Corporate VC Performance: (my rebuttal to a Wharton academic)

I read this article today titled "Want to Crank Up Corporate Venture Capital Performance? Consider Matching Independent VC Pay Packages" that was published in the Knowledge at Wharton. I'm always in favor of being paid more, but I wanted to comment on this article because it has so many fallacies that it was worth mentioning.

Here one: The article states that "Independent VCs take big risks and, when they bet right, they reap big rewards. Google, eBay and Amazon all started with venture backing. Independent VCs also receive a big piece of the profits that they generate for their investors. Because of this argument, Corporate VCs should take big risks to improve returns."

This is based on an incorrect assumption that corporate VCs exist to provide big returns. Corporate VCs are not in the business of taking big risks to get big returns. These VCs exist to push investments or accelerate the growth of markets or technologies in areas that may be of interest to the Corporation while providing a good return to the firm. So there is a mix of financial and strategic goals and one cannot be sacrificed for the other.

Corporations typically become interested in segments, products or areas that are no more than four or five years out, for these to be meaningful in terms of top or bottom-line impact. Beyond that, it becomes an R&D initiative that can be developed in-house. Big companies don't have the bandwidth or resources to tackle something that is rapidly approaching themselves. By investing in these spaces of interest, they create some sort of a hedge or place-holder for the corporation to be actively involved. While these investments are at arms-length and any deals struck between the corporation and the startup are commercial and stand on their own merit, these relationships can help the corporation learn about the space and get to know the players, and help grow the startup faster.

Due to this role and stage of investing, corporate VCs are unlikely to invest in paradigm-shifting companies that no one has contemplated yet (the risky ones that the author talks about). Corporate VCs need to be follow-on investors (or Series B-type investors) where the financial firms or "risky investors" have already committted capital and got the company going. These VC firms won't stay in business if they were'nt later stage. The money is not to swing for the fences so the partners get rich - its to put highly educated bets in industries, act as validators and catalysts and get to the end result faster - on sectors that are already being setup.

None of the Corporate VCs I have met are looking to invest in startups where the technology and market risk is not taken out. In fact I am increasingly finding it hard to find financial VCs willing to take market and technology risks (but that is another point). Corporate VC firms bring significant assistance in terms of technical and management know-how, access to channels and international market, potential to provide or accelerate development. This means that product has to be more developed - or even shipping, for them to act significant value to the startup in ways that no financial firm can do so.

There is the other odd argument from the author - pay VCs more and they'll take more risks. This is counter-intuitive because VC pay structures encourage asset gathering and payouts through management fees alone that are significantly attractive. If management fees were significantly reduced, VCs would have to become far riskier than they are today. Since a lot of risk-taking VC firms are barely returning the principle back - so the only way they're getting paid is through management fees, the incentive is not aligned with risk taking anymore. VCs don't want to lose these management fees, and are therefore taking less and less risk as a result. If the Professor talked to entrepreneurs who are on the frontlines every day, he'll find out - a lot of the "venture" has gone out of venture capital investing.

Corporate VC syndicates also tend to be larger because they come in when the need for capital is larger. This is simply a function of deal size. Later deals have more VCs plus the returning VCs in the syndicate.

A last point on personnel. Corporate VCs attract people from within the firm. While not everyone from within the business unit would make a good investor, these internal relations are critical. However, as long as these corporate VC firms balance themselves out by attracting outstanding people from the outside (at a reasonable compensation), they'll do as well, if not better than the financial VCs - who are unfortunately struggling with market conditions and a regulatory environment that is simply stacked against the industry.

Click here to read the article from Wharton...definitely needs a rebuttal