Corporate venture capital groups (CVCs) and innovation teams in the AEC space have been popping up on a nearly bi-weekly basis, as the competitive necessity to leverage project-augmenting innovations becomes pervasive.
Internal and external innovation (R&D & Venture, respectively) is a relatively new subject for the built world's corporate leaders with most of these industry-advancing teams having formed in just the past few years.
However, with the volume and velocity of corporate capital and time pouring into built-world technologies, it's critical that resources are effectively deployed.
Strategic investors have led ~1/3rd of deal flow BuiltWorlds has tracked in 2023 YTD compared to less than 10% in 2022, a testament to the growing importance and impact of this rapidly emerging CVC community.
Below you can see some of the largest CVC launches in this space over the past 2 years, with a notable acceleration in the past 12 months. Note that the CVCs at the bottom of the chart without an indicated fund size didn't announce a capital commitment, and are more than likely investing directly off the balance sheet.
CVC Launches in The Built World (Since 2022)
Leading built-world executives are now challenged with how best to approach startups (external innovation) in this developing venture ecosystem.
When, if at all, does it make sense to launch a strategic venture investment arm?
Launching a corporate venture fund is no small feat as it can take months or even years for a company to clearly define and approve a CVC fund’s objectives, size, measures of success, dedicated resources, etc.
Not to mention that the average lifespan of corporate venture arms is just 4 years as a result of management changes, poor performance, and a lack of operational alignment, to name just a few catalysts for a CVC's dissolution.
There are a number of different CVC structures that can create value for a construction organization, but it is imperative that the objectives are clearly defined and that KPIs are measurable.
CVCs have an inherent mandate to produce a degree of both strategic and financial value creation, but the weight that’s put on each can vary significantly depending on leadership’s objectives.
A failure to properly define these objectives can lead to internal dissonance and elevate the risk of a CVC getting shut down entirely. Stanley X, Stanley Black & Decker’s internal and external innovation division, experienced this exact issue last year when management was forced to cut back on “unnecessary spending” as the company struggled to navigate the inflationary environment. Stanley X is a great example of an external innovation program that fell into that unfortunate category.
If Stanley X had established clear paths to operational improvements, had structured plans to develop new & improved business lines, or even just better-defined financial objectives, Stanley Black and Decker's innovation arm wouldn't have been as obvious a place to cut the fat.
Stanley's venture program was also not a separate entity from the business's normal operations leaving it vulnerable to the preference of new management. When Ronald Allan took the helm of Stanley Black and Decker last summer it was an easy place to start layoffs in his resource restructuring plan.
Separating a CVC from core operations insulates these programs from the proclivities of new management, and allows these funds to direct their focus toward long-term value creation without worrying about transitory business cycles.
Should your innovation team and CVC be separate or synchronized?
CVCs in the AEC space have taken on a number of forms.
Some CVC groups are kept under their innovation team umbrella and are hyper-focused on partnering with startups that align with an identified business unit issue. These groups are typically comprised of internal innovation scouts and if they invest at all, it's directly off the balance sheet.
Innovation heads who wear the CVC hat are generally much less motivated by financial returns (IRR) if at all (a necessary component to any effective CVC), and focus more effort on mutually beneficial startup partnerships and technology implementation. The investments from these groups will typically only occur after a successful pilot with an internal stakeholder, adding a layer of validation but potentially lowering their IRR upside as a result of a delayed/missed investment opportunity (pilots can take anywhere from a couple of months to more than a year).
Other CVCs are launched as a separate investment vehicle outside of the company’s normal P&L and are generally more motivated by financial performance. These funds are generally allocated a specified amount of capital to deploy and have more agility to take advantage of opportunities as they arrive than the former structure, though the perceived risk is higher without a proven pilot.
Does it make sense to hire an outside team to run a venture arm or should you hire internally?
Venture investing is a skill just as much as project management, architecture & design, innovation implementation management, etc. something corporate execs in the built environment seem to have a tendency to overlook.
You wouldn't have an architect manage a jobsite, because those jobs require totally different skill sets. Similarly, a head of innovation who is focused on identifying and implementing new technology would likely not be able to effectively structure a corporate venture program.
When the head of innovation also wears the CVC hat, the resources required for proper financial & strategic due diligence to support both existing and prospective investments might not be there. According to a recent survey conducted by Silicon Valley Bank, 38% of CVCs spend more than 40% of their time managing their own corporate parent, impairing their ability to effectively operate the fund.
Effective early-stage investing requires a dedicated team of experienced professionals who understand how to model expected returns, understand exit strategies, and have a pulse on the VC market environment. At the same time, due to the heavy nuances inherent to this industry, it is good to have at least some internal hires involved to validate the need and usability of each prospective venture investment.
What are the benefits and drawbacks of being an LP in a Pure-Play Built World VC vs. Investing Independently?
Investing directly into high-risk startups is not for the faint of heart or the undercapitalized. This is why many corporate leaders in the built world have opted to invest in a pure-play built-world VC fund dedicated to investing in early-stage AEC innovations full-time.
Becoming an LP (limited partner, aka fund investor) requires a much smaller capital commitment for those who don't have the resources to justify launching a CVC or those "venture curious" groups that are just dipping their toes into the world of venture investment. As an LP in a built world fund, you'd receive broad exposure to startups in the space, but won't necessarily uncover all the innovations that address your company-specific problems as the fund has to cater to its entire LP base (other corporate/institutional investors with their own agendas). The need to support current portfolio companies can also add a level of bias to the deal flow received.
As an LP you give up focus, management fees (2% per annum is the industry standard), and autonomy, but retain resources.
As a direct investor, you give up the sometimes significant level of resources (time & capital) required to launch an effective CVC, but can attain a much deeper understanding of the competitive landscape, and the visibility to stay ahead of the curve in your operational niche(s).
BuiltWorlds Venture Forum addressed these questions and more in last week's meeting at the Venture East Conference in Miami, with UFP Ventures' Adam Goodson & Mac Gerlach leading the conversation having just gone through this CVC structuring process themselves. Click the link below to find out how you can get involved.