When it comes to innovation, we live in an era of outsized returns.
If you invested in the SP500 12 months ago, you would be up more than 50% today despite the human and economic tragedy of Covid-19. But if you look under the hood, these gains were largely driven by Apple, Amazon, Facebook, Google & Microsoft.
These five companies have driven the majority of the gains in the stock market, and in 2020 they briefly exceed 25% of the value of the whole index. Without them, an index holding the remaining 495 stocks would have been a losing investment. The top five are, of course, all tech companies. And they are winning because they have been able to create competitive advantages through the innovative use of technology.
Of the $13.2bn invested in UK tech companies in 2019, $3.5bn was invested by corporate venture capital teams.
A lot of this innovation is through internal R&D. But a staggering amount also happens externally through both M&A and VC. The global tech leaders know all too well that a lot of the most disruptive innovation happens not in corporate R&D labs, but inside the many startups that have set out to disrupt the way existing players do business.
Most other large corporates have caught on to this fact, fuelling a boom in VC investments made by corporates. Of the $13.2bn invested in UK tech companies in 2019, $3.5bn was invested by corporate venture capital teams.
Big businesses typically either make their own VC investments through in-house corporate venture capital (CVC) funds, or they become LPs (investors) in existing VC funds. In this way, large multinationals have become a huge part of the startup ecosystem.
The missing piece of the puzzle… and opportunity for mid-sized corporates
However, thousands of mid-sized corporates are missing out. We are not talking about ‘small businesses’ here. These companies turn over hundreds of millions in revenue and employ thousands of people. However, they typically don’t have the +£100m required to set up their own venture teams.
Mid-sized businesses don't have the +£100m required to set up their own venture teams.
There’s a talent issue, too. Even if mid-sized corporates created smaller in-house funds, it’s not easy to find talent to run them. The best investors are looking for both freedom to invest, and also enough capital to make an impact.
But, just because they don't have access to the same massive pool of capital as large multinationals, doesn't mean they need to remain excluded from the innovation that happens in the startup ecosystem. There are other ways for these businesses to take advantage of opportunities in the startup ecosystem. We’ll explore that in a minute. First, let’s look at the state of innovation for mid-sized corporates.
The state of play: mid-sized corporates are struggling to innovate
Mid-sized corporations are under a lot of pressure to innovate — especially post-pandemic. In a marketplace that’s increasingly competitive, increasingly regulated and (thanks to Brexit and Covid-19), increasingly volatile, agility and innovation are the only ways to survive.
63% of CFOs see innovation as a critical factor during the recovery period.
According to PWC, 63% of CFOs see innovation as a critical factor during the recovery period. But on the one hand, they are often struggling to attract the best technical talent to their in-house R&D efforts. And on the other, they do not have the financial resource to set up their own venture capital programmes.
How mid-sized corporates can win: partnership, collaboration and investment
Currently, you see a lot of mid-sized corporates running hackathons and intrapreneurship initiatives. These things are good for generating ideas, but generating ideas is not the same as building new businesses.
Building a successful startup requires years of unbelievable effort and dedication, and the motivation to make this work can typically only be created when founders have the upside to win big when things work out — combined with the real risk of losing out if things don’t work to plan. It is hard (=impossible) to recreate this structure inside a corporate setting.
Accelerators have also become popular. But we are arguably past the saturation point with accelerators, and in many cases, even the biggest firms are using partnerships to increase their clout. Boeing partnered with the Aerospace Technology Institute, Rolls-Royce and GKN on their accelerator programme. The German Startup Autobahn is the product of over 30 big-name partners including Daimler and Bosch. One mid-sized corporate can’t compete with that kind of brand equity, nor the varied and sophisticated programme they’re able to offer.
This leaves a third route for mid-sized corporates — namely VC investments. Building a portfolio of investments requires substantial time commitment, however, and it is often hard for anyone but the largest corporates to attract the talent required to build a successful in-house venture team.
There is an alternative to the 'go it alone' strategy — partnering with specialised venture capital investors.
But there is an alternative to the 'go it alone' strategy — partnering with specialised VC investors. The past decade has seen the creation of a lot of new, independent VC firms. These funds specialise in identifying and investing in startups operating in all different parts of the global economy. Specialist VC investors have access to thousands of startups and knowledge of how to select and support the founding teams to make them successful.
This is a marked difference to the regular, generalist VCs that typically predate them. Although these firms can be good at offering general market access, they do not have the same focus on, and access to, niche sectors. What these emerging managers often lack, however, is the capital required to back more winning teams and compete with the big bucks from the corporate VCs and the large, generalist venture funds.
By partnering with these emerging VC funds, mid-sized corporates can get much closer to the startups that are likely to disrupt their industries. And they can do so in a way that is financially much more affordable and manageable.
How it works
In real terms, it works like this: mid-sized corporates are typically able to invest between £2m to 4m. Through this investment, they gain access to portfolios of between 20-40 companies. If they have co-investment rights, they can then invest more in the companies they really like, or in those that have strategic value.
All early investors get diluted in later stages, but they also bought in at low valuations. Done right, returns can be great at early-stage investment, because the valuations are so much more attractive. And the mid-sized corporates wouldn't invest for control, they would be investing for access — so they have a good handle on what's coming, before it has grown massive.
It’s up to the boards and CFOs of these companies to grasp the initiative and to work together with funds to join the dots.
And equally, it is up to the emerging VC managers to seek out partnerships with mid-sized corporates and be ready to take the opportunities when they arise.
This way, more aspiring corporates will be able to benefit from the innovation that happens in the startup ecosystem. And more startups will benefit from the investment and customer partnership these corporates can bring. Done right, this is a winning proposition for everyone — including the mid-sized corporates who can help make it happen.
Mads Jensen is partner and cofounder of SuperSeed, the VC investor in B2B startups.