Corporations are increasingly investing in new ventures that might provide some competitive advantage. But is corporate venture capital always a sound investment? And should entrepreneurs always accept advances from corporate suitors?
It depends on the circumstances, according to a new study by Kevin Steensma, a professor of management at the University of Washington Foster School of Business, and Haemin Dennis Park, an assistant professor of entrepreneurship and innovation at the University of Missouri-Kansas City.
Their examination of early-stage computer, semiconductor and wireless firms demonstrates that corporate venture capital funding is particularly beneficial to new ventures when they operate in uncertain environments or require specialized complementary assets—expertise and infrastructure in product development, manufacturing, law, sales, distribution and customer service.
“There are always strings attached,” Steensma says. “Where a new venture accesses its capital has a significant bearing on its chance of success.”
The company you keep
In securing capital, entrepreneurs have more options than ever. Though independent firms hold the lion’s share of the $30 billion venture capital industry, last year corporate venture capital had a hand in 20 percent of all investment deals. And that number is rising.
Established firms deploy venture capital units to enhance their long-term strategic interests. They might be out to identify and develop complementary technologies, to expand their markets, to stimulate demand for their products or to lay the groundwork for a potential acquisition.
The relationship is a tradeoff. The recipient entrepreneurial venture gets cash and—often more importantly—access to the investing company’s vast resources in commercialization, manufacturing and marketing.
But handing over a minority share of equity means that the new venture must navigate its investor’s corporate interests, which may conflict with its own. It can also close doors to other resources that might otherwise be procured from the investor’s competitors. Lastly, corporate venture capital units may lack the expertise and autonomy to oversee new ventures as effectively as independent VC firms can.
To identify the conditions under which corporate venture capital investment makes sense, Steensma and Park examined 508 early-stage ventures in the computer, semiconductor and wireless industries that received VC funding between 1990 and 2003.
They found that corporate investment increases the chance of success for new ventures that operate in volatile, unpredictable industries—such as wireless. However, in more stable, mature industries—such as computer hardware—corporate venture capital can inhibit new ventures.
When new ventures require specialized—rather than generic—complementary assets, the benefits of corporate investment were found to outweigh the ability the access the open market.
“Corporate investors often have a large amount of resources and will customize those resources because they have a stake in the new venture,” says Steensma. “With an arm’s-length partner, providers of manufacturing and marketing are less willing to customize for you, especially in volatile environments.”
A related study by Steensma and Park demonstrates that corporations tend to invest in new ventures that are more innovative, and that new ventures that receive corporate venture capital tend to remain more innovative than those that receive only independent venture capital.
Corporate investors possess both the complementary resources and the motivation to nurture their investees to continue innovating, Steensma explains.
This isn’t always a good thing. Pressure on a new venture to innovate can come at the expense of profitability or strategic growth.
“A new venture has limited resources,” Steensma adds. “When you accept capital from a corporate investor, they may use their influence to encourage you to continue innovating—for better or worse.”
Both studies indicate that entrepreneurs should carefully weigh the consequences of the capital they accept. “Start-ups want to make sure that their strategic investments don’t crowd out their short- and long-term strategy,” Steensma says.
“When does corporate venture capital add value for new ventures?” is published in the January 2012 Strategic Management Journal.