CHAPTER

14

INVESTING IN STARTUPS

Many organizations are encouraged to invest in startups to learn about emerging trends, to help them become more innovative, and to share in the gains when the startups are sold or go public. The outcome of these partnerships, however, is often disappointing. Established companies fail to learn much from startups, and startups fail to improve their odds of success by working with established companies. To effectively harness synergies between established companies and new ventures, our research suggests that organizations should design appropriate structures and incentives to enhance their corporate investment mechanisms and facilitate knowledge and access between both parties.¹

WHY IT MATTERS

Increasingly, companies are turning to networks of external partners to accelerate their efforts to innovate and compete. One key group of digital innovation partners is startups,² which are often perceived as innovating closer to the customer and working in entrepreneurial and agile ways. Indeed, many organizations have established startup incubators, accelerators, and/or corporate venture capital (CVC) units to benefit tactically and financially from startups’ knowledge and capabilities.³

However, previous studies have identified long lists of shortcomings with such collaborations, and recent research reveals that collaborations between startups and established companies are tenuous: 45 percent of established companies and 55 percent of startups are either “dissatisfied” or “somewhat dissatisfied” with their partnership.⁴

Clearly, there is a large opportunity for both established companies and startups to gain from partnering, but getting it to work for the benefit of both is not easy.

BEST PRACTICES AND KEY INSIGHTS

We recommend three concrete steps to gain the most value from investing in startups.

Establish Structures Built on VC Practices

First, set up a separate structure to work with startups. Most corporations already have departments that evaluate new investment opportunities, such as merger and acquisition (MSA) teams, innovation units, and business plan competitions. It’s tempting to integrate startups into these entities. But working with startups is substantially different from other corporate partnering or investment activities.

We recommend establishing a unit built on venture capital industry best practices. These include hiring VC professionals who understand how to successfully navigate the VC ecosystem. Hiring at least one experienced venture capitalist has been correlated with ongoing CVC unit success.⁵ These professionals bring deep practice knowledge of structuring venture deals, as well as an established network to source promising deals.

Take the case of South Korean electronics manufacturer Samsung, which formed Samsung NEXT as a software and services innovation subsidiary. As a hardware manufacturer, Samsung was keen to quickly improve (and integrate) software and services. To achieve this, NEXT was staffed with venture capital, MSA, industry experts, and other professionals to immediately create and scale breakthrough software and services. Leveraging its $150 million venture capital investment fund, Samsung NEXT aimed to support early-stage startups with pre-seed to Series B investments.⁶

Once an established company chooses to invest in a startup, we recommend that it not request strategic rights as part of the funding arrangement. These rights may prevent startups from reaching fair market value when they are sold. In addition, call options, the right to match an acquisition offer, etc., can scare off potential acquirers, which risk losing the acquisition to the CVC-sponsoring organization. Asking for strategic rights may also steer the most promising startups away from CVC deals. Founders and existing investors may worry that the exit price will be compromised.

Incentivize Collaborations with Startups

Second, startups typically expect to gain nonfinancial benefits from the partnership, such as access to corporate knowledge and resources and exposure to potential customers. In reality, these benefits tend to be overstated, since there is little to no incentive for corporate employees to collaborate with the startups.

The solution? Top management should make cooperation a fundamental part of corporate culture by actively encouraging employees to collaborate with startups—and by doing so themselves. This helps to demonstrate commitment and relevance. Moreover, companies should adopt corporate incentive systems that will help match employees (with relevant skills and knowledge) with the startups. These incentive systems may include participation in compensation schemes paid to the investment team. Temporary secondments of corporate employees to startups, and vice versa, also help to increase understanding and collaboration. We also recommend establishing internal bridge roles or linked teams composed of employees acting as intermediaries between the startups and relevant corporate entities.

GV (formerly Google Ventures) and Germany’s Metro Group are good examples of CVC units committed to creating value for their portfolio companies. GV has dedicated teams that make sure its portfolio companies interface with Google technology and talent. Metro Group grants portfolio companies preferential access to its international store network and its customer base of independent hospitality businesses.⁸

Facilitate Knowledge Sharing and Communication

Third, poor communication is often the chief cause of failed partnerships between startups and established companies. Thus clear and effective communication protocols should be established, so that the right people in the corporation gain necessary insights about new industry trends, opportunities, and threats. For example, by involving the CVC unit in corporate strategy discussions, innovation activities, and digitization committees, companies can foster the transfer of insights from startups to the relevant corporate stakeholders.

It is also important to create clear processes around IP ownership rights. If startups worry that the corporate partner will steal their best ideas or technology, they will not collaborate fully. At the same time, complex processes involving the sponsoring company’s legal department might scare away startups. The best approach is to establish simple rules regarding IP rights—rules that are clear to all parties from the start.

It can also be helpful for startups to provide regular information updates, new technology seminars, and meet-and-greets to expose their ideas and insights to as many corporate employees as possible. Through regular and continual contact between corporate employees and startups, a culture of sharing and learning, beneficial to both sides, can be established. We suggest that corporations define clear processes and structures that allow CVC units to capture and share insights gathered from their work with startups.

Such processes can be fostered through close links between the customer-facing part of the established company and the startup. The Metro Group developed a process that catalogs both internal and customer pain points and then links them to startups in its CVC ecosystem that offer relevant solutions. The company also holds regular meetings to explore how these startups can work with the company and its customers to resolve problems.⁹

Another example of cooperation is the way Airbus set up the UP42 ecosystem with the help of BCG Digital Ventures in 2018. Designed to help develop the growing geospatial solutions market, the platform offers access to earth observation and terrestrial data, provides data processing algorithms, and gives developers the infrastructure they need to run their code. UP42 benefits greatly from the “unfair advantage” that Airbus grants it—specifically, access to high-quality satellite images and tremendous domain experience built over decades. It complements these key assets with external data and analytics to provide a comprehensive environment for geospatial solutions.¹⁰

• • •

In theory, partnering with startups provides a win-win for both sides. Startups gain access to capital, valuable corporate resources, industry know-how, advice, and, perhaps most important, contacts and sales leads. For corporations, benefits include the possibility of above-average financial returns connected with any venture capital investment, along with strategic benefits such as access to new technologies or insights that may otherwise be unavailable. However, none of these benefits are likely to accrue unless the established company and the startup actively invest time, energy, and resources into the partnership.

Hacker’s Toolbox

Clarify which type of CVC you are setting up. If you are setting up a CVC to work with digital startups, then make a very clear decision up front whether you are creating a financially driven CVC, a strategically driven CVC, or some combination of both. Your structure, processes, and targets will be quite different depending on your answer. Try to avoid what Scott Orn and Bill Growney describe in a TechCrunch article as tourist CVCs,¹¹ or ones that reflect a desire to be part of the CVC game without a clear set of objectives in mind. CVCs driven primarily by financial considerations act very much like traditional VCs—their main objective is to return capital back to the parent. Strategic CVCs care a lot more about finding new sources of business value and getting access to complementary resources and technologies. In either case, it is a good idea to hire VC insiders, who understand the nuances of this very idiosyncratic area of finance, then give them a great deal of autonomy to run it in the most appropriate manner.

Provide incentives for employees to work with startups. Incentivize key people in the organization to share in the success of the startup. People are busy, and without a clear reason to work with startups, most people will not do so, or do so superficially. These incentives may go as far as to include a share in the exit price of the startup, similar to the incentives given to the CVC team.

Don’t be greedy. Insisting on being able to match any acquisition offer, insisting on having a first right of refusal, or insisting on sharing sensitive information can scare off startups with the best growth potential. For this reason, compared with traditional VCs, CVCs often end up working with second-tier companies.¹² If you insist on including these terms in contracts with startups, make sure that the potential outcomes are appealing enough—that is, that you offer other compensating benefits such as access to key knowledge or technologies—to attract the best companies.

RELATED CHAPTERS

Managing Partnerships and Ecosystems (Chapter 13)

Implementing Open Innovation Effectively (Chapter 15)

Staying on Top of New Technologies (Chapter 29)