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Equity Is on a Roll, but Are Investors in for a Let-down?
Mind over Money
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Prof. Gary Dushnitsky says value of corporate VC is greater with
strategic, not financial investments
Gary Dushnitsky, a Wharton professor of management and an expert in entrepreneurship, had heard managers of corporate venture capital (CVC) complain about their inability to prove their value to their superiors. When he would moderate panel discussions he heard these practitioners units grouse about the lack of objective, broad-based data. Or he would listen to them debate the different approaches to their field: Some corporate VC groups seek financial returns alone while others use their investments as a way to access new technologies.
But no one could tell him which approach ultimately gave a better return and increased the value of its parent company. Dushnitsky and Michael Lenox, a management professor at Duke University, decided to find out.
"We're in an age where management is becoming more scientific," Dushnitsky says. "But corporate VC is one of the areas where, if you look at the maps, you'll still see dragons floating on the margins. Nobody really has a good sense of how to structure it or what its mandate should be."
Dushnitsky and Lenox's conclusion: Despite all the big dollars that get tossed around, corporate venture capital's real benefits accrue to strategically-oriented, not financially-driven CVC programs. Companies that use corporate VC as a way to access new technologies increase their value more than those who undertake solely to make money.
"Exposure to new ventures may help investors innovate themselves or procure promising technologies through licensing or acquisition," Dushnitsky and Lenox write in a study recently published in the Journal of Business Venturing. "Also, supporting new ventures that develop complementary products and services may further increase the demand for current and future corporate products."
Strategic investing also can lead to a paradox, the two scholars point out: Winning by losing. "Even the outright failure of the venture may not be a bad outcome if the strategic benefits outweighed the initial investment," they write.
These sorts of benefits appear greatest in the semiconductor, computer and device sectors, they say. Which makes sense—Intel, after all, is famous for the effort it devotes to venture investing, even though many of those investments don't help it build better microchips. "Intel often invests in software because a strong supply of software allows for demand for its cutting-edge microprocessors," Dushnitsky explains.
Dushnitsky and Lenox examined corporate venture investments from 1990 to 1999. They created a data set of nearly 1,200 firms, of which 171 had made venture investments during the study period. They measured firm value using a ratio called Tobin's Q, which takes in account both a company's market capitalization and its tangible assets.
They feared that the Internet bubble might skew their results. But when they factored out the bubble years, the finding remained—firms pursuing strategically-oriented corporate venturing trumped those with purely financial-focused venturing efforts.
Even among strategic investors, firms employ varied approaches, Dushnitsky points out. Some seek acquisition candidates in hopes of marrying a promising new technology with one of their existing ones. Others just want a window to cutting-edge technologies, which they might then license. "The thinking here is, 'We realize that, as big as our R&D department is, it's not as big as the universe,'" Dushnitsky says.
And still others, like Intel, try to foster what Dushnitsky calls "technological ecosystems" in which their products and services can thrive. Some companies, like Johnson & Johnson, combine these approaches, he says.
In contrast, companies that pursue corporate venture capital for mostly financial reasons alone may go astray. "These are the ones that were motivated by the amazing returns that they saw VCs generating," Dushnitsky says. "They were saying, 'We're sitting on a big pile of cash, and we're as able as VCs are to identify opportunities and provide value-added services like connecting startups to suppliers, customers and distributors."
Trouble is, corporate venture capitalists who believe this are usually wrong—at least inasmuch their efforts can be measured in terms of their parent company's value.
And that's why Dushnitsky counsels corporate managers to stick with strategically-oriented investments: "Even if you think if you're better at due diligence than a VC, it doesn't really benefit your shareholders to pursue financial venture capital."
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