Corporate Venture Capital: The Factors Behind Successful Investments

Corey Phelps, Professor of Strategy and Business Policy - July 15th, 2011
Corporate Venture capital: grass growing from money

One way for established firms to explore new ideas is by making corporate venture capital investments. Such partnerships are more likely to be formed when the firm is pressed to do so by intense competition within its industry, or if it can successfully leverage its technological, marketing and social network resources to attract start-ups although resource-rich firms seem to be less influenced by industry competition than resource-poor firms.

Corey Phelps ©HEC Paris

Corey Phelps is Professor of Strategy and Business Policy at HEC. His current research focuses on understanding how companies use strategy alliances, mergers and acquisitions, and (...)

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When private equity was exploding in the 1990’s, actors other than traditional venture capital firms became involved in funding start-ups: they were big corporations such as AOL, Intel or even pharmaceutical companies like GlaxoSmithKline and Merck. Their aim was strategic, a way of keeping abreast of new business models, new markets, and technological changes – in short, a way of practicing open innovation, or looking for new ideas outside their own R&D labs. Corporate venture capital investments have been growing (and crashing) along with the boom and bust cycles of private equity investments. But some of those big corporations have no background in venture capital, to the point that independent investors tend to regard them as “dumb money.” Plus start-ups tend to be fearful of established companies, always wary that the latter are out to steal their ideas. So when Corey Phelps began to take an interest in corporate venture capital (CVC), he came up with a framework explaining the motives, means and opportunities of corporate investors: why were they investing in the first place, and how could they entice start-ups?


The first element that Corey Phelps and his colleagues looked at in their study was industry conditions. “In an intensely competitive industry, with many actors, where product margins are small, there is more pressure to look for new sources of business,” he says. “If it is a sector where technological change is rapid, with large R&D, such as electronics, telecommunications, there is high pressure to seek new sources of value creation as well.” In that context, CVC partnerships are a strategically flexible way to quickly obtain windows on uncertain growth opportunities such as new technologies, new markets or new products relevant to the firm’s core business. It also spreads risk across multiple, low-commitment external initiatives. Unsurprisingly, the study did support the hypothesis that industry technological change, measured by R&D expenditures against sales, had a significantly positive effect on CVC tie formation. A third “push” factor that motivates companies to invest is that of industry appropriability, i.e. the extent to which the economically valuable knowledge they produce can be protected from spilling over to competitors, for example by patents. Says Corey Phelps, “if the mechanisms to protect inventions are not very effective, there is tremendous pressure on firms to move quickly to commercialize their ideas” - another incentive to form CVC partnerships demonstrated by the study.


The second set of factors that largely influences a company’s opportunities and motivations to invest in young ventures is the quality of its resources – beyond financial capital (since it is also offered by independent venture capitalists). “Technological resources such as manufacturing equipment, R&D engineers or even attorneys specialized in patents, are attractive to start-ups, as are marketing resources like extensive distribution channels, market knowledge, a strong brand – think Microsoft – since that’s what young firms do not own, but need in order to successfully commercialize their product or service,” says Corey Phelps. “Resource-rich firms also have more bargaining power with the start-ups who would like to use their resources, and tend to buy their equity share cheaper,” he adds. A resource-rich company is also motivated to use any excess capacity – say, sales channels that are only used 80% of the time, or developers who can devote time to new projects – to maximize their efficiency rather than leaving them slack. Again as expected, firm technological and marketing resources, measured by stock of patents and advertising expenditures, was found to have a significant and positive effect on the formation of CVC partnerships.

But a less intuitive result of the study was the effect of an investing firm’s diversity of experience: “Most CVC activities are syndicated, with several investors sharing the risk and pooling their expertise,” explains Corey Phelps. “This creates affiliation social network between co-investors, and gives access to valuable information, mainly about new opportunities.” And indeed, as corporations invest in various sectors, they become more central within venture capitalist social networks and this has a positive effect on the formation of new CVC ties.


The most interesting result that the research revealed, however, was that the interaction between the two main factors – industry competitiveness and firm resources – produced a counter-intuitive effect. While those companies with the ability to exploit more investment opportunities could be expected to be more active than poorer companies in a challenging environment, the study revealed exactly the opposite. Paradoxically, the richer firms were less likely to pursue exploratory strategic initiatives as environmental turbulences increased - possibly because of the perceptions of decision-makers. “Organizations tend to grow fond of what made them successful in the first place, so they often persist in what they have done in the past when the world changes, rather than overhauling their strategies and adapting. It is often the case that, the richer the firm, the more inert!” says Corey Phelps. One explanation could be that they are not aware of the threats, or choose to further exploit existing assets. “For example, Dell has always sold a lot to of PCs to enterprises, but it has been a flat-growth market for years. Yet they were locked into their strategy of paying attention to enterprise customers, who don’t care much about product design, whereas the PC market for consumers, who want cool-looking computers, is the one growing,” he says. The HEC researcher says he sees many large companies struggling with that issue. 

 Based on an interview with Corey Phelps and the article “Towards understanding who makes corporate venture capital investments and why”, co-written with Sandip Basu and Suresh Kotha, Journal of Business Venturing?  no. 26, 2011.

Applications for decision-makers
Applications for decision-makers

Firstly, corporations wishing to invest must be systematic in evaluating their resources: what excess capacity have they got and how can it be leveraged to attract potential partners? In particular, they must look at the specific technological and marketing assets they can offer as industrial players, since they are competing for opportunities with independent venture capitalists who already offer financial capital. It’s also important to be honest about the expected costs and benefits of the move itself, since some investors fall prey to the bandwagon effect, jumping into venture capital just because everyone else does. “Corporate investors tend to enter the market late and exit early, which is the worst possible strategy,” warns Corey Phelps. Last but not least, would-be investors need to convince professional venture capitalists, almost more so than start-ups, that they can deliver the goods. “The majority of VC investments are syndicated, which means that companies need to overcome the bias against ‘dumb money’ to break into networks of investors that are in effect good old boys cliques,” says Corey Phelps. “Their admission ticket is once again the value they can add, as industrial entities.” Then they can benefit from the advantages of an investor network.


The study focused on the formation of new CVC (corporate venture capital) partnerships. It was based on a  sample of 477 firms in the 1990 Fortune 500  list, operating in more than 300 industries. Within the sample, 83 firms engaged in CVC activities, making 1860 investments worth a total $7.7 billion. The study covered the period 1990-2000, mainly because the number of firms investing as well as the average volume of investment grew during those years.