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ALFRED P. SLOAN SCHOOL OF MANAGEMENT

INITIATING SUCCESSFUL
CORPORATE VENTURE CAPITAL INVESTMENTS

IAN C. YATES and EDWARD B. ROBERTS

MIT SLOAN SCHOOL OF MANAGEMENT

June 1991

WP# 3308-91-BPS

vooACHUSETTS
iiNSiiiuTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS 02139

INITIATING SUCCESSFUL
CORPORATE VENTURE CAPITAL INVESTMENTS

IAN C. YATES and EDWARD B. ROBERTS

MIT SLOAN SCHOOL OF MANAGEMENT

June 1991 WP # 3308-91-BPS

MIT 'IBpil
MAR 3 01932-

INITIATING SUCCESSFUL CORPORATE VENTURE CAPITAL INVESTMENTS*

IAN C. YATES and EDWARD B. ROBERTS

Sloan School of Management
Massachusetts Institute of Technology

ABSTRACT

49 large U.S. corporations that make corporate venture capital (CVC) investments as part of their new
business development strategies were studied. Venture capital firms were found to be the key deal
source of the more successful CVCs. Market familiarity was found to be even more important than
technological familiarity in initiating strategically successful investments in small enterprises. Later
round investments performed better strategically than did early round financings. CVC financial
success flows from its strategic success, which in turn is influenced favorably by strategic focus.

EXECUTIVE SUMMARY

The strategies of 49 large U.S. corporations using corporate venture capital (CVC) for new
business development were studied and evaluated. Venture capital firms were found to be the key deal
source for CVCs making investments in small ventures that the CVCs judge to be successful
strategically. Successful CVCs frequently first invest in venture capital funds as a venture capital
limited partner, then take a more proactive long-run approach by investing side-by-side with private
venture capitalists directly in start-ups.

Corporate familiarity with the venture's market was found to be more important in determining
strategic success than familiarity with the venture's technology. CVCs must therefore evaluate the
venture's market as carefully as the venture's technology and seek to add value to ventures through

* Address all requests for information to Edward B. Roberts, David Samoff Professor of Management
of Technology, Sloan School of Management, Massachusetts Institute of Technology, 50 Memorial
Drive, Cambridge, MA 02139.

marketing.

Strategically successful CVCs make more investments in later rounds, foster supplementary
business relationships between their corporation and venture firms, and exercise less control over their
portfolio firms, as compared with less successful CVCs. The financial performance of CVC programs
was found to correlate positively with strategic success. CVC managers also report that strategic
success results from a focussed strategy.

INTRODUCTION

All companies committed to growth must develop new businesses. A firm's options include
developing new products for markets in which it already participates, taking existing products to new
markets, or delivering new products to markets it has not traditionally served.

Many funis have discovered the value of corporate venture capital (CVC) as an integral or
supplemental part of their strategic new business development program, making equity investments for
less than 100 percent ownership of new or young firms. Throughout the history of U.S. business,
corporate venturers have participated in some extremely successful start-ups, including DuPont's
backing of GM, Sears' minority ownership of Whirlpool, GE and AT&T's funding of RCA, Haloid's
(later becoming Xerox) financing of Carlson/Battelle (Rind, 1981), and, more recendy. Coming's
investment in Genentech, and Compaq's funding of Conner Peripherals.

These extremely successful corporate venture capital investments highlight the potential of CVC
as a strategic development tool; however, while CVC offers significant benefits, many corporations
have become frustrated with CVC and have discontinued their corporate venturing programs. The
complex processes that CVC entails and the sophistication required to execute them effectively has
caused many corporations to eliminate CVC programs. In addition, many corporations lack the
patience to give CVC programs the long time necessary to grow to a point where they develop
significant new businesses. Figure 1 schematically illustrates the various processes of CVC from
inception to execution. In approximate chronological order, the tasks of a strategic CVC program are
developing the venture program, initiating the investments, managing the investment portfolio, and
assimilating investments into the corporation's businesses. Each of these tasks must be executed
successfully for the corporation to derive significant strategic benefit from its CVC program.

The successes of one task influence the success criteria for another, complicating CVC program
execution further. For example, start-ups which do not meet the original CVC goals and focus may
still become desirable investments if they provide products or services used by a number of different
ponfolio firms and thus can foster synergies within a CVC's portfolio.

This research attempts to establish the critical strategies employed by successful corporate
venturers by analyzing the performance of CVC programs in a quantitative framework. Much of the

previous literature on corporate venturing provides anecdotal case studies of a specific firm's or
industry's experiences. Only a few prior studies exist that have attempted quantitatively to determine
the causes of success of CVC programs.

We first review the literature relevant to corporate venture capital, with particular focus on
previous attempts to identify factors critical to the success of CVC programs. The objectives and
methodology of our research are then presented. The results are analyzed and discussed next and finally
the findings are summarized.

CORPORATE VENTURE CAPITAL STRATEGIES: THE LITERATURE

CVC is primarily a new business development tool to help corporations in moving away from
markets and technologies with which they are famili;u-. (Robens and Berry, 1985) Further, CVC can
be used to supplement other new business development strategies, providing firms with a "window on
emerging technologies". (Roberts, 1980)

Because CVC is such a difficult new business development tool to use effectively, many articles
have been written to explore the processes involved in CVC. These articles are written by corporate
strategic planners, consultants, and private venture capitalists (VCs), all of whom have a different focus
when examining the performance of CVC programs. Many articles have even appeared in the
"popular" press, including Slutsker (1984), Biu-ns (1984), Posner (1984), Gibson (1986), White
(1989), Selz (1990), and Buderi (1990). This review summarizes some of the significant work relating
exclusively to CVC and reports factors that authors indicate are critical to the success of CVC
development efforts. Literature written by practitioners and consultants involved in CVC is presented
first, followed by the additional perspectives derived from academic research.
Practical Experience

In one of the earliest articles describing CVC for new business development, Peterson (1967)
discusses DuPont's corporate venturing activities. (See also Gee and Tyler, 1976.) At that time,
DuPont probably had had more experience in this type of new business development than any other
corporation. Peterson highlights the need for good investment opportunities. DuPont's "deal flow" is
reported to have come from four sources: central R&D, other R&D throughout the firm, universities,

government and other research-based agencies, and strategic planning and analysis of future needs.
DuPont's appraisal and selection process included answers to three critical questions: Is the potential
business large enough? Will its ROI be high enough? Will the proprietary position of the venture offset
its risk? These questions have market, financial, and technology dimensions, but lack any evaluation of
venture management capabilities, which violates the saying that "it's the jockey, not the horse, that is
important in winning the [venture] race" (see MacMillan et al., 1985). Other than the financial return
achieved in the long-run, Peterson claims that a corporation derives the additional benefits of fostering
an innovative culture in its own organization and developing management expertise.

Hardymon et al. (1983) criticize some of the oversimplifications of Peterson's article, arguing
that, whatever their other merits, CVC programs :u-e not a successful means of promoting
diversification, as Peterson implied. They say that CVC programs fail for at least four reasons. First,
corporations face a restricted universe of investment opportunities and often find themselves "left out"
of the venuire capital deal syndication network. In partial support Bygrave (1988) provides a detailed
study of the importance of "networking" in the venture capital community. Second, corporations using
CVC for new business development encounter problems acquiring companies from their portfolios,
sometimes called investment stalemate. Third, many corporations see"opaque" technology windows
and have difficulty transferring technology from their mall company portfoUo to their firms' core
businesses. Finally, Hardymon et al. assert that a conflict exists between running a focussed
diversification program and building a healthy venture capital portfolio, seeing this problem as
exacerbated when corporations base venture managers' compensation on the portfolio's financial
performance.

While DuPont was the largest CVC of the 1960s and before, Exxon was probably the largest in
the 1970s. A senior manager in Exxon Enterprises, Ben Sykes (1986) relates his views on the causes
of the rise and fall of Exxon's CVC program. According to Sykes, Exxon's experience shows that if
internal venturing is to work, it must be an important mainstream operation. Sykes reports from Exxon
data that the venture manager's technical experience is not related to start-up success, while his
management experience highly correlates with success. The three primary diversification strategies
Sykes advocates are: (1) acquire a large company in the target field; (2) start few R&D-oriented

ventures; and (3) use CVC investments primarily as "probes".

Winters and Murfin (1988) analyze Lubrizol's CVC program, drawing some general
conclusions about CVC. They state that the objective of most corporations is the strategic benefits
resulting from venture capital investing, such as acquisitions, technology licenses, product marketing
rights, international opportunities, and windows on technology. These objectives are frequendy mixed
with a financial return objective. They report that the most imponant factors for success of a corporate
program are the creation of a high-quality deal flow and the use of outstanding people to interface
between the corporation and the private VC world.

Winters and Murfin applaud the creation of a formal CVC subsidiary, like Lubrizol Enterprises,
as an effective way to achieve corporate strategic objectives. Even with a venturing subsidiary, the
corporation has assets of value to a venture such as "deep pockets", reputation, and marketing and
distribution capabilities. Lubrizol's subsidiary structure is seen as facilitating dealings with
entrepreneurs, acceptance by the private VC community, and better internal relations within Lubrizol
itself. The authors note numerous potential pitfalls encountered by CVC business developers. First,
corporations can have inadequate definition of strategic versus financial objectives. Second,
corporations tend to be arrogant, parricuhirly those corporations which have been successful at other
methods of business development. Third, corporations are slow to respond to prospective deals, which
they see too few of anyway. They observe that this lack of quality deal flow is worsened when firms
seek to make early stage investments in start-ups.

Private venture capitalists provide an additional perspective on the behavior of CVCs. These
VCs invest side-by-side with CVCs and often have CVCs as limited partners in their funds. In
addition, some of the VCs which have written articles also draw from prior career experiences as CVC
managers. Fast (1981) recommends that CVCs closely emulate the strategies of VCs, because he
argues that the financial performance of VCs is superior (see Weiss, 1981). He says CVCs should
invest first in VC funds, then, as they learn VC, take a more proactive role. Fast outlines a number of
factors which he believes can ensure the success of a CVC program. Like Winters and Murfin (1988),
Fast suggests that CVCs be organized as limited partnerships because this structure "forces" patience as
corporations cannot divest, investments are staged in a manner consistent with ventures's development

life-cycle, and an easy-to-implement incentive-based compensation system is provided. Further, Fast
asserts that CVCs should follow the same intervention and management guidelines as VCs, being
hands-off and big-picnjre oriented, avoiding "micromanagment", and planning for the venture's
financing needs.

Kenneth Rind, who worked as a corporate venture capitalist for Xerox before becoming a
private venture capitalist, has written extensively on CVC (Rind, 1981; Golden and Rind, 1984; Rind,
1989). Rind concludes that CVC is a useful tool for corporate development, but is difficult to do
internally; thus, outside partnership investment can serve as a useful alternative first step or as a
supplement. CVC is reportedly difficult because of a lack of appropriately skilled people, contradictory
rationales, legal problems between fiduciary responsibility and corporate opportunity, and inadequate
corporate time horizons. However, Rind (1989) does point out a number of advantages that accrue to
small firms which have a corporate investor such as: assistance in all corporate endeavors, credibility
with customers, banks, and others, relief from many specialized aspects of business (i.e., international
marketing), immediate income from R&D contracts, deep pockets through a more flexible, lower cost
financing package, and, finally, a potential merger partner. Ford and Ryan (1981) discuss some of the
benefits of having a corporate partner to aid in marketing efforts in greater detail.

Most recently Hegg (1990) revealed details of 3M's $75 million global CVC program, with
participations in 27 private venture capital limited partnerships (VCLPs). He reports both significant
financial returns and strong strategic linkage to 3M's business units, including acquisition of some of
the portfolio companies.
Academic Studies

Because CVC has been used as a significant new business development tool for several
decades, significant academic research has been devoted to addressing various aspects of CVC. One of
the largest programs of this research has been carried out at the Snider Entrepreneurial Center of the
Wharton School by MacMillan, Siegel, and co-workers (MacMillan et al., 1985; MacMillan et al.,
1987; DeSarbo et al., 1987; Siegel et al., 1988). These works emphasize the importance of corporate
venture managers in determining the success of a given CVC program. These key managers must be
high-quality, well-compensated, and should be given the flexibility to operate independently, possibly

being established in a group separate from the corporation. These studies indicate that successful CVCs
should focus on achieving fmancial objectives. Thus, CVCs should behave in many respects, such as
investment selection and company management, like a private venture capitalist. Their conclusion
regarding the similarities between the behavior of successful CVCs and successful private VCs match
the opinionsof Fast (1981).

Hlavacek et al. (1977) provide early motivation for strategic use of CYC, stating that studies
indicate that over 74% of technological innovations originate in small firms. Yet acquisition too
frequently removes the advantages that a small company might bring to a large corporation. Successful
CVC partnering is reported to result from a threefold strategy. First, corporations should locate a
company which has strengths where it has weaknesses. Second, the large firm should have an
entrenched and extensive marketing organization that is capable of fully exploiting the venture's
proposed technology. Finally, and perhaps most importantly, the large firm must be "hungry" and
willing to do everything it takes to ensure the venture's success.

Greenthal and Larson's (1982) information on CVC leads them to caution venturing
corporations that they must have realistic goals. Corporations should seek either to acquire new
businesses, gain access to new technology, or, most simply, generate a sizable return on investment.
Greenthal and Larson believe that organizing CVC with these realistic goals in mind is key. If the
corporation is focussed solely on ROI, then becoming a limited partner of a private venture capital fund
is appropriate, otherwise the CVC group must be more proactive. They assert that the success of CVC
groups is affected primarily by their position in the organization, the management systems controlling
the CVC managers, the quality of the CVC managers, and the compensation of these managers.

Levine (1983) expands on Greenthal and Larson's work, concluding that the "inside track" on
new technologies should be more important to corporations than ROI. CVCs have problems because
they feel that they have to dictate the small firm's product and technology decisions. In addition, CVCs
are treated differendy by private VCs because they assume that CVCs are not under the gun to hquidate,
as private VCs are.

Block, Sykes and their co-workers at New York University have produced additional pertinent
recent studies (Block, 1983; Block and Ornati, 1987; Sykes and Block, 1989; Sykes, 1990). Block

and Omati (1987) find that performance incentives for CVC managers are not essential, because they
often lack sufficient time horizons. Sykes and Block (1989) indicate that the two major obstacles to
CVC success are (1) conflicts between the formal policies of the large firm and the needs of the small
firm, and (2) misdirection of small firm because of irrelevant and damaging corporate management
practices.

Sykes' most recent article on CVC (1990) outlines many drivers of strategic success for CVC
programs. Sykes surveyed a large number of CVCs and determined that their success depends on
mutually beneficial strategic objectives between the small and the large firms, frequent and open
communications between the corporation and the venture, and financial returns on investment. Direct,
proactive investment is seen to be better if only one strategy is chosen, but being a limited partner in a
private VC fund is identified by Sykes as providing "deal flow" for direct investment possibilities. He
remarks that effective relationships between CVCs and VCs are built over extended time periods,
usually by co-investing and serving together on the boards of directors of start-ups. Factors found not
to influence the success of CVC programs itre CVC manager experience and compensation, the
organizational position of corporate contact, the source of direct investment, and the number of
corporate investors in a VCLP.

OBJECTIVES AND METHODOLOGY
Objectives

The study described here is directed at understanding how to improve the process of initiating
investments, one stage of the process of new business development through CVC (Figure 1) in which
little previous research has been done. The process of initiating investments has been subdivided into
three separate, but related, activities: (1) uncovering good investment opportunities; (2) selecting which
investments to make; and (3) structuring and managing the investments. Specifically, this research
attempts to:

•determine the best methods for CVCs to uncover investment opportunities,

•find the determinants of success in the investment identification process,

•establish guidelines for structuring and managing CVC investments.

Methodology

To study the CVC programs of large U.S. corporations, a questionnaire on direct investment in
small companies was sent to over 150 growth-oriented large firms, hoping that this approach would
ensure that a large fraction of those corporations using CVC would be contacted. To increase the
significance of the questionnaire's results, great care was taken to ensure that the surveys were sent
directly to someone involved on a day-to-day basis with new business development. (The complete
questionnaire is available from the authors.) 54 firms responded to this survey, with 49 providing
complete, quantitative responses. The other five respondents had programs that were not "old" enough
for meaningful results, according to their replies. If, as asserted by Sykes (1990), only 80 U.S. firms
have CVC programs, 49 firms indeed constitute a broad sample of the corporate venturers. 75% of the
respondents were large multinational corporations, with 60% being in the Fortune 5(X) and 15% in the
Forbes International 500. The responding firms represent a wide range of industries and are believed to
be representative of the spectrum of CVCs. Half of the fums (25 of 49) were also contacted in
follow-up phone conversations, selected based on their pursuit of a particular strategy of interest to us,
as pointed out later in this paper. The telephone conversations qualitatively confirmed the conclusions
drawn from statistical analyses and explored some of the more unique approaches to CVC in greater
detail. Finally, 22 of the 49 firms responded to another follow-up mail survey (sent to all 49 initial
respondents) that focussed on investment structure and venture management. These 22 are a reasonably
representative subset of the original group, as is discussed further when these data are analyzed.

For the sake of hypothesis testing a firm is classified as "strategically successful" based on
self-assessment by the respondent that the firm's CVC program was producing a rate of new business
development that was superior to that from internal development effons, given the same level of
resources. The potential bias in these evaluations is evident and no systematic objective information
was collected. Furthermore, although a "success" score on this question could result from poor internal
development effons, it was felt that this would not typically be the case.

This definition of success can be justified for theoretical and practical reasons. First, from a
theoretical standpoint, this definition normalizes for firms which are situated in high growth industries
and may experience high rates of new business development from all their new business development

activities. In addition, from a theoretical standpoint, normalizing for equivalent resource commitment
removes biases introduced by top management decisions to emphasize one mode of new business
development over another. From a practical standpoint, despite room for bias in the direction of overly
positive appraisal, the definition in fact divided the responding corporations almost in half, with a wide
range of self-scores. Most importantly, it provided two groups that exhibit markedly different behaviors
and are clearly pursuing dramatically different strategies in their CVCs.

UNCOVERING GOOD INVESTMENT OPPORTUNITIES

Uncovering good investment opponuniries that are worth pursuing is extremely difficult; it's
like "searching for a needle in a hay stack". A number of studies (Peterson, 1967; Hardymon et al.,
1983; Winters and Murfin, 1988; Siegel et al., 1988; Sykes, 1990) identify establishing and
maintaining a high quality "deal flow" as critical to the success of CYC programs. To evaluate the deal
sources of corporations, their primary sources of investment opportunities as well as the distribution of
all sources of investment opportunities were examined. Table 1 shows the average distribution of all
deal sources for all 49 firms in the study. In-house people are the largest source of deals (32%),
followed closely by venture capital firms (28.2%); together these top two deal sources represent over
60% of all investment opportunities. In his study of CYC strategies, Sykes (1990) also finds these two
to be the predominant deal sources, although venture capital firms are identified as being more
important in his study (27% for YCs versus 20% for In-house); Sykes' study focusses more on YC
limited partnerships, which may account for the quantitative differences.

Figures 2 and 3 show the differences between successful and less successful firms, on Uie basis
of the average of all sources and the primary sources of investment opportunities. Firms that are more
successful use venture capital firms as a deal source to a much greater extent tiian do less successful
firms. Table 2 presents a statistical comparison of successful and unsuccessful CYCs, verifying that a
statistically significant difference exists between the sources of investment opportunities. The venture
capital community is clearly the best source of a high quantity of high quality deals, perhaps because
venture capitalists add value to their portfolio firms, thereby reducing the probability of venture failure.
Deal Sourcing from Venture Capitalists

1 1

These analyses strongly indicate that a venture capital deal sourcing network plays an integral
role in a successful CVC program. To determine how large corporations cultivate such a network,
CVCs that were classified as successful and that also had sourced more than 33% of their deals from
the venture capital (VC) community were contacted. In addition, a number of venture capitalists with
experience in or with corporate venture capital were also interviewed.

These successful CVCs indicate that their primary methods of cultivating deal flow from the
venture capital community are:

•investing direcdy in VC portfolio firms (usually called co-investing),

•networking with VCs without investing (see Bygrave, 1988),

•contacting those VCs which hold some of their corporation's pension assets.

According to VCs (see also Golden and Rind, 1984), the factors which give CVCs credibiHty in
the co-investing process include:reputations of corporate people involved in venturing, demonstrated
ability to both generate and share leads, resources to constructively evaluate ventures on a timely basis,
and commitment to be in venturing for the long-run. In addition to these qualities, successful CVCs
added the following pointers which they said could help corporate venturers become pan of the VC
community: ability to co-exist with VCs, flexibiUty with respect to deal structure and ultimate
acquisition, and willingness to provide VCs with a "way out" or liquidity in later rounds (see also
Slutsker, 1984, and Buderi, 1990).

Based on the interviews, investing in VC funds, i.e. becoming a venture capital limited partner
(VCLP), appears to be useful primarily as an entry strategy, to be used in the early stages of the CVC
program. Continuing to be a VCLP does not appear to be critical for long-run strategic performance,
as corporations have to move into a more proactive role in the venturing process, making and managing
direct investments in small companies themselves (see also Fast, 1981).

Although some VCs recommend that a corporation become a VCLP to learn about "how the VC
game is played" and to develop credibility within the VC community (see Golden and Rind, 1984),
successful CVCs criticized being a VCLP as a long-run strategy for a number of reasons. First, for
corporations with a fixed pool of venturing funds, being a VCLP in the long-run is reportedly an
"expensive" method of generating deal flow. Second, as a VCLP, some corporations see "opaque"

windows on technology, getting deals only after the fund has rejected them. Alternatively, "opaque"
windows may result from corporate venturers' lack of proactive efforts, expecting that they will be
"spoon fed" by the VCs. Third, becoming a VCLP may signal that a corporation is unwilling or unable
to participate in the high value-adding activities of venture capital, such as deal evaluation and portfolio
firm management. Thus, some VCs seem to see corporate VCLPs as "dumb money". The conclusion
that being a VCLP is not a long-run strategy may not apply to dedicated, single-corporation VC funds,
which can be similar strategically to CVC subsidiaries.

INVESTMENT SELECTION AND STRATEGY

Selecting which investments to make is challenging because, even after an exhaustive search,
many investment opportunities are not worth pursuing. Thus, separating the "wheat from the chaff is
a vital part of a successful venture process. Indeed, private venture capitalists, who are not "restricted"
by strategic objectives as corporations are, report that they invest in only about 1-2% of all deals they
see (Rind, 1982).

In this section, we first discuss the effect of strategy on the success of CVC programs, paying
particular attention to strategies of diversification with respect to both market and technology. These
analyses lead naturally into a brief discussion of selection criteria for successful CVCs.
The Effect of Diversification

Many studies (see Rumelt, 1982; Peters and Waterman, 1982; Roberts and Berry, 1985; Zirger
and Maidique, 1990) report that new business development through diversification is harder than
"sticking-to-the-knitting". Our data in Figure 4 also show that new business development in
diversified areas through CVC is more difficult than non-diversification investments.

Although a significant difference exists between the average success of diversifying CVC firms
and stick-to-the^nitting firms as shown in Figure 4, diversification seems more feasible than is
implied by some authors. This finding that CVC is a reasonable method of new business development
for diversifying firms is consistent with Roberts and Berry's conclusion (1985) that CVC is the most
viable method of new business development for firms seeking to diversify.

Because diversification has both technology and market dimensions, the effects of market and

technology familiarity on the success of CVC programs were examined separately. Figures 5 and 6
show the average success rating for those following market and technology diversification and
stick-to-the-knitting strategies. Corporate familiarity with the venture's market is as important in
determining strategic success as familiarity with the venture's technology. However, examining the
differences between strategically "successful" and "unsuccessful" firms, market familiarity is shown to
be even more important in Table 3. That closeness to market is more important than closeness to
technology has been noted previously by Sykes (1986), MacMillan et al. (1987), and Roberts and
Meyer (1991). Table 3 shows that the market familiarity of successful firms differs significantly, at the
92% confidence level, fi-om that of unsuccessful firms. For technology familiarity, the level of
confidence that a difference exists between successful and unsuccessful firms is less than 50%.
Selection Criteria of Successful CVCs

There have been at least four significant studies on the investment selection criteria of CVCs
(MacMillan et al., 1987; DeSarbo et al., 1987; Siegel et al., 1988; MacMillan et al., 1985). Table 4
shows the difference in selection criteria of CVCs and VCs from one study. Some natural differences
exist, such as the three "strategic" criteria that are used only by CVCs; however, neglecung the two
criteria, "articulate in discussing venture" and "track record relevant to venture", might be serious
oversights by CVCs. According to Siegel et al. (1988), these two criteria are statistically significant
determinants of success. Table 4 also presents information useful for designing selection criteria for
corporations considering launching a CVC program.

From conversations with a number of CVCs, it appears that many CVCs seem to have a "blind
spot" when it comes to some aspects of investment evaluation (see also Peterson, 1967). CVCs need to
make sure their selection criteria are "balanced" with respect to evaluating the venture's market and
management team and not too focussed on evaluating just the venture's technology. CVCs with
technical backgrounds or who are affiliated with the corporation's R&D may have a greater tendency to
overemphasize technology in their selection criteria. The analyses shown in Figures 5 and 6 and Table
3 demonstrate that market familiarity can be even more important than technology familiarity in
generating strategically successful outcomes. Thus, CVC investment selection criteria and due
diligence should be at least as heavily, if not more heavily, weighted towards the venture's proposed

market as they are to its technology.

INVESTMENT TIMING AND STRUCTURE

Having found and selected a market-technology focus, the timing, structure and management of
the initial investment in a venture may define the investment's ultimate strategic potential for the
corporation. Incorrectly timed and poorly structured corporate alliances can be as fatal to a start-up as
misunderstood markets or infeasible technologies. This section first discusses the stage in the growth
of a venture during which the more successful CVCs invest and then treats some of the issues relating
to investment structure and management of ventures by the corporation.
The Effect of Venture Age

Investing early in a venture's life is riskier, but a corporation can place more "bets" for its
investment dollar and learn sooner about emerging technologies and markets. Figures 7 and 8 contrast
the investment timing of more successful and less successful furos. Figure 7 shows that strategically
successful CVCs make more investments in later rounds, as compared with less successful firms.
Figure 8 highlights that this later round investment strategy is even favored by successful diversifying
firms, indicating that this effect is not a stick-to-the-knitting-versus-diversification effect. Table 5
shows that the differences in investment timing between more successful and less successful CVCs are
statistically significant, with the strategy of later round investments being much more successful.

At least six possible explanations are plausible for this effect of investment timing. First, the
effect might simply represent the expected risk-return tradeoff that changes through the growth of a
start-up. Second, in later investments, the match between the venture's strategy and the corporation's
strategy can be more easily ensured due to more information being available. Third, in early
investments, the corporation may structure the investment so that the incentive for innovation within the
venture is removed. Fourth, in forcing stan-up companies to have synergies with the corporate
portfolio, corporations may "misguide" the venture, as is discussed by Levine (1983). Fifth,
corporations that invest early may be too "conservative" and therefore not invest enough to make this
strategy work effectively. Finally, the effect may be tautological, reflecting additional later round
investments by CVCs into those earlier investments that turn out to be strategic "fits" with the

corporation! Whatever the possible explanation, the results cannot be ignored by CVCs.
The Corporation-Venture Interface

The lower strategic yield from early round investments might potentially be mitigated by
well-structured and correctly-managed investments. A second survey, focussed on investment
structure, was sent to the respondents of the first survey. While only 22 of the 49 firms responded,
analysis of these results provides at least qualitative information regarding the critical behaviors of
CVCs. 14 of these 22 respondents were successful by our definition, so this is a reasonably
representative group.

Figure 9 shows that on average strategically successful and unsuccessful CVCs use a similar
spectrum of investment structures, with both groups using equity or convertible debt over 60% of the
time. This similarity in investments may be due to the fact that CVCs must negotiate these investments
with the start-up and other investors, all of whom probably prefer corporations to use "straight" equity.
The more successful CVC firms do form pannerships in which they are the limited partner (LP)
approximately twice as often as do unsuccessful firms. These types of investments are not used
firequently, but can be a useful way for corporations to exploit a start-up's technology in a market
which is defined by user-type or geography. Again, this is at least in part tautological, i.e., closeness
of fit strategically produces greater likelihood of adopting the closer ties of a partnership, and vice
versa.

Figure 10 shows the average initial equity ownership percent, extent of supplementary
relationships, and magnitude of control of CVCs. The magnitude of CVC control is measured by four
different parameters: % of investments in which CVCs manage the operations on a day-to-day basis,
% of investments in which CVCs have a board member, % of investments in which CVCs control the
board, and % of investments in which CVCs can replace the start-up's CEO. Successful CVCs have a
lower average initial equity position than unsuccessful CVCs, which may indicate that successful CVCs
place more "bets" by not "putting all their [investment] eggs in one basket". In addition, successful
CVCs seem more capable than unsuccessful CVCs of requiring or fostering supplementary business
relationships between their corporation and investment ponfolio firms. By exploiting these synergies,
successful CVCs are able to add more than money to their venture investments. Although fostering

extensive business relationships appears vital to effective CVC performance, exercising excessive
control is not, as is indicated by the fact that successful CVCs have a lower fraction of investments in
which they either manage day-to-day operations, have a board member, exercise board control, or
have the abihty of replacing the venture's CEO. These three differences in managerial approach seem
profound.

FINANCIAL SUCCESS OF CVC PROGRAMS

Much of the earlier literature pointed to the relationship between financial success of venture
programs and strategic success (Peterson, 1967; Fast, 1981; MacMillan et al., 1985; MacMillan et al.,
1987; DeSarbo et al., 1987; Siegel et al., 1988; Sykes, 1990). This relationship is complicated here
because our data are subjective, self-reponed "facts". Managers may convince themselves that
financially successful ventures were, in retrospect, strategic. Conversely, corporations will rarely
benefit from synergies so large that they offset the poor financial performance of a venture program.

Figure 1 1 shows the expected positive correlation between financial and strategic success of
CVC programs. The positive relationship between financial and strategic success is particularly strong
for strategically successful firms. This strong positive relationship for strategically successful firms
may be due partly to managers convincing themselves that any venture that makes money is strategic.
CVC programs that are well positioned strategically are also successful financially, which is comforting
to top managers considering launching a CVC program.

Yet inferring that imposing financial objectives on a CVC program will yield strategic results as
some previous papers have suggested ignores the cause-and-effect relationships. Managing a CVC
program primarily for financial success will probably produce a diversified portfolio of ventures
scattered all over the market-technology familiarity matrix (see Hardymon et al., 1988) with few of the
intra-venture or venuire-corporation synergies that are necessary for effective corporate growth
(according to Roberts and Berry, 1985, and Roberts and Meyer , 1991).

QUALITATIVE ATTRIBUTES IMPORTANT TO CVC SUCCESS

Asking CVC managers to provide qualitative factors critical to their CVC program success

might have brought forth a list of their own CVC attributes. To remove this bias of self-reported data,
CVCs were asked which three firms they considered good at making direct investments in small
companies and why they consider them successful. Table 6 shows the top eight corporations regarded
by respondents as "good" at corporate venturing. Over half of the respondents indicated they thought
these firms were successful because of one or more of the following factors: (1) a well-defined
strategy, with focus, clarity, and constancy of purpose; and (2) well-organized, with independence and
support from top management. Because strategic focus is reported to be a driver of success, financial
performance objectives may not produce strategically successful CVC investments, as discussed above.

CONCLUSIONS

The strategies of 49 large U.S. corporations that are using corporate venture capital (CVC) for
new business development were studied and evaluated. These corporations are from a wide range of
industries and are thought to represent the broader spectrum of CVCs. The strategies of more
successful firms were quantitatively and qualitatively compared with those of less successful firms to
provide insights into effective CVC strategies.

1. Venture capital firms (VCs) are the key deal source for CVCs making
strategically successful direct investments in small ventures.

To interact effectively with VCs, CVCs should directly invest in VC portfolio fmns, network
with VCs without necessarily investing, and contact VCs holding some of the corporation's pension
assets. As an entry strategy, CVCs should invest in VC funds, becoming a VCLP; however, being a
continuing investor in VC funds is not necessary in the long-run for generating deal flow.

2. Corporate familiarity with the venture's market is more important in
determining strategic success than familiarity with the venture's technology.

CVCs must therefore evaluate a venture's market with greater due diligence than seems typical
in current practice. Further, corporations should seek to add value to their ventures through marketing
expertise.

3. Strategically successful CVCs make more investments in later rounds, as
compared with less successful firms.

CVCs should either make more later round investments or structure early round investments to
increase the probability of strategic success. In particular, CVCs should not exercise excessive conQ-ol
over their portfolio firms.

4. The flnancial performance of CVC programs is positively correlated with
strategic success, but CVC managers report that strategic success results from a
focussed strategy.

Therefore, corporations using CVC for new business development do not pay a financial price
for the program. However, if the corporation is seeking to develop new businesses from its CVC
program, CVC managers should not have their compensation based solely on their CVC portfolio's
financial performance.

Acknowledgement

The authors appreciate the financial sponsorship of this work by Exxon Chemical Company. Many of
the analyses performed here were suggested and/or improved by Mark Pratt of Exxon Chemical.

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LIST OF TABLES

Table 1 Sources of Investment Opportunities

Table 2 Statistical Comparison of Sources of Investment Opportunities

Table 3 Statistical Comparison of Market and Technology Diversification Strategies

Table 4 Comparison of Investment Criteria of CVCs and VCs

Table 5 Statistical Comparison of Timing of Investments

Table 6 Corporate Venturers Regarded as "Good" at Venturing by Other Corporate Venturers

TABLE 1. SOURCES OF INVESTMENT OPPORTUNITIES

% of All Investments from Source

In-house People

32.0

Venture Capital Firms

28.2

Unsolicited Business Plans

17.0

Investment Bankers

7.6

University Research Programs

5.8

Consultants

4.9

Miscellaneous Networking^

4.5

100.0%

"•"Primarily at conferences

TABLE 2. STATISTICAL COMPARISON OF
SOURCES OF INVESTMENT OPPORTUNITIES

Unaffilated Venture Capitalists* All Venture Capitalists'*

Critical t-value+ 2.06 L48

(Successful-Unsuccessful)

P++ 0.025 0.10

Universities Primary Source Distribution

(see Figure 3)
Critical t-value 1.41 1.12

p 0.10 0.15

+ t-value calculated as (mean of Successful-mean of Unsuccessful)/pooled standard deviation.

Therefore, positive numbers indicate that successful firms use this strategy to a greater extent, negative
values indicate that successful firms use this strategy less.

"•■+ Probability that we are mistaken in believing that a difference between successful and
unsuccessful firms exists, based on a one-sided t-test. Lower values indicate greater statistical
significance.

Unaffiliated are VC funds with which the corporation is in contact, but in which the corporation
has not invested money, i.e. the corporation is not an LP of the VC.

This category of VCs includes all deals from VCs.

TABLE 3. STATISTICAL COMPARISON OF
MARKET AND TECHNOLOGY DIVERSIFICATION STRATEGIES

Market Familiarity* Technology Familiarity

25 Successful Average: 2.90 3.40

Std. Dev.: 0.80 0.79

24 Unsuccessful Average: 3.33 3.44

Std. Dev.: 1.06 LIO

Critical t-value+ -L59 -0.13
(Successful-Unsuccessful)

0.50

See Figures 5 and 6 for definition of market and technology familiarity.

"•" t-value calculated as (mean of Successful-mean of Unsuccessful)/pooled standard deviation.

Therefore, positive numbers indicate that successful firms use this strategy to a greater extent, negative
values indicate that successful firms use this strategy less.

"•"•" ProbabiUty that we are mistaken in believing that a difference between successful and
unsuccessful firms exists, based on a one-sided t-test. Lower values indicate greater statistical
significance.

TABLE 4. COMPARISON OF INVESTMENT CRITERIA OF CVCs AND VCs*

Most Frequently Rated Essential % CVC % VC

Capable of sustained effort
Familiar with market
Able to evaluate and react well to risk
Market/Industry attractive to corporation
Product fits with corporation's strategy
Target market enjoys high growth rate
Product can be protected
Entrepreneur demonstrated leadership
Return lOX investment in 5-10 years

Criteria in top ten for VC, but not CVC

Articulate in discussing venture
Track record relevant to venture
Investment can be easily made liquid

*Source:Siegeletal. (1988).

TABLE 5. STATISTICAL COMPARISON OF TIMING OF INVESTMENTS

Zero/Seed Stage

First Round Investments

Critical t-value*
(Successful-Unsuccessful)

-2.17

P-^

0.005

0.02

Second Stage

After Initial Public Offering

Critical t-value
(Successful-Unsuccessful)

2.45

1.84

0.01

0.05

t-value calculated as (mean of Successful-mean of Unsuccessful)/pooled standard deviation.
Therefore, positive numbers indicate that successful firms use this strategy to a greater extent, negative
values indicate that successful firms use this strategy less.

■•" Probability that we are mistaken in believing that a difference between successful and unsuccessful
firms exists, based on a one-sided t-test. Lower values indicate greater statistical significance.

TABLE 6. CORPORATE VENTURERS REGARDED AS "GOOD" AT VENTURING
BY OTHER CORPORATE VENTURERS

Corporation % of

Respondent

DuPont

Eli Lily

General Electric

Coming

Hoffman-La Roche

roM

Monsanto

LIST OF FIGURES

Figure 1 The complex processes of a corporate venture capital program.

Figure 2 Examination of differences in average deal sources of successful and unsuccessful firms

indicates that successful firms use venture capitalists as a deal source to a greater extent

Figure 3 Examination of differences in primary deal sources of successful and unsuccessful firms

indicates that successful firms use venture capitalists as a deal source to a greater extent.

Figure 4 Diversification is harder than sticking-to-the-knitting in corporate venture capital investing.

Figure 5 Sticking-to-your-market is more successful than diversifying. Diversifying in the market

dimension is at least as difficult as diversifying in the technology dimension (see Figure 6).

Figure 6 Sticking-to-your-technology is more successful than diversifying. Diversifying in the

market dimension is at least as difficult as diversifying in the technology dimension (see Figure 5).

Figure 7 Investing in later rounds increases the likelihood of strategic success.

Figure 8 Investing in later rounds increases the likelihood of strategic success, independent of

diversification strategies. See Figure 4 for definition of "diversification".

Figure 9 Similar types of investment structures are used by both successful and unsuccessful CVCs.

Figure 10 Successful CVCs take lower initial equity positions, develop and foster supplementary

business relationships more effectively, and exercise less control over ventures than do unsuccessful

CVCs.

Figure 1 1 Financial and strategic success are positively correlated, particularly for strategically

successful CVC programs.

Figure 1. The complex processes of a corporate venture capital program.

Dgveloping
the venlUTG
program

Establish venture goals and focus
Fornnulate venture group structure
and strategy

nilialing Uncover investment opportunities

nvGEtrnGnts Establish investment selection

criteria
Structure and make investments

Managing

Assist the management of

the investment

individual firms

portfolio

Foster synergies among portfolio

firms

Help determine each portfolio

firm's strategy

A9£im11ating

Establish common strategies

invQEtmgnts

among firms

Into business

Develop significant new business

group

Transfer venture expertise into

core businesses

Figure 2. Examination of differences in average deal sources of successful and
unsuccessful firms indicates that successful firms use venture capitalists as a deal
source to a greater extent

O
a
a
O

20 -

^ 10

Legend:

^ 25 successful firms
I I 24 unsuccessful firms

^- '•'\/-\.o<^'

.<^

e" ^ G°

Figure 3. Examination of differences in primary deal sources of successful and
unsuccessful firms indicates that successful firms use venture capitalists as a deal
source to a greater extent.

■^ 50

D
+-•

o
a
a
O

Legend:

Wi 25 successful firms
□ 24 insuccessful firms

^<?' "?%<?

Figure 4. Diversification is harder than sticking-to-the-knitting in corporate venture
capital investing.

I-
LU

Different 5

Similar 3

Core 1

1 3 5

Core Similar Different

TECHNOLOGY

COMPARISON OF OVERALL STRATEGY

Sticking

-to-
Knitting

Diversification

Legend

Number

Success Average

3.696

3.308

Standard
Deviation

0.736

Comparative t value 1.521

Figure 5. Sticking-to-your-market is more successful than diversifying.
Diversifying in the market dimension is at least as difficult as diversifying in the
technology dimension (see Figure 6).

I-
LLI

Different 5

Similar 3

y///////A

'■z^zm,

m/y/yy//,

w/m

■

Core 1

■■mm

'mmmm^

1 3 5

Core Similar Different

TECHNOLOGY

COMPARISON OF MARKET STRATEGY

Sticking

-to-
Market

Diversification

Legend

Number

Success Average

3.576

3.250

Standard
Deviation

0.683

Comparative t value 1.216

Figure 6. Sticking-to-your-technology is more successful than diversifying.
Diversifying in the market dimension is at least as difficult as diversifying in the
technology dimension (see Figure 5).

h-
LJJ

DC
<

Different 5

Similar 3

Core 1

1 3 5

Core Similar Different

TECHNOLOGY

COMPARISON OF TECHNOLOGY STRATEGY

Sticking

-to-

Technology

Diversification

Legend

Number

Success Average

3.759

3.350

Standard
Deviation

0.745

Comparative t value 1.272

Figure 7. Investing in later rounds increases the likelihood of strategic success.

40 -

Legend:
r~l 25 successful
24 uTSuccessful

Figure 8. Investing in later rounds increases the likelihood of strategic success,
independent of diversification strategies. See Figure 4 for definition of
"diversification".

Legend:
b|| Successful
Unsuccessful

^ J' -S-*

^^ ^°V

«^^^

■y ^-^

Figure 9. Similar types of investment structures are used by both successful and
unsuccessful CVCs.

70
60
50
40
30
20
10
O

Legend:

H 14 successful

I I 8 unsuccessful

^e^

o- X)

s<Z^

x<^

Figure 10. Successful CVCs take lower initial equity positions, develop and foster
supplementary business relationships more effectively, and exercise less control over
ventures than do unsuccessful CVCs.

40 h

Legend:

H 14 successful

I I 8 unsuccessful

J^^ ^-^->o^

o- O^V^

Figure 11. Financial and strategic success are positively correlated, particularly for
strategically successful CVC programs.

0)
(/)
(D
U
U
D

0)
D)

i—

0)
>

•

/
/
/

]

•

^ i

LEGEND:

_ □ Category Avg.

No.

Number of Firms in Category
1 1 1

Strategic Success Rating

MIT LIBRARIES DUPl

lllllillililllii
3 TDflD 0D75abbl D

Date Due ?-^-f z^

JAN. 0 2 1934'

3 TOflO DD7Sflhbl 0

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