Setting up a corporate venture capital fund (“CVC”) can be one of the most efficient and effective ways to attract external innovation to a large enterprise. Done wrong, it can also be a colossal waste of money, brains, and time.

Unfortunately, it is typically done wrong.

Returns data for CVCs is notoriously difficult to compile, but according to unpublished data by Correlation Ventures, which includes data from DowJones VentureSource as well as other primary and secondary sources, dollar-weighted (by round size), realized, cash-on-cash multiples for all U.S. venture financings in companies exiting (viz., out-of-business, acquired, or IPO) from 2008 through 2017, were 2.2X for all financings, as compared to 1.8X for all financing with at least one corporate VC participating.

The difference in returns gets less pronounced the later the stage but persists across all stages. In other words, the earlier the round, the worse CVC investments do relative to deals with no CVC.

While financial data is hard to get, innovation sourcing efficacy is effectively impossible to measure. That said, anecdotal data points to higher staffing turnover and higher than normal fund closure rates for CVCs as compared to traditional VC, all of which imply that the parent corporation is not satisfied with the CVC as a vehicle for sourcing innovation either.

So while a CVC should, in theory, be a fast, cost effective, way to access cutting edge innovation, all too often they move slowly, make mediocre investments, and miss out on the hottest deals.

The reasons for this fall under two general categories. Let's break down what goes wrong... and how to do it right.

Failure to function effectively as a VC fund

  • Inability to attract high quality venture professionals due to inadequate incentives
  • Corporate executives improperly involved in the process
  • Investment funds incorrectly allocated

Failure to integrate effectively with the corporate parent

  • Target startup investment stage not matched to corporate capabilities
  • Allocation strategy suboptimal
  • Startup sourcing strategy fails to play to parent corporate’s strength
  • Engaging the corporate organization at the wrong time
  • Passively assuming that innovation will be received by the corporate parent

Failure to function effectively as a VC fund

  • Inability to attract high quality venture professionals due to inadequate incentives

The rap on CVCs is that they are for people on the way up or the way down. The newly hired general partner is either an up-and-coming star looking for a good platform before raising his or her own fund or someone with a failed fund who is looking for a soft landing. While an overgeneralization, there is a kernel of truth: why would anyone who could raise their own fund put up with corporate politics?

So how can a corporate snag a rising star versus a falling one? It can start by replicating traditional venture fund economics so the best talent doesn’t opt out. When JLL set up their $100M CVC fund JLL Spark, they were careful to set it up as an independent fund, giving the general partners the same kind of carried interest they would get if they were running their own fund.

Farsighted corporations think even further ahead: If the first CVC fund does well, the general partners will want to raise a second, likely larger fund, and will naturally be tempted to go out on their own. A savvy corporate will not only expect this but will encourage it by being the lead investor in the second fund while allowing the general partners to bring in outside money to make the fund even bigger. As long as the money doesn’t come from a direct competitor – unlikely in any event – the corporate sponsor should be thrilled: they get more firepower for the same investment on their part.

In addition to structuring Toyota AI Ventures as a standard “2-and-20” VC fund with Toyota Research Institute as the sole LP, Toyota has structured this fund as a template that other Toyota business units can use, either solely or with outside LPs, for their own CVC funds.

This story appears as it was originally published on our sister site, www.hiveforhousing.com.

Stay tuned for part 2.

Acknowledgments: I’d like to thank David Coats (Correlation Ventures), David Gerster (JLL Spark), Blake Luse (Ferguson Ventures), David Teten (HOF Capital), Linda Isaacson (First American Title), Jill Ford (Toyota AI Ventures) (Stacey Wallin (BD Tech), Ameet Amin (Colliers) and everyone else who contributed their thoughts to this article.