Structuring a Corporate Venture Capital Organization (V) — Invest on Market Terms
By Dr. Patrick Flesner and Dr. Stephan Bank
Many executives that want to initiate corporate venturing activities already struggle answering the question how to set-up a CVC organization for success. The six guiding principles described in this series of articles are supposed to help answer this question.
Guiding Principle 1: Create a Traditional Venture Capital Fund Structure
Guiding Principle 2: Define a Clear Investment Focus
Guiding Principle 3: Embrace Fast Decision-Making
Guiding Principle 4: Ensure Long-term Commitment
Guiding Principle 5: Invest on Market Terms
CVC units are usually set-up in order to generate strategic value for the given corporation and — given these strategic goals — it seems that CVCs are sometimes willing to pay more for a stake in a company than traditional VCs are willing to pay. Although the median pre-money valuation of late-stage deals with CVC involvement has consistently been higher than VC deals without a corporate investor, the gap has widened even further in 2019 (see Pitchbook Chart below).
The problem with investing on above-industry-standard valuations is that traditional venture capital investors who also want to invest are often kicked out of the investment process since they cannot invest on comparable terms without giving up the chance to make the required return on investment. If the respective CVC unit becomes known as an investor willing to “overpay”, other venture capital funds may avoid sharing deal flow and co-investing with this CVC unit, which will have a material negative impact on the CVC unit, at least in the long run.
Above-industry valuations may also backfire on startups when they need to raise funds again but cannot find external investors willing to invest on an even higher company valuation.
Last but not least, paying a high price naturally reduces the return potential. And if a CVC unit fails to also generate attractive financial returns it may lose its internal right to play and may be shut down sooner than later.
We therefore believe that the long-term CVC success chances are better if a CVC unit acts like traditional VCs and invests on market terms.
