The Life Cycle of Corporate Venture Capital

Recent decades have witnessed non-financial firms’ forays into venture capital by creating Corporate Venture Capital (CVC) divisions. That is, these firms create internal CVC divisions to make systematic minority equity investments in innovative startups. As an illustration, consider GM Ventures, the CVC unit initiated by General Motors in 2010. On behalf of General Motors, GM Ventures invested in dozens of auto-related technological startups through minority equity stakes in early-stage venture rounds. The case of GM Ventures is hardly an isolated occurrence. CVC has become a common form of corporate investment adopted by hundreds of firms and has emerged as an important source of entrepreneurial capital. It accounts for about 20% of VC investment (National Venture Capital Association, 2016), and is comparable in size to 5% of US corporate research and development (R&D) spending.

The question naturally arises: why do firms go beyond traditional corporate investment to make arms-length entrepreneurial investments in startup ventures? There can be several different explanations. First, the agency view of CVC would argue that CVC is just a new (and potentially more subtle) way for managers to enjoy exciting perks and waste shareholders’ money. Alternatively, CVCs can be motivated by incumbent firms’ desire to earn purely financial returns from a promising entrepreneurial sector. This financial view of CVC would argue that incumbent firms shift from internal investment to external investment such as CVC when internal investment opportunities are poor. Last but not least, the strategic view of CVC emerges from several theories arguing that CVCs can be used to seek strategic complementarities from connecting to startups, most noticeably to expose firms to startups’ new technologies, because startups are where the innovations are.

My paper aims to empirically investigate these different conceptual views of the CVC rationale. To achieve this goal, I compile a comprehensive sample of CVC divisions launched by US-based public firms in the past three decades using information from both archival data and media searches. This sample is augmented by information on CVC investment history, portfolio companies, and parent firms’ innovation, financials, and governance. This detailed dataset allows me to empirically study each stage of the CVC life cycle—from when firms enter CVC, to how CVCs invest in and interact with portfolio companies, to the decision of terminating CVCs. The key insight that helps to distinguish between the agency, financial, and strategic views is that each view generates different predictions at each stage of the CVC life cycle.

The analysis begins with the CVC entry decision. I explore the determinants of CVC entry in a firm-year panel. The main finding is that typically CVCs are started following deteriorations in internal innovation, reflected in decreases in innovation quantity and quality. This finding supports the strategic view of CVC, which argues that firms increase external information acquisition to complement internal innovation when the ability to internally generate ideas deteriorates. The evidence could also be consistent with the financial view, which predicts that firms substitute internal R&D with CVC investment when internal innovation opportunities dry up. In contrast, measures of corporate governance, including institutional shareholding and the G-Index, do not explain CVC entry decisions, which indicates a lack of support for the agency view.

I next explore the investment phase of the CVC life cycle, hoping to further distinguish between the strategic and financial motives. I find that the technological proximity between the patent portfolios of a CVC parent firm and a startup has a positive effect on the probability that a venture relation will be formed. But more importantly, conditional on working in proximate technological areas, CVCs are more likely to invest in startups about which they have less information, reflected by fewer mutual citations. In addition, CVCs appear to have a “reverse home bias”—that is, they are less likely to invest in companies in their own geographic regions, with which there are already strong local innovation spillovers. Can parent firms integrate such complementarities into internal innovation? The answer is yes. CVC parent firms are more likely to cite patents generated by their portfolio startups after making the investment. This citation pattern only happens after investments are made, and never before. Overall, CVC appears to be an important component in the system of gaining innovation.

The final analysis concerns the termination stage of CVCs. CVCs appear to be temporary divisions that have shorter and non-uniform life cycles. The median duration of the CVC life cycle is about four years, with an average of six. I show that a CVC’s staying power is closely related to the innovation dynamic of the parent firm, and it is terminated when internal innovation begins to recover. The staying power and termination decision are not explained by exit failures of portfolio companies or by governance changes such as CEO turnover.

In summary, the findings of this paper lend the strongest support to the strategic view—CVCs are in general temporary corporate divisions for incumbent firms to respond to negative innovation shocks and help those firms to expose themselves to new technologies in order to regain their innovation edge. This message is important for shareholders who need to govern and monitor CVC adoptions, for startups and venture capitalists who work with CVCs in entrepreneurial financing, as well as for policy makers who regulate interactions between firms and aim to stimulate innovation.