-making process in M12, Microsoft’s CVC unit. Think of this as a “yes veto.”

Finding and Keeping CVC Team Talent

Most CVCs are small, lean organizations, with three to seven investment professionals. Sometimes additional team members connect portfolio companies with the parent. The following questions can help leaders decide on the structure of their CVC team.

Should your CVC team be insiders or outsiders? The most efficient CVCs include both. Insiders have deep connections to the parent company and know intuitively how to navigate its culture. But executives with institutional VC experience — even if it’s not in the exact domain of the parent company — can be invaluable because they have been embedded in the innovation ecosystem. They can help insiders understand the broader landscape when it’s time to build deal flow or seek syndication with other investors.

How should CVC personnel be compensated? Institutional VCs live and die by the carried interest, a profit-sharing arrangement with their investors. About 1 of every 4 CVCs has a similar profit-sharing arrangement, which is often structured as a bonus. Yet in 6 out of 10 cases, financial performance does not even affect an employee’s bonus. The conundrum stems from a complicated trade-off: Parent companies don’t want to simply imitate institutional VC arrangements, which would be detrimental to their strategic objectives, since CVC financial performance does not translate directly into long-term impact on the parent and in fact could lead to a conflict of interests. Also, as one CVC leader said, echoing the sentiments of many, “You don’t want to make more than the CEO of the company.”

On the other hand, most successful CVCs invest in industry disrupters that have an outsize financial performance, and team members are incentivized to do so. Talent retention is also a major consideration. The best CVC team professionals leave not for a competitor but for an institutional VC firm, and many of our interviewees lamented that they lack the necessary tools to keep their best and brightest. In CVCs, high turnover is detrimental because it makes the relationships between the units and their portfolio companies less credible, especially if CVCs have negotiated a board position. We observed a much larger turnover in CVCs compared with their institutional VC peers. To be fair, this is not always related to compensation; often, it happens at the whim of corporate headquarters when projects are put above people.

Many CVCs ultimately fail precisely because they can’t attract or keep the right talent, so some parent companies have balanced their compensation packages: They have imposed a ceiling on the compensation pool based on fund performance to reduce unnecessary risk-taking — and to prevent employees from overshadowing the CEO, of course — and added a slew of long-term strategic performance metrics and equity compensation plans.

Decide Where All of the Above Is Going to Happen

Is it more efficient for your CVC to be close to the parent company or far away? Two-thirds of S&P 500 CVCs are within a mile of headquarters. Does that mean it’s always a good idea? We would argue that it isn’t. Proximity to the mothership — and the difficulty that CVCs might have integrating into the venture space — might cause CVCs to succumb to plodding corporate bureaucracy and routine. Deborah Hopkins, former head of Citi Ventures, told us that the decision to locate Citi’s CVC arm in the San Francisco Bay area, far from Citi’s headquarters, was a major contributor to its success.

Thirty-five percent of CVCs in the U.S. are located in California, but only 23% of their parent companies are. Outside the U.S., 32% of CVCs have set up shop in a different country than their parent has. If your objective is to leverage external innovation, especially outside your core, your CVC unit is likeliest to thrive where your industry’s innovators are building the future.

Of all the key lessons we have learned studying and working with CVC leaders and their bosses, one stood out: Innovation, especially in today’s disruptive world, requires a different approach than most have been taking. Smart VCs have been using what we call the venture mindset to survive and succeed. But disruptive innovation knows no borders and should not be limited to VC funds and VC-backed companies. Modern business leaders should strive to acquire this venture mindset no matter their industry or geography. Its power in making CVCs effective is just one successful application.