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The case for Corporate Venture Capital

Recently I published a couple of articles about Corporate Venture Capital (CVC). First I compared the adoption of corporate venture capital by large companies in US and Singapore and concluded that Singapore companies have a long way to go to catch up to US companies. Then I looked at some possible reasons for this difference. 

This time I thought I should address the obvious question; why Corporate Venture Capital? Is it really a big deal that the biggest public companies in Singapore seem to be significantly behind when it comes to adopting CVC?

When I use the term Corporate Venture Capital (CVC) in this article I use the term broadly to describe a systematic effort by a large company to engage with start-ups. This could be through a CVC fund, accelerator, incubator or some other platform that allow a big company to meet innovative start-ups.

Companies launch CVC programs both as an offensive and defensive strategy. 

The two most important offensive strategies are:

1.     Strengthen the company’s competitive advantage

2.     Generate financial returns.

The most important defensive strategy is:

3.     As a hedge against potential disruption

Other reasons could be to increase internal innovation, outsource some or the organization’s entire R&D, inculcate an entrepreneurial mindset in the organization, attract and retain the best talent, update the organization’s positioning, etc. But let’s focus on the key reasons to launch CVC activities;

Strengthen Competitive Advantage

A well-executed Corporate Venture Capital strategy can be a company’s best tool to stay updated on new technology and market trends. The company is positioned to spot changes in the market early and it allows them to take advantage of new opportunities. Kodak, Blockbuster, Nokia… there is a long list of big companies that did not realize the world was changing before it was too late. Having an active CVC unit in your company ensures that you company doesn’t join that list.

CVCs essentially act as a supplement to internal research and development. Investing in small companies can also serve as a gateway for possible acquisition. A minority stake in a company allows the firm to evaluate the potential acquisition more in-depth and potentially offer a buyout.

Financial Returns

In addition to being a good strategic tool for your business CVC can also produce excellent financial returns. In the past few years Singapore has attracted a number of new VC funds tasked to allocate hundreds of millions of dollars into start-up investments. This funding is available because investors see opportunity for outsized returns in this asset class. A Corporate Venture Fund has some advantages that should position them to make even better returns than pure financial investors. Firstly – domain knowledge – drawing on the deep knowledge of the industry the parent company is in a Corporate Venture Fund should be in the best position to evaluate and identify potential winners in their industry. Secondly – after making the investment a Corporate Venture Fund can draw upon the resources of the parent company to help the start-ups they have invested in succeed.

Hedge against disruption

Occasionally new technology surfaces that seem like it has the potential to disrupt whole industries. One example of this is block chain technology in banking or insurance. We are starting to see adoption of this technology but it is only the beginning and nobody can accurately predict just how much of an impact this technology will have in five years’ time.

So, some established companies hedge their position by investing in companies that will be successful if their core business is disrupted. They may not believe that it is likely to happen but at least this way they have positioned themselves in the event of dramatic and unlikely changes in their industry.

These are some of the main reasons why Corporate Venture Capital is a popular diversification and hedging tool for many large US corporations.

So, does it matter then that only 12 of SGX 100 most valuable companies have a CVC program compared to 75 of Fortune 100 companies?

Of course looking at these numbers alone is just an indication, you would have to consider a variety of factors before you draw a final conclusion on this. However, it certainly looks like SGX companies are less concerned about innovation than their US counterparts.

As a shareholder of a couple of these companies I would say that this matter. I assume all investors on the SGX would like to think that the companies they invest in are prepared for the future. Anyone with a medium to long term investment strategy should consider how their investments are positioned in a rapidly changing technological landscape. You would want to avoid investing in companies that have built their business on yesterday’s technology.

These companies are major employers and tax contributors so the general public and the government also have an interest in these companies success. Especially given that Singapore is a small country the impact of the success or failure of a handful of these big companies will impact the overall economy much more than it would in a bigger economy.

For local entrepreneurs of course it would be good to have additional sources of funding and easier access to the network of the biggest companies in the country. But the situation is a bit more complex. In the past few years risk capital available for entrepreneurs have grown almost exponentially. So introducing even more risk capital without also increasing the deal flow there is a risk of unbalance in this market. Start-up valuations would rise and this would put pressure on returns for venture funds. If these funds fail to produce an attractive return they will face challenges when raising their next funds and in a worst case scenario we could see the positive trend in this market reversed.

Based on this I would say that it does matter that only 12 of SGX 100 companies have a CVC program. Especially given that CVC, if done correctly, can be a profit center for the company. So not only will it benefit the company in the long run by making sure it stays competitive but the CVC program can also pay for itself and generate financial returns similar to a financial VC.

There has been a positive trend with more CVC programs launched in the past couple of years. Hopefully this is just the start and we will see more SGX listed company’s use of CVC more closely mirror their US counterparts in years to come.

Next week I will dive deeper into other aspects of CVC in South East Asia. Stay tuned! Have a great weekend!