Ebook When Does Corporate Venture Capital Investment Create Firm Value?
Over the past decade, billions of dollars have been invested by establish companies in entrepreneurial ventures, yet, there is little systematic evidence whether such investment creates value to investing firms. Also known as Corporate Venture Capital (CVC), investment levels have oscillated dramatically since the appearance of CVC funds in the 1960’s. We attempt to shed light on the conditions under which corporate venture capital lead to the creation of firm value. Previous work reports that entrepreneurial ventures funded by established firms experience favorable valuation at IPO. The focus of this paper, however, is the benefits to the investing firm. The benefits have been found to vary widely across CVC programs. We propose that variance in CVC performance can be explained by differences in the orientation of CVC funds, as some firms seek direct financial returns on investment while others pursue indirect strategic benefits.
This study supplements existing work in two ways. First, we study the conditions under which CVC investment creates value for investing firms. By looking at value creation, we go beyond narrow financial returns and capture both the financial returns and the strategic benefits. Second, we employ a panel of about 1,200 US public firms during the period 1990-1999. Whereas previous literature relies on case studies or small size descriptive surveys, the use of extensive archival data allows us to study the impact on firm’s value creation while controlling for macroeconomic conditions, industry environment and firm characteristics. Specifically, we control for confounding effects due to cross-industry differences, intra-industry factors (e.g., temporal changes), and intra-industry heterogeneity in firms’ attributes.
It is unclear whether CVC investment should generate a significant financial return on investment. On one hand, established firms may be well positioned to benefit from such investments. They can experience economies of scale and scope in selecting valuable ventures (leveraging expert personnel, in-depth knowledge of markets and technology, etc.), and may be better positioned to enhance the value of their portfolio companies (through complementary capabilities and resources, bargaining power with suppliers, access to distribution networks, and an endorsement on the future viability of the venture). On the other hand, there are reasons to be skeptical of corporate venture capital as purely an investment vehicle. CVC investors likely suffer from rampant information asymmetries. High quality ventures may hesitate to share information about their key technology with established firms for fear of imitation. The effectiveness of CVC programs is also weakened due to internal conflicts. CVC managers may lack the high-powered incentives common within independent VC funds, resulting in the departure of seasoned managers.
Corporate venture capital can also yield indirect benefits, which we term “strategic benefits”. Foremost among potential strategic benefits is that CVC may provide a valuable window on technology. Corporate venture capital may provide an effective means of scanning the environment for novel technologies that either threaten or complement core businesses. Indeed, many firms engage in corporate venture capital primarily as a mean of tapping cutting edge technologies. In the words of Microsoft’s CFO “Our investment strategy is an explicit acknowledgement that Microsoft has no great lock on innovative ideas"(RedHerring, Oct. 1998).” Firms may be willing to tolerate lower financial returns in the presence of strategic benefits. Even the outright failure of the venture may not be a bad outcome if the investing firm retains the entrepreneurial technology. All else being equal, we would expect that the potential innovative benefits of CVC investment compensate for the structural deficiencies that plague CVC programs only when a firm assumes a strategic orientation.
Overall, this study suggests that corporate venture capital investment is associated with the creation of firm value, but this relationship is conditional on both sectoral and firm-specific factors. In particular, the positive relationship between CVC and firm value is greatest within the devices, semiconductor, and computer sectors. Moreover, the contribution of corporate venture capital investment to firm value is greater when firms explicitly pursue CVC to harness entrepreneurial inventions. Thus, varied CVC performance may be best explained by differences in the underlying objectives of the programs. We conclude that in those industries where entrepreneurial ventures are an important source of innovations, corporate venture capital can be a vital part of a firm’s innovation toolkit.
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