Corporates often grapple with the "Innovator's Dilemma," where the gravitational pull of the core business's existing processes, incentive structures, and risk models stifles the pursuit of groundbreaking innovation.
The dilemma is further exacerbated by corporate governance systems designed for operational excellence rather than innovation.
These structures, while effective for the incremental growth of billion-dollar core businesses, often kill potentially disruptive innovations at their inception, as Pilot 44’s Andrew Backs suggested during a recent Innov8rs Learning Labs session.
One of the most significant hurdles is the common practice of funding innovation from P&L and margins, where innovation expenses must be recognized immediately even though potential returns occur far in the future.
This makes innovation budgets subject to intense scrutiny, especially during economic downturns, often resulting in budget cuts. The pressure for immediate financial performance is at odds with the long-term investment required for disruptive ventures, which may not contribute substantially to top or bottom line for years.
In response, a solution is to invest in growth initiatives that are developed and incubated externally, as a “Venture NewCo” that operates with startup agility, and then to eventually integrate successful ventures back into the core business.
Let’s explore how that works in practice.
Venture Building: Creating New Businesses From The Ground Up
If we define a venture as a disruptive growth initiative (or “homegrown” internal startup) that goes beyond product and/or incremental innovation by combining a variety of new models, “venture building” is the application of startup-centric tools and lean processes to the design,
development and incubation of new ventures within a large company.
Venture building represents a strategic approach for corporations to foster innovation and drive long-term growth by creating new businesses from the ground up. Unlike traditional corporate innovation strategies that focus on internal R&D or acquiring startups, venture building allows companies to leverage their resources, industry insights, and market access to build ventures that can address unmet needs or disrupt existing markets.
By operating somewhat independently from the parent corporation, these ventures can remain agile and adapt quickly to market changes, much like startups. This separation also helps in maintaining a startup culture that is conducive to innovation, attracting talent that prefers the dynamism of startups over the stability of large corporations.
Venture building offers corporations a structured way to diversify their portfolios and explore new revenue streams. By actively creating and scaling new businesses, corporations can gain insights into emerging trends and technologies, which can inform their broader strategic decisions.
Successful venture building requires a robust support system for the ventures, including access to mentorship, industry networks, and capital.
Generally, these are the key variables to consider:
- Staffing - How do we find the right combination of Corporate, Venture Builder and external staffing resources that provide a more complete set of capabilities, creativity and broader external perspective?
- Agility - How can we ensure that we can work with enough agility, creativity and autonomy to ensure that we are pushing the envelop in terms of both our positioning and go-to-market execution?
- Authenticity - How do we avoid the initial product being perceived as a “corporate” offering that lacks the startup authenticity that is so important to early ventures?
- Incentives - How do we incentivize all founders and employees such that they are willing to work in a more aggressive and intense manner?
- Legal/Risk Profile - How do we structure the entity such that we have greater leeway in messaging / claims without being encumbered by strict corporate governance & legal guidelines?
- Systems Infrastructure - How can we accelerate the adoption and deployment of new technologies, without being encumbered by high PII standards and legal requirements?
- Funding - Do we need to structure the entity such that we can raise external capital or will the corporate fund completely? How do we separate the disruptive venture from the delivery of core business P&L?
The Patient Capital Approach: Spin-Out/Spin-in Venture Building
Successful startups often rely on venture capital, which is designed to support ventures through their initial non-revenue-generating phase with patient capital. This approach acknowledges that crossing the "chasm" to exponential returns takes time, effort, and a tolerance for initial losses.
In contrast, corporate innovation efforts are frequently hampered by an expectation of immediate returns and a risk-averse culture, making it difficult to support the sustained investment required for disruptive innovation.
The Spin-Out / Spin-In Venture Building method allows for corporates to leverage the patient capital approach. By funding ventures off the balance sheet, corporations can invest in innovation without directly impacting their short-term financial performance, offering a more sustainable model for disruptive ventures.
A cornerstone of this approach is the corporation's role as a minority stake investor in a newly formed, separate company, funded off the balance sheet as an “arm's-length” investment.
This structure allows the “Venture NewCo” to operate independently, shielded from the parent company's risk aversion and financial scrutiny. Such independence is crucial for nurturing an entrepreneurial spirit and agility, akin to that of a startup, thus enabling the venture to pivot, adapt, and innovate without the encumbrances typically associated with corporate operations.
As a minority shareholder, the corporation does not need to recognize any gains/losses on the P&L and as such, it minimizes any risks associated with the early operation of a “startup” entity.
Moreover, this approach encourages strategic partnerships and external funding rounds, broadening the financial base supporting the venture and mitigating the corporation's financial risk. For other investors interested in a certain vertical for example, co-investing with a corporate could be a plus. It may not be a fit for every VC, so it’s important to define your preferred co-investors.
This approach not only diversifies the “Venture NewCo”’s funding sources but also integrates valuable external perspectives and resources, enhancing the venture's market relevance and scalability.
As the “Venture NewCo” matures and de-risks, the corporate investor has options to bring it back into the company through exclusive/favorable buyback rights, contingent on the venture's success and strategic fit.
Since this buy-back option is pre-negotiated, it could be tied for example to revenue milestones that effectively caps the value, so the cost to spin back in doesn’t get out of control, which addresses a concern executives often bring to the table..
Getting Started… Existing IP or Assets
It’s actually more straightforward than you may think to get started. Your M&A team will get this approach quickly, and your executives will understand investing from the balance sheet versus P&L.
To surface opportunities that could benefit from this approach, you could start by looking at existing IP and assets within your organization, that could thrive externally, or have been struggling to get funding. In most companies there’s a lot of opportunities just collecting dust.
Of course, you can plug this Spint Out/Spin In approach into your existing venture building or front end of innovation processes, adding a decision point in your funnel whether or not to fund a particular initiative as a “Venture NewCo”.