Designating a CVC Fund: Key Considerations – Part II

In the previous post, I introduced the three key considerations to design a corporate venture capital (CVC) fund and mentioned the six pillars for setting up the fund. I also explained the first pillar called strategy. Here, I will present the five following pillars as well as some suggestions and conclusions.

People - The type of people who are linked to the fund is key to its own success, as well as the investments and the quality of the relationships that are developed with the entrepreneurial ecosystem and with the entrepreneurs. Unlike a traditional venture fund, a CVC considers a group of six associated and clearly interrelated teams.

• Management team – In most CVC funds, the fund leader is a senior executive (usually within the C-Level) who has a clear vision and strategy of the company and a remarkable understanding of how both the fund and each one of the investments can add value to the organization.

• Investment team – This team is made up of professionals with experience in investments and M&A in startups, whose role ranges from relating to ecosystems, identifying potential investment opportunities, leading the pre-investment stages, such as validating entrepreneurs and their companies, participating in the due diligence, investing in the startup and managing each of the investments.

• Investment committee – This committee is the one that ultimately decides on each of the opportunities presented by the investment team and on the suggestions and recommendations made by the same team according to the due diligence analysis. In the case of a corporate, this committee is mainly made up of executives directly related to the organizational strategy, as well as members of the business units of interest to the company.

• Board of advisers – The members of the board come largely from sectors in which the company is interested in entering through investments and, in many cases, provide an external view of the company that enriches the vision and tendencies and helps to reformulate many of the organization's approaches.

• Knowledge transfer and integration – Unlike a venture capital fund, much of the success of a CVC comes from the ability to capitalize on the investment through the incorporation of knowledge or integration of the startup within the organization. Understanding how the startup can be integrated into the production processes of a larger organization is not a small thing. In the same way, considering the life cycle of technology and its contribution to a new product is essential.

• Service portfolio – Entrepreneurs, when considering collaborating with a corporation, not only take into account the investment but also the added value that a large company can bring, such as access to clients, markets, and the potential to scale faster, among others.

Incentives - Unlike a traditional venture capital fund where the compensation of its members is regularly structured by a salary (which comes annually from the fund management fee, regularly between 1.5% and 2.5 % of the total fund), a performance bonus and success compensation according to the performance of the fund (called carry interest, which usually corresponds to 20-25% of the profits generated by the fund at the time of divestment). In this case, the group of fund managers or GPs are aligned with the investors in the fund or LPs, since both are correlated through the success or failure of the fund. In the case of a corporate, the members of the fund are employees of the company and their motivation within the fund is different, so the compensation must also be designed differently and be more aligned with the contribution of the fund to the corporate strategy, the risk that the strategy entails, the expected contribution to growth based on innovation, as well as the experience and trajectory of the CVC members. Setting some of these goals requires designing the appropriate metrics for each organization.

Deal flow – Investing in startups that generate strategic and financial returns implies that the CVC fund has both the volume and quality of companies good enough to guarantee the success of the investments. This implies not only relating to the right startups and entrepreneurs, but also being efficient in understanding trends in the sectors and market segments of interest, analyzing numbers and managing value relationships with other investment funds and agents of the entrepreneurial ecosystem. Following up on startups that are not yet within the expected growth range or desired investment amount is also important. Participating in entrepreneurship events, acquiring analysis tools and having conversations with entrepreneurs is key to identifying good opportunities.

Governance – The governance of the fund is important for its success. Therefore, it is relevant to establish processes, policies, and procedures that define the way the fund should operate. Establishing a good reporting structure depends on several factors, but it is undoubtedly key to track the fund’s operation and results. An example of this is how investment decisions should be established, the due diligence process and the approvals that the investment committee will generate. Additionally, establishing whether the CVC will take seats in invested startups is relevant.

Ecosystems – Some CVC funds have a reach in various regions due to the geographic expansion they have made over time. This makes it easier to leverage their resources to establish relationships with various ecosystems. However, even the smallest corporate funds should consider establishing relationships with other ecosystems, as this broadens the opportunity to identify the best collaboration or investment opportunities. Strengthening relationships with investment funds, accelerators and incubators is decisive in the success of the fund's strategy. For many startups, the possibility of opening a new market in the hands of a corporation is usually very attractive.

Suggestions and Conclusions

Although in recent years we have been able to observe a greater number of CVC funds, it is also true that many of them will not continue because some of them did not consider the three key conditions before designing the fund: commitment and execution;  vision; and willingness to take risks.

In this way, many funds close because they did not establish a clear vision of the contribution that the model can make to the corporate growth strategy; therefore, there is no long-term commitment, nor were the adequate structures created to guarantee a good fund execution. In the same way, they are not prepared to understand the context in which startups and their entrepreneurs live.

Considering an investment to catch the wave just because others are doing so, can show that the opportunity is being taken. But it also demonstrates an incomplete vision because the strategic component that investments have for a corporation is wasted.

The ideal is to start easy, but with determination toward the generation of value for the company and the creation of new vehicles for growth.

Luis Hernández Alburquerque is an expert leader in Corporate Venturing and Corporate Venture Capital (CVC) focused on transforming mindsets to build growing organizations based on innovation, technology and venture investments.