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Essay on Venture Capital – Motivations For Corporate Venturing

| June 27, 2017

1.       Introduction

Traditionally, the interest of companies in creating venture funds was influenced by the venture capital climate. Increased rates of corporate venturing activity recorded in the 1960s, 1980s, and 1990s were in correspondence with the flourishing venture capital investments (Narayanan et al., 2009). Despite the deterioration in private equity investment owing to the fall of the dot-com sector in early 21st century, corporate venturing is still considered to be an important business activity in large business organisations (Gailly et al., 2014). However, corporate venturing is marred with complexity including the disconcerting array of existing corporate venturing forms (Guerrero & Peña-Legazkue, 2013). As Garg (2013) argues, for many years, large business organisations have been cautious about the idea of corporate venturing. Some have witnessed a failure of their venture initiatives while others have given up so easily. Generally, the lifespan of corporate venturing initiative is around one year (Basu & Wadhwa, 2013). Even business organisations with a strong capital base have struggled to utilise knowledge that is gained from start-up initiatives (Basu et al., 2011). Certainly, it is not easy to run a corporate venture capital successfully. However, as the rate of discontents in research and development increase, corporate venturing is gaining respect and appreciation in the business world (Masulis & Nahata, 2009). To clearly position the reasons that motivate organisations to consider corporate venturing, it is imperative to analyse the concept of growth and development as a result of the effectiveness of research and development initiatives at the organisational level.

2.       Venturing and Firm Innovativeness

Ideas that are innovative can be produced via internal R&D or access externally through activities such as corporate venture capital initiative. Companies must not limit themselves to in-house R&D as a source of innovativeness. In spite of the high prevalence of internal R&D as a source of innovativeness in many business organisations from a historical perspective, a decision to limit an organisation to sourcing its innovativeness from internal R&D has its limitations (Srivastava & Agrawal, 2010; Guerrero & Peña-Legazkue, 2013). As research on economic-based industries suggests, monopolies lack efficiency which results in the costs associated with inefficiency being passed down to the final consumer (Narayanan et al., 2009; Napp&Minshall, 2011). This idea is also recognised in corporate entrepreneurship research. Specifically, Gaba and Bhattacharya (2012) argued that elevated R&D expenditure at the organisational level is an indicator of internal inefficiencies and elevated agency costs rather than successful innovative initiatives or antagonistic risk-taking approaches.

Therefore, it is necessary for corporations to eliminate the monopoly enjoyed by their R&D units. Economics positions the existence of competing players as a source of efficiency when compared to a monopoly state (Basu et al., 2011). At organisational level, structuring of corporate innovative initiatives can be realised through the development of several R&D centre or supporting various technological initiatives through approaches such as corporate venture capital. Furthermore, research has raised concerns over the possibility of collusion pitfalls in cases where the number of players is limited (Napp & Minshall, 2011; Basu & Wadhwa, 2013). This can be addressed by offering a significant geographical dispersion of R&D centres. Indeed, according to Gaba and Bhattacharya (2012), having numerous research sites that are geographically distributed enhances corporate innovativeness by providing assistance in disabling organisational inertia, offering variety, and ultimately speeding up the development of new capabilities and technological advancement.

The option of multiple technological activities that is founded on corporate venture capital initiatives is also common among various leading companies on a global scale in the recent past. A decision to introduce the concept of competition in processes that generate organisational innovativeness has been found to eliminate inefficiencies in organisational innovativeness activities (Maula et al., 2009). Agency theory emphasises on inefficiencies that emanate from contracting associations between a firms engaging another firm to undertake certain activity on its behalf, which entails a decision to delegate a significant decision-making authority to an agent (Srivastava & Agrawal, 2010). The consideration, in this case, is that both players in the contract are rational, self-interested, risk-averse, and opportunistic. Consequently, the opportunistic behaviour of the agent may not be in agreement with the best interests of the principal (Garg, 2013; Bruneel et al., 2013). The agent’s opportunistic behaviour is manifested via adverse selection, moral hazards, and hold-up (Cumming & Johan, 2010). In addition, any form of misalignment that exists between the principal’s and the agent’s interests implies enduring loss by the principal (Maula et al., 2009; Souitaris & Zerbinati, 2014).

A typical situation where an agency problem is applicable is the case of a relationship between business managers and owners (Cumming & Johan, 2010). However, this situation can easily be applied to the relationship between a firm’s R&D unit and its top management. In this case, the internal R&D unit is positioned as an agent of the firm’s top management that is involved in technical advancement. Therefore, selection process that is adverse may be a significant issue if the R&D unit initiates a project that extends beyond its expertise. The issue of moral hazards is common in cases where actions taken by an agent cannot be verified which is a common occurrence in complex research and development projects, where observable results rather than behaviours that cannot be verified is the solution (Narayanan et al., 2009). Hold-up challenges may emerge when internal projects that are not successful are not suspended from corporate funding even when the outcomes are useless in spite of significant corporate expenditure.

Therefore, a decision to create a corporate venture capital initiative is a solution to some of the problems associated with agency challenges. Specifically, corporate venture capital plans provide internal R&D units with a significant challenge over their monopoly on generating organisational innovation. According to a research done by Basu et al. (2011), challenging the monopoly by internal R&D unit on innovation production has assisted several business firms to directly move into successful business initiatives that would have been assumed under normal internal R&D situation. As much as corporate venturing is considered to be dangerous due to the threat of opportunism (Garg, 2013), a decision to limit innovative activities to internal R&D unit is more problematic (Cumming et al., 2009). The challenges associated with monopolies are just part of the challenges. Without sufficient level of diversity, strategic renewal, which is considered a major entrepreneurship, can never be realised. Development of corporate venture initiatives is, therefore, significant in minimising moral hazards and adverse selection (Maula et al., 2009).  Allocating an organisation’s funds to a corporate venture is a significant threat to the availability of funds that can be applied in internal R&D projects, which spurs competition based on the economic perspective analysed above.

3.       Motives that Drive Corporate Venturing

Research has established that a corporate venture capital fund is more flexible, can move faster, and is generally cheaper when compared the conventional research and development in assisting an organisation in the process of responding to changes in business models and technologies (Maula et al., 2009; Napp&Minshall, 2011). According to Garg (2013), such a fund can be used in the process of stimulating demand for a firm’s products. Furthermore, corporate venture capital is an investment that may earn a company a return that is attractive. It is, therefore, a tool that is used by a firm in capturing ideas that ultimately influence the future of an organisation. There are various benefits that come with venture capital including faster response, better analysis of business threats, easier disengagement, enhanced investment impacts, increased demand, and higher returns.

3.1.     Venturing and Business Response

Through offering an inside perspective of new technological areas as well as an approach that can lead to possible ownership and use of novel ideas, corporate venturing allows businesses to swiftly respond to changes in the market. In a study done by (Narayanan et al., 2009) about venturing initiatives, it was established that companies that were able to make successful financial investments experienced better success levels. Consequently, such development capabilities that are experienced under venture capital initiative take a longer period of time to be realised if done by a firm on its own and is generally more expensive (Souitaris & Zerbinati, 2014). Given the resources and time needed to modernise research facilities and recruit researchers with the right skills and expertise, expanding a firm’s internal research and development can be generally painstaking (Phan et al., 2009).

3.2.     Venture Capital in Threat Management

Venture fund can be used by an organisation as an approach to gathering intelligence, which assists the firm in protecting itself from emerging threats to its competitiveness in the market. For instance, Analog Devices, the silicon-chip specialist formulated a venture program in the 1980s focused at investing in a variety of competing technologies (Basu et al., 2011). The goal, in this case, was to collect strategic information at a lower cost. The process resulted in a discovery that it was difficult and expensive to make chips using non-silicon materials. This resulted in a hike in Analog’s market valuation. In this case, the decision to utilise corporate venturing program offered the company a source of insurance. In this case, if the alternatives that the company had opted to explore had been viable, it was covered from the risk of being faced out of the market by its competitors. Conventional approaches to research and development does not offer data that can be used in predicting sources of competitive forces. Specifically, most corporate research and development units focus on projects that are narrow which can result in neglect of areas that can cause a significant disruption from external competitors. Accordingly Phan et al. (2009) argue that most business managers in firms with versatile internal R&D functions face challenges when it comes to determining whether their companies are blindsided with regard to new innovative developments that may threaten their competitiveness

3.3.     Venturing and Easier Detachment

Another positive aspect of venturing that is related to the ability of a firm to speed up its response to threats and change is that it offers organisational management a faster approach to detach from investments that appear to be doomed to fail. In particular, many firms find it challenging to abandon innovations that are not very good but are developed internally (Rohrbeck et al., 2009). Such projects can remain in a firm’s product development for many years resisting termination. This can well be illustrated by Nokia’s continued focus on developing its mobile phones based on the Symbian operating system even when most of its competitors had opted to go into free fall, which negatively affected the competitiveness of Nokia in the market. The relationship that exists between firms and their venture funds which is arm’s-length is advantageous in this respect. In particular, as much as a firm may be reluctant to terminate an initiative that is unpromising, the presence of co-investors provides a platform for forcing the decision.

3.4.     Venture Capital and Increased Impacts of Investment

Venture Capital provides business firms opportunities for combining their capital with other venture capitals, which results in the magnification of the effects of an investment to a firm. These benefits are particularly apparent in cases where technological uncertainty is significantly higher. The iFund, which was supported by Apple Company and introduced in the market by Kleiner Perkins Caufield & Byers, a venerable VC firm, provides an illustration of this case. This investment enabled Apple to build applications for its new mobile phone products at the lowest cost possible. This was in contrast to the case of Nokia, which was a major market rival to Apple Company whose operating system, Symbian was unsuccessful and very costly. As a result of the success of the iFund, similar such initiatives have been positioned by many other companies including famous venture capital developments such as Facebook and Research in Motion.

3.5.     Venturing and Market Demand

Venture firm provides a firm with several sources of leveraging. This can be illustrated by the iFund case. In particular, a decision by venture capitalists to promote the development of technologies that were reliant on the parent firm business platforms results in increased demand for the firm’s products. This approach was considered by Intel Capital in the late 1990s when it founded a capital that speeded the adoption of Intel’s next generation chips in the market (Rohrbeck et al., 2009). This fund was invested in numerous hardware and software makers who were mostly Intel competitors and their products capitalised on the power presented by the new chip developed by Intel. These investments resulted in the accelerated adoption of Intel chip within a short period of time. Intel capital was also involved in seeding firms that were developing wireless internet products founded on a platform that had been championed by Intel. This resulted in rapid adoption of wireless products from Intel in the following years, which illustrated the success of the company in applying corporate venturing in creating a network of wireless actors.

3.6.     Venturing and Returns

Research has also established a financial benefit that is associated with venturing. Specifically, the main objective of any venture capital initiative is to generate revenue for the partners. With regard to corporate venture capital, the main goal is gaining a strategic advantage in the market, which ultimately culminates in increased profitability as much as the initial income generated as a result of the venture itself is insignificant with regard to the bottom line of corporate firms (Masulis & Nahata, 2009). Business organisations introduce value in start-ups that they find, which is commonly in the form of resources, skills, and reputation (Phan et al., 2009). This also changes the perception of the new entity’s prospects in the face of external investors. Public and private equity investors generally believe that start-ups that are founded on venture capital will be absorbed by the investors at an attractive valuation. Accordingly, Basu et al. (2011) established that business start-ups that are funded by corporations are more likely to attract more attention among high-quality players in the market when compared to ordinary start-ups. It also emerged that such start-ups that are backed by corporate venture funds have a better performance with regard to stock price when compared to those that are backed by traditional investment groups.

4.       Conclusion

The analysis of the corporate venture capital and its significance in the business world demonstrated a clear picture of its implication in growth, development, and competitiveness of business organisations in the wake of a globalised business environment. Specifically, it was apparent that corporate venture capital initiative could be applied by business organisations in increasing their innovativeness and the general firm efficiency and ultimately their competitiveness. Consequently, corporate venture capital initiatives demonstrate entrepreneurial aspects that are associated with significant effects on business corporations. Consequently, based on the deeper analysis of the strategic aspects of corporate venture capital investments, this paper has affirmed that it plays a strategic role in competitiveness and sustainability of corporate entities in the contemporary business settings hence an attractive initiative in most corporations.

 

 

5.       References

Basu, S., & Wadhwa, A. (2013). “External venturing and discontinuous strategic renewal: An options perspective.” Journal of Product Innovation Management30(5), pp. 956-975.

Basu, S., Phelps, C., Kotha, S. (2011). “Towards understanding who makes corporate venture capital investments and why,” Journal of Business Venturing26(2), pp. 153-171.

Bruneel, J., Van de Velde, E., & Clarysse, B. (2013). “Impact of the Type of Corporate Spin‐Off on Growth.” Entrepreneurship Theory and Practice37(4), pp. 943-959.

Cumming, D., & Johan, S. (2010). “Venture capital investment duration.” Journal of Small Business Management48(2), pp. 228-257.

Cumming, D., Fleming, G., &Schwienbacher, A. (2009). “Corporate relocation in venture capital finance.” Entrepreneurship Theory and Practice, 33(5), pp. 1121-1155.

Gaba, V., & Bhattacharya, S. (2012). “Aspirations, innovation, and corporate venture capital: A behavioural perspective.” Strategic Entrepreneurship Journal, 6(2), pp. 178-199.

Gailly, B., Da Gbadji, A. G., & Schwienbacher, A. (2014). “International analysis of venture capital programs of large corporations and financial institutions.” Entrepreneurship Theory & Practice, Forthcoming.

Garg, S. (2013). “Venture boards: Distinctive monitoring and implications for firm performance.” Academy of Management Review, 38(1), pp. 90-108.

Guerrero, M., & Peña-Legazkue, I. (2013). “The effect of intrapreneurial experience on corporate venturing: Evidence from developed economies.” International Entrepreneurship and Management Journal9(3), pp. 397-416.

Guerrero, M., & Peña-Legazkue, I. (2013). “The effect of intrapreneurial experience on corporate venturing: Evidence from developed economies.” International Entrepreneurship and Management Journal9(3), pp. 397-416.

Masulis, R. W., &Nahata, R. (2009). “Financial contracting with strategic investors: Evidence from corporate venture capital backed IPOs.” Journal of Financial Intermediation, 18(4), pp. 599-631.

Maula, M. V., Autio, E., & Murray, G. C. (2009). “Corporate venture capital and the balance of risks and rewards for portfolio companies.” Journal of Business Venturing, 24(3), pp. 274-286.

Napp, J. J., &Minshall, T. (2011). “Corporate venture capital investments for enhancing innovation: challenges and solutions.” Research-Technology Management, 54(2), 27-36.

Narayanan, V. K., Yang, Y., & Zahra, S. A. (2009). “Corporate venturing and value creation: A review and proposed framework.” Research Policy, 38(1), pp. 58-76.

Phan, P. H., Wright, M., Ucbasaran, D., & Tan, W. L. (2009). “Corporate entrepreneurship: Current research and future directions.” Journal of business Venturing, 24(3), pp. 197-205.

Rohrbeck, R., Döhler, M., & Arnold, H. (2009). “Creating growth with externalization of R&D results—the spin‐along approach.” Global Business and Organizational Excellence, 28(4), pp. 44-51.

Souitaris, V., & Zerbinati, S. (2014). “How do corporate venture capitalists do deals? An exploration of corporate investment practices.” Strategic Entrepreneurship Journal8(4), pp. 321-348.

Srivastava, N., & Agrawal, A. (2010). “Factors supporting corporate entrepreneurship: an exploratory study.” Vision: The Journal of Business Perspective, 14(3), pp.163-171.

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