Finance -- 'Dumb' Is Smart:

Dec. 21, 2004
When done the right way, corporate venture capital pays big dividends.

Not that long ago, venture-capital funds run by corporations often were dubbed "dumb money." The primary reason? Corporate venture capitalists (VCs), who tend to invest in firms with which they have a strategic link, routinely paid more for their investments than did traditional venture-capital firms. No longer. More companies than ever before are setting up venture-capital funds, and they're becoming masters of the investment game. Corporate venture funding hit a record $6.3 billion last year, nearly four times the $1.7 billion invested in 1998, according to The Corporate Venturing Report newsletter. What's more, such companies as Minneapolis-based ADC Telecommunications Inc., a computer networking equipment supplier, are running their VC operations as astutely as the fiercest independent VCs. The $49 million that ADC invested in a dozen start-ups during the last five years has multiplied impressively into stakes worth about $679 million. Broader-based numbers compiled by Paul Gompers and Josh Lerner, two professors at Harvard Business School, Boston, are similarly impressive. Reviewing more than 32,000 venture capital placements between 1983 and 1994 using an initial public offering (IPO) as a measure of success, the two profs found that 35% of the firms funded by corporate VCs had completed IPOs while only 30% of the firms backed by traditional VCs had. Additionally -- and contrary to prevailing wisdom -- the percentage of companies completing IPOs was slightly higher -- at 40% -- when a strategic link existed between the corporate VCs and the companies in which they invested. In the increasingly knowledge-driven world of manufacturing, corporate VC programs are, in fact, becoming critical building blocks of many companies' research efforts. "The companies we invest in are one more vehicle to access innovation, along with our investment in R&D," says John Hanley, managing partner at Lucent Venture Partners, a subsidiary of Lucent Technologies Inc., which has offices in Palo Alto, Calif., and Murray Hill, N.J. Although Lucent doesn't disclose the precise financial returns on its venture investments, Hanley says the group "is very satisfied." Robert Switz, chief financial officer and head of business development with ADC, agrees. "We can't afford an exorbitant number of advance development programs," he says. "These investments give us a window to the future." How can you put venture capitalism to work for you? Clearly, investing in companies with which there's a strategic fit is important. And there are four other critical, though not necessarily as obvious, best practices.

  • Develop relationships with traditional VC firms. Lucent, for example, decided early on to work with -- rather than against -- independent VCs, says Hanley. "We looked at the value the VCs bring in terms of contacts and knowledge," he explains.
  • Compensate VC employees appropriately. Top-drawer independent VCs get a cut of their deals, often pushing their salaries into seven figures. Corporate VC employees typically are paid more in line with their corporate colleagues, leaving their employers vulnerable to high attrition rates.
  • Draw on expertise from the rest of the company. Successful venture programs, such as ADC's, rely on the know-how of their colleagues in R&D and business development to identify promising investments. An added benefit: Engaging others in the company helps cement their commitment.
  • React quickly. The VC industry can get deals done in almost no time. Corporate VCs that want to win have to operate similarly. For instance, the partners at Lucent spend every Monday reviewing current and potential investments. They can respond to proposals in a few days, if necessary.
Karen M. Kroll, president of Kroll Communications, Minnetonka, Minn., covers finance for IndustryWeek.

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