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One lesson I learned early in my road down the path to becoming an early-stage investor was how corporate venture capital works. It doesn’t work like regular venture firms.
Remember, the first job of the corporate management team is to earn returns for shareholders. Despite what you might hear from elite corporate groups about “responsibility to society”, the only reason for a corporation to exist is to build stuff its customers want and create retained earnings that flow back to investors.
When times are good, corporations get the venture bug.
They create corporate venture thinking they can make investments in startups to take the DNA of that startup and inject it back into the corporate culture. It doesn’t work. Even when a corporation pursues a strategy of buying other companies, or buying a controlling stake in other companies with the idea of changing its own culture, it doesn’t work. GE is one case and point but in the academic study I linked to they found that “Controlling for other effects, employees from the acquirer fare better than employees from the acquired firm, suggesting that they have greater power in the newly merged hierarchy. As a separate effect, the more that either firm dominates the other in terms of number of employees, the better do its employees fare compared to employees from the other firm.”
If you work for a firm that gets acquired by a bigger firm, you are more likely to lose your job than keep it. Keep that in mind as Albertson’s and Kroger try to merge.
Lo and behold, in today’s Term Sheet the economic downturn is causing corporate ventures to clip their wings. They write:
We’ve seen this before. To refresh your memory, corporates lost billions on their venture investments during the Dot Com Bubble and started pulling back significantly from the venture space. Microsoft, for instance, had $5.7 billion disappear off its balance sheet during the first nine months of 2001 due to investment writedowns.
That being said, the corporate pullback isn’t all that bad this time around, comparatively speaking. Corporates invested $40.5 billion into startups around the globe in the three months ending in September, according to KPMG, down from $59 billion the quarter prior and down from nearly $100 billion in the third quarter of 2021. But certain sectors, in particular, are still attracting corporate interest.
We are only at the beginning of the cycle.
If you are an entrepreneur and a corporate vc wants in on your deal, you need to ask some questions.
How committed is the company to venture?
What will potential customers think about if they know a corporate VC is on your capitalization table?
What will potential acquirers think if corporate VC is on your cap table? It might eliminate some options.
Will “regular” VC firms avoid investing with a corporate VC on the cap table?
Way back in 2010, I met with CME about doing a corporate VC arm. I said they should lead investments at seed in companies that would help create an ecosystem around their core business. Some of those companies would grow and could be acquired and integrated into the corporate business. Some would exist as service providers and make some processes of the company more efficient.
Instead, they created a bureaucratic corporate VC arm and had no real strategy or people with hard-core personal investing experience. When it didn’t yield good returns, they killed it.
That story repeats over and over in corporate venture.
There is a big difference between corporate merger and acquisition activity and corporate venture. I think M+A might pick up if companies have cash on the balance sheet. However, if the storm gets bad enough they might just go into a shell and do all they can to insulate themselves. The first step is cutting employees which continues to happen quietly in all kinds of companies in every business sector. No reason to be bullish on the stock market in general but valuations in private markets aren’t immune from a 30% drop in the stock market. The increase in interest rates will change internal hurdle rates corporates use to decide whether to build new capacity for production or expansion. The hostile regulatory environment that the Biden Administration has instituted also is a headwind. If you don’t believe me on the nature of the environment, I’d point to SEC commish Gary Gensler.
At the same time, when you have economic downturns it is time to start sniffing around to see if any new innovative companies are being built. Not having a job and. not being able to feed yourself is a pretty good incentive to build something useful people might want.
We aren’t at that point in the cycle as we still are on the ride down the hill.
Corporations are funny because they cut back on marketing spend in downturns, and they cut back on venture capital if they had it. However, big downturns are exactly the time to rethink what they were doing when it comes to marketing and refocus their spending, perhaps allocating more. It’s also a good time to engage in a venture capital operation if they set it up the right way.