Deal Syndication in Corporate Venture Capital: The Big Idea
Corporations that choose to invest in startups through corporate venture capital programs often partner – or syndicate – with other investors. Only 1 in 5 corporations with dedicated CVC programs go it alone at all times. Reasons for syndication are many. Classic rationales mentioned by venture capitalists include risk sharing, risk reduction, access to deal flow, and the so-called window dressing or the desire to be associated with a successful investment, which may be important for public corporations. Other reasons, specific to corporate venture capital, have to do with the benefits of ‘virtual agglomeration,’ explains Entrepreneurship Sergey Anokhin from Kent State University. They include knowledge spillover among fellow-investors, access to individuals capable of running VC programs for corporations, and, perhaps most importantly, access to the pool of technologies that are of strategic interest to the corporation. It is thus hardly surprising that over 80% of corporate investors syndicate at least some of their deals with other incumbents.
Syndication and the Information Exchange Paradox
CVC syndicates, says Professor Anokhin, function as forums for idea exchange. Of course, learning from ventures that the incumbents support is expected. Most corporations that pursue strategic benefits when supporting new ventures explicitly go after the ‘window on technology.’ This is very consistent with the open innovation philosophy that many incumbents have come to embrace over the past two decades. But what is often ignored is perhaps equally important: Not only do corporate investors learn from the new ventures they support but also they get to observe and learn from their fellow-investors. When many incumbents are involved in a particular new venture, opportunities for learning are abundant. For instance, PacketVideo Corporation was supported by at least ten incumbents, including Comverse Technology, Sun Microsystems, Reuters, Motorola, Sony, Intel Corporation, Kyocera, Philips, Qualcomm, and Texas Instruments. It is easy to see that the ability to interact with these incumbents’ representatives can be extremely valuable not only for the new venture itself but for corporate investors as well. This is the main reason why CVC investors may be eager to ensure that the information exchange among all the parties involved is as open as possible.
Yet, it is precisely this same openness, warns Dr. Anokhin, that could also be problematic. Not only do corporations learn from their investees and from fellow investors, but they also can see their own know-how misappropriated by other investors. In other words, information exchange should be both open, to ensure that corporations learn from the new ventures and other incumbents, and closed at the same time, to make sure that valuable information does not leak to competitors. This is known as the Information Exchange Paradox of Corporate Venture Capital.
Four CVC Strategies
With sizeable investment portfolios and many other corporations involved in working with the new ventures, incumbents may lose more than they gain in the process of pursuing technological possibilities. Accordingly, CVC managers must strike a careful balance in terms of the number of new ventures they support and fellow investors they work with. They need to choose from one of the four strategies available. Some, like Applied Materials, may try to invest in just a few ventures and position themselves far away from the center of a dense syndication network hoping to learn as much as possible from those ventures they fund while not losing any valuable insights to fellow investors. This strategy is known as the minimalist strategy. Others, like Lucent Technologies, try to get into as many deals as possible and embed themselves right into the center of the syndication network, pursuing the maximalist strategy. It is also possible to target a central position in the network while investing in as few corporations as possible, primarily joining the deals that many other incumbents support. This strategy is called minimizing centralist, and is favored by companies like Kyocera. Finally, corporate investors may choose to support many startups but syndicate as little as possible. Novartis follows this strategy, known as maximizing isolationist. Each of these four strategies has its proponents among CVC investors, yet the relative effectiveness of each of these strategies is a big question.
Relative Effectiveness of the Four Strategies
To study the relative effectiveness of these strategies, the research group led by Professor Sergey Anokhin has looked at strategies and innovative outcomes of 163 corporate investors active on the CVC market over a number of years. One of these strategies turns out to be particularly effective when it comes to increasing the incumbent’s innovativeness. Corporations that adopt the maximizing isolationist strategy and invest in many startups while staying away from the center of the syndication network demonstrate the highest patenting activity as a result. The second best, interestingly, is its exact opposite, the minimizing centralist strategy – investing in just a few startups but strategically occupying the center of the syndication network. The remaining two strategies are relatively ineffective. In the case of minimalists, incumbents learn relatively little from those few investees they support. Maximalists, on the other hand, seem to lose more than they gain by having to manage many investees and many fellow investors, and do not see the desired outcome of their investments on innovativeness.
Finally, all the action happens in the industries characterized by high concentration, or the industries dominated by several powerful players. For industries that are highly fragmented and entrepreneurial, CVC investments or syndication do not exert much impact on the ability of incumbents to learn from their investees or fellow investors. This is because such industries rely on other mechanisms for idea exchange, explains Dr. Anokhin, and specialized platforms like CVC programs cannot do much to improve the less formal mechanisms common for the entrepreneurial environments.
What it all Means
The most important implication of this study, says Sergey Anokhin, is that corporations should plan their CVC activities strategically, and choose from the two strategies that clearly outperform others. Maximizing isolationists and minimizing centralists learn the most from their engagement in VC investments, at least as evidenced by their patenting rates. The minimalist strategy may be seen as a first step towards mastering the art of CVC investment, while the maximalist strategy is unlikely to be of much use to corporations that aim at improving own innovativeness and is perhaps best suited for incumbents seeking other strategic – or purely financial – benefits from their CVC programs.