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Avoid bad bets: Collaborate with startups before acquiring equity

Enterprises like to own. That in itself is not a bad thing. However, when it comes to acquiring startup equity, proof of value should come first.

· CVC,Collaboration

Enterprises are good in product development but seem ill-equipped now that we entered the 3rd phase of digital transformation.

In response to pressures and rapid changes, enterprises are increasingly gravitating toward partnerships with early and later-stage tech startups. Hackathons, product bundling, co-creation, co-research, venture clienting, strategic investments – these are some of the terms used when enterprises think about working together with startups.

Corporate Venture Capital is on the rise

Equity investments have seen record levels according to various local and global sources.

Acquiring a (controlling) stake in an early-stage tech company is worth considering when time is of the essence. And when the startup’s technology, its team, IP, or solution are exceptional and core to the enterprise’s (future) business.

However, the corporate-startup equity game is expensive and fraught with pitfalls:

  • Most organizations are not well-resourced for finding and vetting startups. They are also fairly biased in what constitutes a good or bad startup.
  • The startup landscape is in a period of both hyper-growth and hyper consolidation. The dust won’t settle for several years. Bigger or well-known doesn’t mean better: There is no best startup -only the best fit.
  • CVC teams are weak at change management. You carve out a deal and struggle with the question of independence or integration. It’s psychology with the people in the organization to prevent corporate antibodies from crushing the startup.

Date first, then marry?

Innovation partnering with startups is not only a much-needed innovation route; it also is a suitable substitute for forthright equity.

Rather than investing hundreds of thousands or millions of Euros on an acquisition, without any proof of strategic fit, the goal is to build multiple partnerships in the EUR 25 - 100 K range.

Its fundamental premise is that small wins might grow in size.

There is early evidence that companies that expand via frequent, smaller deals over many years generate between 8.2% and 9.3% total annual shareholder returns as opposed to 4.4% annual total shareholder returns for ‘big bet’ deals. And the more deals you do, the better you get at finding and closing the best ones.

So, start with a venture clienting or co-creation project that could reasonably generate a small win. After trying a couple of things, a model for partnership might be revealed that has a significant impact on both to stay committed. Equity-investment, among others, might be the next logical thing to do.

The below figure illustrates innovation partnering as a repeatable process or ‘portfolio model’ with a variety of outcomes:

Takeaway

 

When it comes to startup investing, don’t fall in love at first sight. Acquire later, probably at a higher valuation, but at a much lower risk.

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