How can incumbents create new growth and value in a rapidly digitising marketplace? #VentureBuilding is a powerful new weapon, that few incumbents take full advantage of today, and even fewer do well...
My key partner and collaborator in this space, Jordan Schlipf from Rainmaking Venture Studio, knows more about this topic than nearly anyone on the planet. In his article below he provides an in-depth description of the pros and cons of different approaches to breakthrough innovation for incumbent corporations, demonstrates the relative value of venture building and, in particular, new methods that align incentives and leverage assets and capabilities most effectively.
Most corporates choosing to create new business lines and/or test new business models have four choices:
This article will compare the four options outlining the chance of success, costs, timeframes, common challenges, and the type of business idea each is best suited to.
What is it? Building new businesses in-house, either using internal talent (current employees) or hiring in external talent.
Chance of Success: Less than 8% of ventures launched internally reach scale. That's worse even than the average 90% who die in the wild.
Time to Success: For those that do succeed, it typically takes at least twice as long as a startup in the wild to build a new company within a large corporate. As an analogue, a standard startup accelerator is 3 months; a corporate accelerator is 6–12 months. Typically, this means 6–12 years to £50m+ in profit.
Cost: I've yet to see a corporate build an internal venture which didn't cost at a minimum two times (more often 4–5 times) what it would take to build it in the wild. Including talent, internal ventures usually cost £50-100m+ to reach scale.
Control: The corporate enjoys 100% ownership, and the new venture typically operates within existing business structures and management.
Best For: New products within the core business. You already have a significant share of the market, so have time to play. There's also inherently less uncertainty, increasing the chance of success and the ability to repurpose experts from within the organisation.
You could also invest here to build long-term capability in-house (if you can retain the founder talent you train), but you will need a parallel approach for the short- to mid-term while you're getting up to speed.
Ultimately, these challenges slow the time to market and dramatically increase the risk and cost of failure.
"I came from that world… if I thought I was going to be able to create that, I would have done. But, unfortunately, it's tough to replicate the energy and technology of a startup."
- Anne Boden, Founder and CEO Starling Bank
Minority investments are an increasingly popular way for corporates to innovate. Between 2013 and 2018, corporate VCs increased invested capital 4x, spending $50bn+ in 2018.
Chance of Success: Here, we can think about two measures - whether the investment makes a profitable return and whether it delivers 'strategic' value/learnings.
The metrics we look to for the financial return are Return on Investment (ROI) and the Internal Rate of Return (IRR). Has the portfolio of investments returned a minimum of 3x cash (i.e. a profitable return given the risks) in a suitable timeframe (typically 7–10 years)?
However, the true IRR or ROI is often ignored or not tracked for corporate investments, with investment teams not held accountable for creating profitable returns. Moreover, it's an incredibly tall order in the first place for those teams. If we take the VC world as an analogue for success, 95% of funds fail to make a profitable return on their investment at all. Of those that do, just 4% return 10x the value.
For the strategic value, it can be even harder to quantify the return. However, there are a few measures that can help make this more tangible:
A question corporates need to ask is whether, given their responsibility to shareholders, they should be taking on this VC risk/return profile — especially if the "strategic value" cannot be tangibly measured.
Time to Results: In exiting startup investments, 7-10 years is the target for most venture capital funds. However, the typical time to realise any return on capital is 12–14 years.
Pilots typically require the startup to be series A or above, so if you invest at the Seed stage, it will likely be ca. two years before the startup has the maturity to deliver pilots with you. You can find more on typical acquisition timelines in the next section on "Buy".
Cost: At Seed, the median VC deal size in 2019 was £350k at a pre-money valuation of £8M. At Series A, it was £3.6M invested at a pre-money valuation of £27M.
The median deal sizes provide a good indication of the costs involved. However, we know that corporates often end up overpaying compared to VC funds. For example, the average Corporate VC deal in 2017 was £16M compared to £12.4M for VCs.
Control: After dilution, corporates typically have a <10% stake in the venture. They often do not have a board seat and are not guaranteed the right to acquire, should the startup be successful.
Best redirected to focus on pilots and joint ventures: Honestly, we struggle to recommend the minority investment model for corporates as it stands.
Suppose the startup you want to work with already exists, and you want to test new technology. In that case, we'd recommend corporate-startup collaborations on pilots and joint ventures, where you can learn about the new technology or product and see if it impacts your bottom line. However, you don't need to have invested in the startup to run a pilot, so make sure you're not overpaying for the privilege.
There are two types of M&A: to grow the core or to innovate. This post focuses solely on M&A to innovate.
Chance of Success: According to Harvard Business Review, 70–90% of Mergers and Acquisitions fail.
Time to Results: Depending on the deal complexity, the acquisition process can take months or years, with the post-acquisition integration process often requiring a more extended period. However, the startup needs time to prove itself worthy of acquisition. If we count from idea inception, it's a long slog. In 2018, the average age of a startup at acquisition was 5–10 years old (37% of acquisitions), followed by 10–15 years.
For the few acquisitions that do succeed in creating profitable synergies, it typically takes 2-6 years post integration for these to materialise.
Capital Required: In 2018, the global median for M&A was 9.3x EBITDA, but it can easily reach the double digits.
For example, PayPal paid 40x revenues for Honey Science Corporation, for $4bn cash. They also paid 13x revenues and doubled its IPO valuation for iZettle, forking out $2.2bn. Meanwhile, Salesforce paid 22x revenues for MuleSoft in 2018, at $6bn. The list goes on and on, with many examples of 12–25x revenue acquisitions, including Microsoft's purchase of GitHub for $7.5bn (25x revenues).
Control: Technically, you have full control post-acquisition. However, if you want to keep the original founders, you will have to cede some of this control in practice, as they value the autonomy to try new things. To get the inside perspective on this, I recommend this post by Waze's Founder Noam Bardin, who shares why he left Google 7 years after Waze's acquisition. He talks about the rising trend for independence amongst acquired founders but how there will always be a clash in cultures.
For more reasons why innovation M&A fails, I highly recommend this blog by the inimitable Steve Blank.
Best For: When the idea already exists, and there are enough startups at maturity, rendering it too late to build your own version. If the acquisition is to survive, culture clashes must be managed (often requiring external specialist support).
Typically, this means partnering with a consultancy to build new ventures.
We realised there was a fundamental misalignment of incentives when building ventures as consultants.
We used to build corporate ventures within our innovation consultancy business (Rainmaking Innovation). When doing so, we charged fees and worked from ideation to implementation, bringing in our own talent. Across tens of ventures in multiple industries, we saw that corporate scale strengths and deep domain knowledge could unlock tangible advantages for our ventures, from infrastructure to data, to customers. But we still couldn't get new ideas to market at the pace, cost, or most importantly, the success rate compared to building our own startups in the wild (without any corporate involvement). Despite all our corporate partners' scale strengths and deep domain knowledge, we were achieving worse outcomes (% success rate and ROI).
Challenges to be surmounted when Partnering:
Ultimately, we realised there was a fundamental misalignment of incentives when building ventures as consultants.
"Over the last seven years, we've done joint projects with BCG Digital Ventures, Creative Dock, FoundersLane… and we've realised that corporations can't buy innovation. Consultancies that charge a fee for ideating and building new ventures rarely succeed because of the fundamental misalignment of incentives. The consultants' motivation is to maximise fee income, not necessarily to produce a successful new venture for the corporate. The Rainmaking model fixes that."
- Uli Huener, Chief Innovation Officer, EnBw
Our new investment-only corporate venture building model:
We've created a hybrid of build, invest and buy; based on years of experiencing doing all three.
We partner with large corporations to build the businesses they ultimately want to own. By partnering with us, they syndicate the early, risky stage of the investment. Then, once proven, they can acquire the startup, with most of the value still to come (in future years post-acquisition).
Our new investment-only Venture Studio approach allows our corporate partners to realise strategic growth as an add-on to traditional pure-play M&A and in-house builds. Our model offers significant advantages for certain types of strategically compelling ventures adjacent to core capabilities and competencies today. We focus 'where you want to be' instead of 'where you are' to fold the new ability (and material profits) into the business once established and scaling. We have a proven record of success and can provide better certainty and improved outcomes (with >40% of every Seed investment reaching scaled $10-50m profitability) through this way of working.
Chance of success: We're turning the typical VC return rate of 1 in 10 into 1 in 3. Ultimately, we de-risk building new businesses; for our corporate partners, Rainmaking and the venture founders.
We have 13 years of venture building experience with a proven process and track record across 60+ ventures. To date, we have achieved a 5.5x cash multiple and a 112% IRR across our portfolio. Survival rates (as of January 2021) across our ventures are: 33% failed, 27% successfully exited and 40% still active.
Furthermore, venture studios typically outperform startups in the wild by 30%, according to a GSNN Study. And that's without the corporate's unfair advantages, which give our ventures a decisive lead, and faster route to scale.
Time to success: The same GSNN study showed that studio ventures achieve 2x IRR in half the time. In our model, ventures are typically brought back by their corporate parent at the 4–6 year mark, once the business is mature enough to survive reacquisition and integration.
Control: Corporates have 30–40% equity, the highest number of board seats of any party (3 seats out of 7), and guaranteed the option to be the sole buyer of the venture, with minimum performance metrics to protect from buying a business that isn't strategically valuable.
Cost: In our Seed round, we invest £200K while our corporate partners invest £400k. This £600k provides the venture with a 12–15 months runway. If we both decide to invest further (as the venture scales), we put in £2–4m, and our corporate partners invest £2–4m. This gives the venture an additional 2–3 years runway.
When it comes time to taking control and integrating the venture in year 4 or 5, the corporate partner already owns c.40%. By taking full (100%) ownership at this stage, the majority of the venture's value is still to be realised, as the business scales during its remaining lifetime. This translates to an average 90% value still to be realised, which is wholly captured by the corporate partner after Rainmaking's exit.
Best For: Creating new (to the corporate) strategically aligned businesses that leverage the core's scale strengths and domain expertise. They represent adjacent opportunities that cannot be realised through product development alone or as part of day-to-day business.
These are the kinds of ventures the corporate wants to own fully and could become a new business line one day where the corporate wishes to syndicate the risk in the early stages and increase the chance of the venture surviving and scaling. But, typically, the corporate doesn't have the relevant in-house capabilities or is looking to scale up new capabilities without adding to FTE headcount in the core business today.
Example Ventures: Typically, our partners are looking to tap into a new market/ or customer group, test a new business model or develop a new capability. Their ambitions for new ventures are strategic and aligned to the core but ultimately adjacent to business as usual. This means the new idea does not need to live within the core business while it grows.
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