Corporate Venture Capital: The Third Wave
May 11 - May 14 and September 2 - September 5, 1997
Examining the opportunities and challenges of corporate venture investing to maximize success
Interest in corporate venture capital has exploded in recent years, both in the U.S. and abroad. In an era when many large firms are questioning the productivity of their investments in traditional R&D laboratories, venture organizations represent an intriguing alternative for corporate America. Much of this interest has been stimulated by the recent success of the independent venture sector — i.e. rapid growth of funds and spectacular returns of more than 50% in 1995. While total annual disbursements from the venture industry over the past two decades have never exceeded the R&D spending of either IBM or General Motors, the economic successes of venture-backed firms — such as Intel, Microsoft, Genentech, and Cisco Systems — have been profound.
At the same time, concerns linger about attempts to replicate the success of venture capital firms in the corporate setting. Clearly, corporate venture capital is not new, as two previous surges in activity occurred in the late 1960s and early 1980s. Each time, well-publicized success of independent venture investors triggered corporate interest. Yet, when their initial venture investments failed, corporations rapidly abandoned their programs. Avoiding the mistakes of the past is a major challenge for corporate venture capital programs today.
While the industry’s past performance underscores the cyclical nature of the venture capital industry, certain basic non-cyclical issues also have a significant impact on corporate venture capital activity. Corporate Venture Capital: The Third Wave systematically examines the opportunities and challenges posed by corporate venture programs, including past experiences and contemporary initiatives.
Participants will study the independent venture sector, focusing on the design of independent venture capital funds, assessment and structure of venture investments, and compensation of partners. Then they will learn to translate the venture model into the corporate setting, identifying major similarities and differences, as well as the aspects that make the corporate environment unique. They will also consider a broad array of successful and unsuccessful programs, from those that directly emulate the independent venture model to those that only adapt certain elements.
By taking an in-depth look at the forces driving venture capital programs, financial executives will gain the knowledge and insight they need to capitalize on this intriguing investment alternative without repeating the dire mistakes that twice devastated the industry in the past. This is the second consecutive year that the Focused Financial Management Series has featured a module on venture capital. In 1996, participants in "Conflict and Evolution in Private Equity" examined the evolving relationships between private equity fund managers and institutional investors.
Corporate Venture Capital: The Third Wave is intended for:
The first wave. The first corporate venture funds were engendered by the successes of the first organized venture capital funds which backed such firms as Digital Equipment, Memorex, Raychem, and Scientific Data Systems. Large companies quickly began establishing divisions that attempted to emulate venture capitalists.
During the late 1960s and early 1970s, more than 25% of the Fortune 500 attempted external or internal corporate venture programs, either financing new firms alongside other venture capitalists or tapping into their own organization’s entrepreneurial spirit. Nonetheless, when the market for new public offerings abruptly declined in 1973, independent venture partnerships began experiencing less attractive returns and corporations began scaling back their initiatives. The typical corporate venture program was dissolved after only four years.
The second wave. Fueled by eased restrictions on pension investing and a robust market for public offerings, fundraising by independent venture partnerships recovered in the early 1980s. Corporate venture investing peaked in 1986, when corporate funds managed $2 billion and accounted for nearly 12% of the total venture capital pool.
After the stock market crash of 1987, however, the market for new public offerings again went into a prolonged decline. This time corporations scaled back their venture investing even more dramatically. By 1992, the number of corporate venture programs had fallen by one-third, and their capital under management represented only 5% of the venture pool.
The shifts in corporate venture capital activity are also driven by some basic non-cyclical influences. In large part, the decline of earlier corporate venture programs can be attributed to three structural failings:
Lack of well-defined missions. Far too often, corporations sought to accomplish a wide array of incompatible objectives — from providing a window on emerging technologies to generating attractive financial returns. This confusion over program objectives often led to dissatisfaction.
Insufficient corporate commitment. Even when top management embraced the concept, middle management often resisted. R&D personnel wanted the funds devoted to internal programs, while corporate lawyers disliked the novelty and complexity of these hybrid organizations. Frequently, new senior management teams terminated programs, seeing them as expendable "pet projects" of their predecessors. Also, these programs often had a negative impact on the firm’s accounting earnings. During periods of financial pressure, they came under particular scrutiny, as managers realized that they could increase reported operating earnings by terminating money-losing subsidiaries.
Inadequate compensation schemes. Independent venture capital funds typically receive 20% of investment profits. This potential for huge payoffs provides powerful motivation. Corporations, on the other hand, frequently were reluctant to make big payments to their venture managers. Instead, successful risk-taking was inadequately rewarded and failure excessively punished. As a result, it became increasingly difficult for these conservative corporations to attract top people to run their venture funds.
To illustrate the consequences of major structural failings, this brief case discussion recaps the rise and fall of a corporate venture program during the industry’s second wave.
In 1980, Analog Devices established a corporate venture program, Analog Devices Enterprises (ADE), to generate both attractive financial returns and strategic benefits in the form of licensing agreements and acquisitions. Funding was provided by Amoco, and ADE had invested $26 million in 11 firms by 1985.
That very year Amoco ceased contributing capital, and the ADE program was suspended. Around this time, Analog Devices took a $7 million charge against earnings; in 1990, with most of the portfolio liquidated, it took another $12 million charge. Of the 11 firms in ADE’s portfolio, 10 were terminated, acquired by other companies at unattractive valuations, or relegated to the "living dead." Only one firm ultimately went public. In this case, ADE’s stake was so diluted by a merger that it was worth only about $2 million at the time of the offering.
What went wrong? Clearly, the ADE program exhibits all three of the classic structural failings: 1. Program managers were hampered by the lack of a clear objective. Instead, they had a threefold mission: to invest in firms pursuing technologies relevant to the ongoing business of Analog Devices and Amoco, to obtain options to acquire firms of interest to Analog’s management, and to generate high financial returns. 2. Analog Devices’ researchers, seeing scarce resources being devoted to ADE, resented the program. Also, Amoco only committed to fund the program for five years, considerably less time than was needed to grow the early-stage companies. 3. Incentives of the various parties appear to have been improperly aligned. The management of Analog Ventures believed that they were insufficiently rewarded, and Amoco did not share in the profits generated.
In the addition to lectures, discussions, and group exercises, the case study method, pioneered by the Harvard Business School, is an integral course component. Specific cases to be studied include:
Participants will arrive and register Sunday evening, May 11, 1997. Classes will begin Monday morning, May 12, and conclude at noon on Wednesday, May 14.
Corporate Venture Capital: The Third Wave combines lectures, case studies, discussions, and group exercises to create an environment where interaction between faculty and participants and among participants themselves promotes an ongoing exchange of knowledge, experiences, and insights.
The course module will be conducted in newly designed classrooms with amphitheater seating, and participants will live in suites of individual rooms arranged around a common area. These facilities are specifically designed for executive education to foster shared learning and out-of-class discussion.
Participants will have ready access to Baker Library, the largest business library in the world, as well as the new Research and Technology Lab, which houses state-of-the-art audio, computing, imaging, projection, and Internet equipment. They’ll also have full use of Shad Hall, the School’s athletic facility and fitness center.
Carliss Y. Baldwin is William L. White Professor of Business Administration, at the Harvard Business School. She received a bachelor's degree in economics from MIT in 1972, and MBA and DBA degrees from Harvard University in 1974 and 1977 respectively. She was an assistant professor at MIT's Sloan School of Management from 1977 to 1981. With Kim Clark, she is studying design practice, industry structure and financing in the computer industry. Recent papers include: "Modularity-in-Design: An Analysis based on the Theory of Real Options" and "Sun Wars: Competition within a Modular Cluster" (both co-authored with K. Clark in 1994). In addition to research and teaching, Baldwin serves as a director of the Federal Home Loan Bank of Boston and Thermolase Corporation. She is an associate editor of Financial Management, and a member of the Publication Review Board of the Harvard Business School Press. In the past year she served on the Economic Policy Advisory Board of the U.S. Council of Economic Advisers and the Advisory Committee to the President of Harvard University.
Paul Gompers, Assistant Professor of Business Administration, specializes in research on financial issues related to start-up, high growth and newly public companies. He received his A.B. in biology from Harvard College in 1987. After spending a year working as a research biochemist for Bayer Chemical AG, he attended Oxford University on a Marshall Fellowship where he completed an M.Sc. in economics. He completed his Ph.D. in Business Economics at Harvard University in 1993. Professor Gompers spent two years as an Assistant Professor of Finance at the Graduate School of Business, the University of Chicago where he created a new course entitled "Entrepreneurial Finance and Management." His research focuses on the structure, governance, and performance of private equity funds, sources of financing, incentive design, and performance of private firms, and long-run performance evaluation for newly public companies. He has published papers in a variety of academic journals, including the Journal of Finance, the Journal of Financial Economics, and the Journal of Law and Economics.
Josh Lerner is an Associate Professor at Harvard Business School, with a joint appointment in the Finance Area and the Entrepreneurial Management Interest Group. He graduated from Yale College with a Special Divisional Major which combined physics and the history of technology. He worked for several years on issues concerning technological innovation and public policy at the Brookings Institution, for a public-private task force in Chicago, and on Capitol Hill. He then undertook his graduate study at Harvard's Economics Department. His research focuses on the structure of venture capital organizations and their role in transforming scientific discoveries into commercial products. He also examines how intellectual property protection shapes high-technology industries. His work has been published in a variety of academic journals, including the Journal of Finance, the Journal of Financial Economics, the Journal of Law and Economics, and the Rand Journal of Economics. He designed and teaches an MBA elective course, "Venture Capital and Private Equity," for which he has written over thirty cases.
William Sahlman is the Dimitri V. d'Arbeloff—Class of 1955 Professor of Business Administration at Harvard Business School. Mr. Sahlman received an A.B. degree in Economics from Princeton University, an M.B.A. from Harvard University, and a Ph.D. in Business Economics, also from Harvard. His research focuses on the investment and financing decisions made in entrepreneurial ventures at all stages in their development. Related lines of research concern the role of financial institutions in providing risk capital and the role of government policy in influencing capital formation in the entrepreneurial sector of the economy. In 1985, Mr. Sahlman introduced a new second-year elective course called Entrepreneurial Finance. During the academic 1995-1996 year, over 400 students enrolled in the course. Mr. Sahlman is Senior Associate Dean, Director of Publishing Activities at Harvard Business School. He serves as chairman of the board for Harvard Business School Publishing Corporation, which is responsible for all external publishing activities including the Harvard Business Review, case studies, Management Productions, HBS Press, and interactive media. From 1990 to 1991, he was chairman of the Harvard University Advisory Committee on Shareholder Responsibility. He is a member of the board of directors of The Butcher Company, Bee Gee Holding Company, Business Matters, Inc., and Milestone Corporation, and he is on the board of advisors for Welsh, Carson, Anderson & Stowe.
Fee for Corporate Venture Capital: The Third Wave is $3,500 and includes tuition, books, case materials, accommodations, and meals.
Fees are due 30 days prior to the start of the program. Cancellations made after this time are subject to a one-third cancellation fee.
Enrollment is limited to a select, qualified group. Professional achievement and level of organizational responsibility are the main criteria for admission, and proficiency in written and spoken English is mandatory.
Participants must have full company sponsorship. Sponsoring companies must agree to assume all fees, provide for reasonable expenses, and relieve the participant of work responsibilities during the program.
Completed applications are due at least six weeks prior to the program start, with late applications reviewed on a space-available basis.
Corporate Financial Engineering: Advancing Business Strategies
May 14 - May 17, 1997
Focusing on significant business opportunities, this module teaches participants how to incorporate financial engineering into corporate activities. Participants will examine the application of financial engineering in traditional treasury activities, in risk management programs, and in designing new business models and strategies.
Creating Value through Corporate Restructuring
May 18 - May 21, 1997
This module teaches corporate managers how to identify and respond to potential restructuring opportunities by focusing on financial strategies aimed at repositioning and revitalizing companies. Participants will gain an understanding of "best practices" for achieving competitive advantage and maximizing shareholder value.
May 21 - May 24, 1997
Participants will learn how to value opportunities and make effective management decisions based on value. This module examines the tools and techniques for assessing the value of major assets in the context of capital projects, corporate control transactions, liability management, and international investments.
Executive Education Programs
Harvard Business School
Soldiers Field — Glass Hall 200
Boston, MA 02163-9986
Telephone: 1-800-HBS-5577 (outside U.S., dial 617-495-6555)
Internet address: firstname.lastname@example.org.
Web site: http://www.exed.hbs.edu
Note: Fees, faculty, course content, and dates are subject to change. Affirmative Action/Equal Employment Institution.
Paul A. Gompers
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