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

0

5

10

15

20

25

1961-62 1965-66 1969-70 1973-74 1977-78 1981-82 1985-86 1989-90 1993-94 1997-98

The First WaveMany 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 DeclineDramatic 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 WaveDramatic 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 PatternDecline 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 WaveHigh 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 WavesCyclical 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 ObjectivesMany 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 ObjectivesTraditional 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 StructuresCorporate 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 didn’t.

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 IncentivesCorporations 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.

DataVentureOne

32,364 investments. Information:

Amount. Location. Stage. Investors.

CVC. Independent VC.

Top CVC Groups in 2000 Corporate Sponsor Capital Under

Management Electronic Data Systems $1,500 General Electric 1,500 Andersen Consulting 1,000 Comdisco 500 Time Warner 500 Times Mirror 500 Visa International 500 Intel Corporation 450 AT&T 348 Hikari Tsushin 332 News Corporation 300 ValueVision International 300 Comcast 250 PECO Energy 225 Siemens 210

CVC Activity Year Number of Rounds Dollar Volume of Rounds 1983 53 1984 91 1985 139 1986 129 1987 152 1988 179 1989 202 1990 233 1991 249 1992 214 1993 198 1994 193 1995 65 193 1996 101 369 1997 229 708 1998 391 1,449 1999 936 7,968

Fraction of VC that is CVC

4%

5%

6%

7%

8%

9%

10%

11%

12%

1987 1988 1989 1990 1991 1992 1993 1994

Year

Per

cen

t of

In

vest

men

ts

CVC vs. Independent VC Entire Corporate Corporate VC and Independent

Sample VC Only Strategic Fit VC Only Status at Time of Investment: Start-Up 9.8% 7.1% 6.4% 10.4% Development 30.5 33.6 35.9 31.2 Beta 4.1 5.5 6.4 4.1 Shipping 45.5 44.4 42.9 44.8 Profitable 7.6 6.9 5.6 7.3 Re-Start 2.4 2.5 2.8 2.3 Location of Firm: All Western U.S. 59.7% 63.7% 59.6% 60.8% California 51.6 53.7 51.3 52.7 All Eastern U.S. 24.1 25.2 29.1 23.4 Massachusetts 12.8 14.0 16.5 12.6 Industry of Firm: Medical 25.5% 25.9% 24.2% 24.2% Computer Hardware 16.7 17.0 16.2 16.8 Communications 14.5 14.2 22.1 15.5 Computer Software/On-Line Services 15.1 15.1 14.0 16.2 Other 28.1 27.9 23.5 27.3

CVC vs. Independent VC

Entire Corporate Corporate VC and Independent

Sample VC Only Strategic Fit VC Only Round of Investment: Mean 2.4 2.8 2.9 2.4 Median 2 3 3 2 Age of Firm at Time of Investment: Mean 3.9 4.0 4.2 3.8 Median 3.0 3.3 3.4 2.8 Amount Invested in Venture Round: Mean 6.1 6.2 6.0 5.7 Median 4.3 4.5 4.7 4.2

Fraction of CVC in Related Industries

62%

64%

66%

68%

70%

72%

74%

76%

78%

1987 1988 1989 1990 1991 1992 1993 1994

Year

Fra

ctio

n of

Cor

pora

te V

C I

nves

tmen

ts in

R

elat

ed I

ndus

try

t

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

Was the Corporate Investment In

A Related Industry?

Age of Firm at Time of Financing 0.0105 [1.16] 0.0116 [1.28] Time Trend 0.0351 [2.38] 0.0358 [2.42] Firm is in Development Stage? 0.524 [2.96] 0.506 [2.86] Firm is in Beta Stage? 0.697 [3.02] 0.6860 [2.97] Firm is in Shipping Stage? 0.184 [1.02] 0.179 [0.99] Firm is in Profitable Stage? -0.180 [-0.72] -0.176 [-0.70] Firm is in Re-Start Stage? 0.456 [1.54] 0.463 [1.56] Firm Based in California? 0.098 [1.05] Firm Based in Massachusetts? 0.362 [2.92] Log Likelihood -2878.1 -2880.8 2-statistic 67.71 70.01 p-Value 0.000 0.000 Number of Observations 2,032 2,032

Success of CVC vs. Independent VCNotion 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

Entire Corporate Independent Corporate VC and

Sample VC Only VC Only Strategic Fit Status at End of Analysis: Initial Public Offering Completed 31.1% 35.1% 30.6% 39.3% Registration Statement Filed 0.7 0.2 0.7 0.3 Acquired 29.0 29.0 30.3 27.5 Still Privately Held 20.6 21.1 19.7 18.3 Liquidated 18.7 14.6 18.7 14.7

Determinants of CVC SuccessAre CVC investments less successful?

CVC vs. independent VC.What determines success?

Relatedness. Stage.

CVC, Relatedness, and Success

Observations are Investments Did Firm Go Public? Did Firm Go Public, Register,

Or Have Favorable Acquisition? Age of Firm at Time of Financing -0.02 [5.52] -0.02 [0.50] -0.02 [6.17] -0.02 [6.13] Round Number 0.13 [11.39] 0.13 [11.18] 0.13 [11.48] 0.13 [11.29] Corporate Venture Investment? 0.15 [2.54] -0.19 [1.31] 0.12 [2.15] -0.23 [1.64] Independent Venture Investment? -0.003 [0.09] -0.002 [0.07] 0.07 [2.54] 0.07 [2.56] Corporate Investment and Strategic Fit? 0.52 [3.15] 0.57 [3.55] Firm Based in California? 0.30 [9.29] 0.29 [8.96] 0.23 [7.44] 0.22 [6.98] Firm Based in Massachusetts? 0.36 [7.83] 0.36 [7.75] 0.24 [5.26] 0.23 [5.04] Firm is in Development Stage? 0.44 [7.73] 0.42 [7.27] 0.38 [6.99] 0.35 [6.41] Firm is in Beta Stage? 0.25 [2.83] 0.22 [2.50] 0.14 [1.60] 0.11 [1.24] Firm is in Shipping Stage? 0.38 [6.28] 0.36 [5.95] 0.30 [5.20] 0.28 [4.82] Firm is in Profitable Stage? 1.32 [17.08] 1.30 [16.61] 1.10 [14.77] 1.08 [14.27] Firm is in Re-Start Stage? -0.56 [4.20] -0.56 [4.19] -0.43 [3.64] -0.45 [3.71] Log Likelihood -14743.6 -14252.0 -15477.4 -14973.7 2-statistic 2409.9 2362.4 2065.5 2025.7 p-Value 0.000 0.000 0.000 0.000 Number of Observations 24,515 23,740 24,515 23,740

ConclusionsCVC 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.