Corporate Venture Capital and the Returns to Acquiring Portfolio Companies

Innovation and Economic Growth

Article Snapshot

Author(s)

David Benson and Rosemarie Ziedonis

Source

Journal of Financial Economics (JFE), Vol. 98:3, pp. 478-499, 2010

Summary

This study looks at when and why corporate venture capital investors benefit when their firms take over startups.

Policy Relevance

Value can be destroyed or created when one firm takes over another. Prior work shows that “massive value” was destroyed by deals inked in the late 1990s. Takeovers of entrepreneurial firms are bright exceptions to that general rule. The study provides the first systematic evidence of how prior venture ties affect the returns to corporate venture capitalists as acquirers of entrepreneurial firms.

Main Points

  • One in five startups purchased by 61 top corporate investors from 1987 through 2003 is a venture portfolio company of its acquirer. This is consistent with the view that spotting acquisition opportunities is a prominent motive for corporate venture capital (CVC) investing.
     
  • Surprisingly, our evidence further suggests that takeovers of portfolio companies destroy significant value for shareholders of acquisitive CVC investors, even though these same investors are “good acquirers” of other entrepreneurial firms.
     
  • More surprisingly, for private takeovers of non-portfolio companies, we find a significant and positive acquirer return of 0.67% on average. But purchases of portfolio companies tend to destroy value for shareholders of these same acquirers, with negative and significant acquirer returns at both mean and median values (-0.97% and -0.75% respectively).
     
  • We find no evidence that the negative market reaction to portfolio-company acquisitions reflects disappointment because higher payoffs are anticipated from the initial investment.
     
  • On a dollar-value basis, our estimates suggest that acquiring-firm shareholders gain $8.5 million from the median non-CVC acquisition but lose $63 million from the median CVC takeover.
     
  • We find no evidence that the negative market reaction to CVC acquisitions is due to competition-driven overbidding (owner’s curse), firm-level governance problems, or hubris among CEOs of these investors.
     
  • Outcomes are better outcomes for investors that do (versus do not) house CVC programs in autonomous organizational units. More value is captured from acquisitions and investors are less likely to “throw good money after bad” by reinvesting in languishing startups.
     
  • Consistent with overconfidence-based theories, managers from dedicated CVC units seem less prone to bias when valuing portfolio companies due to greater exposure to investment opportunities (“deal flow”) or superior training in finance. Alternatively, organizing CVC activities in standalone units could enable superior monitoring and compensation of investment activities, thus helping mitigate intra-organizational agency problems. Our conversations with managers point toward both explanations.

 

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