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Corporate venture capital and the value-added for technology-based companies

What benefits, other than cash, can corporate venture capital investors offer their portfolio companies? This article, based on a dissertation by Dr Markku Maula at the University of Helsinki, provides some of the answers. It focuses on the mechanisms through which corporate venture capital investors add value to technology-based new firms and the factors influencing those value-adding mechanisms. Maula also explores the implications of these findings for corporate venture capital investors and entrepreneurs.

The dissertation seeks to contribute to the body of literature covering the field of interorganizational relationships of entrepreneurial firms. More specifically, the dissertation attempts to fill a significant gap in the research into relationships between entrepreneurial firms and their corporate venture capital investors. Even though it has been recognized that relationships with large corporations can have significant implications for the performance of technology-based new firms through corporate venture capital investments, there is little rigorous, theory-based, empirical research that focuses on the factors influencing the value-added that start-up companies receive from their corporate investors. The dissertation contributes to the literature by developing and empirically testing a model of the value-added mechanisms and of the factors influencing those mechanisms.

Based on a review of the literature covering corporate venture capital and related domains of research into interorganizational relationships, the dissertation identifies resource acquisition, knowledge acquisition, and endorsement benefits as the primary mechanisms through which corporate venture capital investments add value to technology-based new firms beyond financing.

Building on received theories, an integrated model of the value-added mechanisms, and the factors influencing those mechanisms is developed. The model draws on the resource-based view and the knowledge-based view of the firm in order to understand the factors influencing resource and knowledge acquisition by portfolio companies. These theories are complemented by social capital theory in providing predictions as to the factors facilitating the sharing of knowledge and opportunities for resource sharing across organizational boundaries. Organisational economics complement the other theories in helping to understand corporate investment in relationships with, and in support for, the entrepreneurial firm. The hypotheses concerning the endorsement benefits for entrepreneurial firms stemming from the relationships with corporate investors draw mainly on the sociological research examining interorganizational endorsement. To extend the literature on the factors influencing endorsements, the model draws on the asymmetric information and signaling theories to identify factors influencing the strength of the signals from the endorsements.Transaction cost theory provides further predictions as to the value of external endorsement for the portfolio company, depending on the switching costs for potential customers and partners.

In order to test the model empirically, primary data were collected from 135 CEOs of US corporate venture capital financed technology-based new firms using two sequential mail surveys. The primary data were complemented by archival data. The hypotheses were tested using multivariate statistical techniques, including multiple regression analysis and structural equation modeling. The model and the hypotheses received support from the empirical data.

The dissertation makes important contributions to the literature in the area of corporate venture capital and interorganizational relationships of technology-based new firms on a more general level. The findings have also important practical implications for entrepreneurs either seeking corporate venture capital or already managing an existing investor relationship with a corporate venture capital investor. In addition to entrepreneurs, the findings have important implications for corporate venture capitalists and venture capitalists. These implications are briefly discussed in the following chapters.

Implications for entrepreneurs

Importance of investor selection. The research demonstrates that there are significant differences in the value-added received by ventures from their corporate venture capital investors. The findings imply that complementarities between the businesses of the corporate investor and the portfolio company are a crucially important success factor. Because complementarities are largely exogenous, a clear implication for entrepreneurs considering corporate venture capital investors is that careful investor selection is extremely important for start-up CEOs. Depending of the specific array of needs of the start-up company, an optimal ‘value-added portfolio' may be constructed by specifically selecting both corporate venture capitalists and independent venture capital investors on the basis of their ability to provide complementary support and advice in their respective areas of strength.

Understanding of the forms of value-added provided by corporate venture capital investors. The present study identified three important classes of benefits available in varying degrees for the portfolio companies from their relationships with corporate venture capitalists. While there are numerous ways to classify different potential benefits from the relationships, it helps entrepreneurs to have a coherent understanding of the major classes of benefits. The present study identified three theoretically and empirically grounded classes of value-added benefits:

(1) resource acquisition,

(2) knowledge acquisition

(3) and endorsement benefits.

These three forms of value-added explained the majority of the variance in the CEOs' assessments of the value added provided by their corporate venture capital investors. Understanding the nature of these benefits and the factors influencing them helps entrepreneurs in approaching suitable corporate investors.

Role of social interaction in the management of the investor relationship. As one factor important for entrepreneurs in managing the relationships with corporate venture capital investors, the present study identified social interaction between the entrepreneur and the investors as a key facilitator of resource and knowledge acquisition. The finding that social interaction mediates the benefits from complementarities and greatly facilitates resource and knowledge acquisition from corporate investors has implications for entrepreneurs managing the relationships with corporate venture capitalists. This finding suggests that social interaction is an important lever that the entrepreneurs can use to obtain greater benefits from their relationships with corporate investors. While it was shown that the complementarities have a significant catalyzing role for social interaction, it is up to the management to interact with the corporate investors and reap the benefits from the association. Therefore, active relationship management is recommended for the entrepreneurs.

Factors influencing endorsement benefits. Endorsement effect may be a particularly important benefit from having a corporate investor particularly if the products of the venture are critical for the business of the customers so that the customers or partners would have high switching costs. A small start-up may not be a credible enough supplier alone. Investment by an industry-leading corporation may improve the credibility and visibility of the venture as a supplier and enhance the impression that the product is reliable and fits potential standards and road maps in the industry. The more prominent the investor, the higher the endorsement benefits for the venture. When selecting corporate venture capital investors, the prominence of the investor is an important consideration.

In addition to the investor prominence and customer switching costs, the present study identified the young age of the venture as a factor that influence the value of endorsements. The younger the venture, the more potential partners and customers will pay attention to the existing partners including corporate venture capital investors. The younger and more uncertain the venture is, the more it can benefit from endorsements by prominent investors. Further, the characteristics of the relationship between the venture and the corporate investor were found to influence the endorsement. The closer the relationship is the stronger the endorsement effects in the eyes of outsiders. In addition to facilitating resource and knowledge acquisition, investments in relationship building can therefore have indirect benefits through increased endorsement effects.

For entrepreneurs, a short summary list of the ten research-based recommendations is presented for technology-based new firms concerning corporate venture capital

1. Select your investors very carefully. Just as investors conduct due diligence on potential investment targets, it pays off for start-ups to conduct due diligence on their potential investors.

2. Build a portfolio of investors that fits your needs. It may be beneficial to have different types of investors bringing different value-added benefits.

3. Pay a considerable amount of attention to the complementarities between your firm and the parent firm of the potential corporate investor. Complementarities are critical for cooperation.Use social interaction to facilitate knowledge acquisition from corporate investors and enable identification of opportunities for cooperation.

4. Consider the potential for acquiring critical resources from the parent of the corporate investor when selecting investors. Complementarities are a key enabler for resource sharing, but social interaction helps in identifying opportunities for cooperation. However, keep in mind that investor relationship does not always give preferential access to corporate resources.

5. Consider the potential learning benefits when selecting corporate investors. Start-up companies may learn a lot from large global corporations regarding markets, customer needs, competition, and technological issues. Social interaction facilitates knowledge acquisition.

6. Consider the potential endorsement benefits when selecting corporate investors. The more influential the corporation, the more valuable the endorsement. Uncertainty and high switching costs for customers make endorsement more valuable. Complementarities improve the value of endorsements and concrete resource sharing makes complementarities more visible.

7. Consider taking multiple instead of only one corporate investor. Multiple investors may increase the endorsement and balance each other reducing the risks for conflicts of interest.

8. Do not reveal more technical documentation to the corporate investor than is necessary for the investment relationship and good cooperation. Revealing too much increases the risk of exploitation and reduces the incentives for continued cooperation.

9. Consider the potential help from taking corporate investors when entering foreign markets. Global corporations (or significant local players in foreign markets) may help to open doors in foreign markets.

Implications for corporate venture capital investors

For corporate venture capitalists, it is naturally important to understand how they can add value. The findings imply that complementarities are a key determinant of the potential economic value of their portfolio firms. The existence and extent of complementarities, therefore, should be explicitly studied during the due diligence process.

Furthermore, social interaction is an important factor facilitating value creation. While social interaction helps ventures to get more out from the relationship through learning and identification of opportunities for resource sharing, closer collaboration also helps corporate venture capitalists to learn more from the venture.

Implications for independent venture capital investors

The findings of the present study are also important for independent venture capitalists. Because the number of deals syndicated between independent venture capitalists and corporate venture capitalists has grown high, it is important for independent venture capitalists to understand what corporate venture capitalists can bring to syndicates. Further, it is important for venture capitalists to understand the conditions under which corporate venture capital investors can add value to syndicates.

The findings of the present study indicate that complementarities between the ventures are an important determinant of value-added provided by corporate venture capital investors for their portfolio companies. Independent venture capitalists are therefore advised to examine the complementarities when considering inviting a corporate venture capital investor in the syndicate.

When the venture needs endorsements for commercialising the products, co-investment by prominent corporate venture capitalists can often do the trick. The prominence of the corporate investor is an important factor to consider when seeking endorsement benefits for the venture. Industry-leading corporations are more influential in this respect compared to smaller corporations. The endorsement by large corporations may be particularly valuable when the venture operates in a systemic business environment offering products that are critical for the business of the customers.

The dissertation was supervised by Professor Erkko Autio (Helsinki University of Technology). Professor Benoît Leleux (IMD-International Institute for Management Development, Switzerland) acted as the opponent in the public examination of the dissertation. Professor Hans Landström (Lund University, Sweden), and Professor Markku Virtanen (University of Kuopio, Finland) acted as the preliminary examiners. The dissertation was accepted ‘with distinction' at Helsinki University of Technology in December 2001.

Dr. Markku Maula's research interests focus on value creation related issues in business strategy and corporate finance with a particular focus on the international venture capital industry, technology-based ventures, and corporate venturing in large corporations. He is currently coordinating research efforts on corporate venture capital, international venture capital investments and syndications, and management of corporate venturing activities in large corporations. A recent research study on corporate venture capital by Markku (co-authored by Professor Gordon Murray of London Business School) was awarded the McKinsey & Company Best Conference Paper Prize Honorable Mention at the prestigious Strategic Management Society conference in 2000. For the second year in a row, a paper co-authored by Markku was also shortlisted for the Booz Allen & Hamilton Best Conference Paper Prize by a Ph.D. Candidate at the same conference in 2001.

Dr. Markku V. J. Maula, Institute of Strategy and International Business, Helsinki University of Technology, Post Office Box  9 500 FIN   02 015  HUT,  Espoo, Finland, +358 405 560 677, +35894513 085, markku.maula@hut.fi

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