Corporations and the Financing of Innovation: The Corporate Venturing Experience Paul A. Gompers Harvard Business School May 3, 2002

Agenda Corporations and venture capital: The History. Key lessons. Results. The continuing challenge.

Corporate Venture Capital Three waves of venture capital. Very volatile inflows. Most recent wave was particular strong. U.S. and foreign.

Lots of Earlier Exploration in Fortune 100

The First Wave Many VC-backed winners in 1960s: DEC, Raychem, Memorex, Scientific Data Systems, etc. Big firms sought to emulate. Most common mechanism was New Venture Division: >25% of Fortune 500.

Rapid Decline Dramatic growth in VC in early 1980s; much publicity around Apple, Genentech, Compaq, etc. Corporations again set up internal and external programs. By 1986, external corporate programs were 12% of VC pool.

The Second Wave Dramatic growth in VC in early 1980s; much publicity around Apple, Genentech, Compaq, etc. Corporations again set up internal and external programs. By 1986, external corporate programs were 12% of VC pool.

Similar Pattern Decline in public market values and activity in 1987; dramatic drop in VC fundraising. Almost 40% of corporate programs abandoned in 4 years. Corporate funds fell to 5% of venture pool by 1992

The Third Wave High returns to independent venture funds in mid-1990s. Opportunities and challenges posed by the Internet and other information technologies. Over 100 programs launched since 1996 alone.

Lessons from the First Two Waves Cyclical element: venture capital went into and out of fashion. But three key design problems limited the success of corporate programs. Multiple objectives. Unstable structure. Inadequate incentives.

Problem 1: Multiple Objectives Many programs sought to accomplish multiple objectives: Window on new technologies. Identifying acquisition candidates. Generating financial returns. Outsiders often saw these multiple goals as a sign of weakness.

Lesson 1: The Importance of Clearly Defined Objectives Traditional venture funds have a simple goal: to make profits. Corporate programs, by definition, have more complex objectives. Corporate venture programs must: Clearly define their goals in advance. Think about implications of the goals. Insure that all understand goals.

Problem 2: Poor Structures Corporate venture programs were often quickly abandoned as a result of: Failure to first understand VC. Top management turn-over and/or infighting. Resistance from R&D personnel and corporate lawyers.

Lesson 2: The Need for a Strong Foundation Finding the right partners was crucial. Venture funds have a formal legal structure, with a clearly understood mission; corporate programs often didnt. The apparent lack of permanence limited their ability to find investments or partners. A formal structure and a strong internal champion are important.

Problem 3: Inadequate Incentives Corporations were reluctant to commit to large payoffs to their venture mangers and internal entrepreneurs. Successful risk-taking was often scarcely rewarded; while failure was Heavily punished. Recruitment and retention were frequent concerns.

Lesson 3: The Importance of Aligning Incentives A powerful aspect of the venture capital model is that when an investment is successful, everyone is successful. Corporations were often limited in designing compensation by worries about fairness. Corporate programs must define in advance clear rules that govern the compensation of its venture investors.

Data VentureOne 32,364 investments. Information: Amount. Location. Stage. Investors. CVC. Independent VC.

Top CVC Groups in 2000

CVC Activity

Fraction of VC that is CVC

CVC vs. Independent VC

Fraction of CVC in Related Industries

What determines relatedness? Control for: Stage. Location. Firm age. Time trend. Increasing relatedness over time. Early stage is more related.

Fraction of CVC in Related Industries

Success of CVC vs. Independent VC Notion that CVC is less successful that independent VC firms. Independent VCs take advantage of corporations by showing them only the bad deals. Is that true? Look at success as defined by IPO or acquisition as a fraction of investments.

CVC vs. Independent VC

Determinants of CVC Success Are CVC investments less successful? CVC vs. independent VC. What determines success? Relatedness. Stage.

CVC, Relatedness, and Success

Conclusions CVC is an important element of financing new firms. Corporate venture capital groups seem to be learning over time. CVC investments appear to be quite successful. Especially those in related industries.

Four Key Recommendations Think about related investments. Corporations must be sensitive to legacy of mistrust by independent VCs. Need to carefully articulate structure. Building a strong structure and addressing incentive issues are key.