CORPORATE America wants in on the next “big thing” and is willing to pay for the privilege. Fresh off its big win with Alibaba, Yahoo! appears close to investing in the messaging app Snapchat, and it’s not alone.
Venture capital investment has reached levels not seen since the dotcom crash, and corporate money is playing a significant role.
A case can be made for corporate venture capital as a strategy, but research suggests that this is probably the exact wrong moment to be using it.
First, the numbers. In late 2012, US corporate venture capital amounted to roughly $1.5 billion invested each quarter. In the second quarter of this year it totaled just over $4 billion. Corporate money used to account for 20 percent to 25 percent of all US venture capital dollars, but this year that number has hovered around 30 percent.
Much of this activity is driven by highly active funds at firms like Intel, Google and Qualcomm. The number of corporate venture funds doing deals each quarter has increased about 50 percent since 2012.
But research suggests the surge of dollars into venture capital will likely be followed by a dip in returns. A paper last year by academics at the University of Virginia, Said Business School and the University of Chicago confirmed that increases in capital committed to venture capital are negatively correlated with funds’ performance. Not that starting a corporate venture capital fund is a bad idea. To the contrary, a 2013 HBR article by Harvard Business School’s Josh Lerner explains how firms benefit from placing such bets. Firms can not only generate returns but also help identify and respond to competitive threats.
But when I spoke to Lerner earlier this year, he agreed that firms should be wary of rushing in at the market’s peak. More prudent is to set up a fund in the next downturn, since such “contrarian” timing has historically been associated with higher returns. For firms that are investing now, he suggested avoiding overheated sectors like social media.
The takeaway is that following the crowd is generally a bad venture-investing strategy. Investing in the next big thing may have to wait.
Walter Frick is an associate editor at the Harvard Business Review.
Walter Frick