Applying a VC mindset to corporate ventures

Applying a VC mindset to corporate ventures

Corporates should adopt a venture capitalists’ approach to assessing and evaluating investment into internal projects, writes Right Click Capital’s Garry Visontay.

Startups have reshaped the conventional rules of exploring and developing new business ideas. And while the relevance to established corporates may not be obvious, there is in fact much to gain and learn from corporates’ younger, more adventurous siblings.

As with all corporates, there comes a time in the business life-cycle when incremental business and process improvements can no longer deliver the scale of gains demanded by management and shareholders.

At this point, corporates either have the choice of doing nothing or taking action.

While doing nothing is an option, it’s important to recognise that there is a big opportunity cost to playing it safe, as pursuing riskier projects might have an enormous pay-off for the company in the long-term.

As a venture capitalist (VC), our thinking is the latter, where only big projects with huge returns are contemplated and deemed worthy of investment.

So, how can you apply a VC’s approach to assessing and evaluating investment into internal projects and ventures in a corporate environment?

1. Set the scene

First, commit to establishing a corporate venture fund (with permission and buy-in at the management/board level) to support new ventures, and include a dollar value.

2. Establish fund parameters and expect failure

Tech investors usually take a 'portfolio' approach to their investments – spreading risk across a number of investments.

Early-stage investment funds are often spread across 20 startups with the expectation that around 12 will collapse in the short-term, five might return their original capital invested, and two or three might hit a home run, delivering >10x returns.

This portfolio strategy allows for many bets to be placed and still derive a healthy return of investment (ROI).

However, corporate management’s mindset is usually not to tolerate failure. And the necessary behavioural change (to adapt to tolerating failure) is also usually a slow process in a corporate environment. So how can expectations be managed?

Investors typically have a good idea of the value of a business from its previous valuation. By adopting this approach (without using external investment data), the valuation can be determined by metrics commonly used by VCs – such as multiples on revenue, the number of users, the number of customers, etc.

Other key valuation measures include:

  • “customer lifetime value,” which may be used for subscription-based or “software as a service” models,
  • comparable transaction value, which may be used if robust, relevant benchmark transactions can be identified

3. Assess your venture proposals

Establish ground rules for new venture proposals, with each proposal following a defined yet flexible format, addressing:

  • The "problem" 
  • The proposed solution
  • The proposed "founder" (team leader) and team
  • The definition of "success” and how it will be measured
  • A timeframe to demonstrate traction or achieve a Minimum Viable Product (MVP)
  • The venture funding requirement

Evaluate internal proposals ('pitches') based on:

  • Revenue or payback potential of the venture by first stating a goal of achieving $X revenue over a certain time period; this provides a “size of the prize” and allows plans to be worked backwards to measure whether the goal is realistic or not.
  • Common hurdles to achieving the “prize” which VCs often consider are:
    • a founder team which is unable to execute on its vision due to lack of technical skills or inappropriate personal team member attributes,
    • an addressable market which is too narrow or too limited in scale to justify the investment funding required,
    • an inability to effectively monetise the business model.

Drawing on my personal experience, there are huge benefits to backing a founder who has previously been successful in building a business and then exiting.

The parallel in a corporate might be the team leader and/or members who have previously been involved in a successful internal innovation project. This also extends to the team composition.

Ideally, teams should have a domain expert, a business driver and a technical lead at its nucleus. Key characteristics to look for include tenacity, strong execution capability, intellect and a good sense of perspective.

4. Agree on benchmarks

With everything you do, it’s important to set venture key performance indicators up front, to measure progress and success.

And while measures such as net present value (NPV)/discounted cash flow (DCF) and Payback Period are the usual indicators of corporate project capital budgeting criteria, these measures are almost never used by VCs in assessing projects or businesses-worthy investment.

Why? Because these conventional metrics primarily measure revenues or cash flow only, which – for VCs – largely misses the point.

Cash flow or earnings do not indicate any of the early progress of a startup in terms of the development of its business model – customer validation, traction and scaling – and monetisation should always be the final objective of a startup investment, not the first.

5. Establish a framework to monitor and manage progress

Corporate project teams should follow the Lean Startup principles (NB: read Lean Startup by Eric Ries). These principles provide a concrete framework for developing hypotheses to test assumptions and then evaluate the results.

The framework provides a highly iterative approach that ultimately leads to a concept called “product market fit” – the idea that the product or service being developed is something that the user can use and would pay for.

One thing to watch out for is the project team having to work within an environment of too many approvals and corporate overhead processes. This can kill innovation and slow progress, so instead the team should have autonomy and be given some degree of independence.

One of the hallmarks of a great founder and high performing startup teams is their ability to execute quickly and with quality. If a corporate project team is moving slowly, then this should be a signal for caution.

The emphasis should be on nimbleness and speed; new ventures rapidly assemble minimum viable products and immediately elicit customer feedback.

6. Establish ongoing reporting and monitoring

VCs usually ask for monthly reports from their investee CEOs. These reports show the key metrics that the business uses to monitor its performance.

Basic profit and loss (P&L) information is provided, as is the all-important 'runway length'. Runway length provides the investor with the time left before the business runs out of money.

Within the corporate project, runway length might still be a valuable metric in applying a sense of urgency for the project team to reach certain milestones before their funding dries up.

In addition, many established startups have boards that meet monthly. Recreating a board structure within the corporate office would be a good approach to providing both the highest level of accountability and a great channel for external input, candid feedback and mentorship to the project team.

Key metrics must be tailored for the specific growth drivers of each startup. Common metrics include:

  • traffic conversion (from website views to enquiries, sales, registrations or conversions)
  • traffic and customer growth (usually month-on-month)
  • paid/"free" users — for "freemium" models
  • customer/revenue "churn"
  • customer acquisition cost (CAC)
  • customer lifetime value (CLTV)
  • gross margin

7. Start small and validate

Provide ventures with an unambiguous 'seed' budget — $50,000 to $100,000 in hard dollars and recharged soft services.

Initially, provide enough budget for hypothesis testing, early idea validation and MVP development, and basic iteration to try and achieve product/market fit.

Once product market fit has been proved, then you can drip-feed further funding.

Following this, the next hurdle is traction. Traction for a disruptive business model is usually related to scaling metrics such as the amount of revenue, number of users and number of customers.

For early-stage disruptive business models, there is never a focus on profitability. It’s all about proving the product or service that people want and then working out how to build growth into the model.

VCs take a longer-term view, in that once sufficient scale is reached, a business model will become profitable.

By following the startup industry, corporate innovation teams have a lot to gain from embracing and using the Lean Startup framework.

In turn, this will help support their efforts in experimenting versus detailed planning as well as being able to evaluate the project’s progress at every short-term hurdle.

Garry Visontay is a partner at venture capital firm Right Click Capital.

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