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WHAT CAN CORPORATIONS LEARN FROM VENTURE CAPITAL?

Interview with Pavel Cherkashin, Managing Partner, Mindrock Capital

ABOUT THE INTERVIEW

Low tolerance for risk, inflexible organizational structures and lengthy chains of command all contribute to difficulties corporations face when it comes to successful innovation. Building up innovation capabilities in-house is one solution but to address these shortcomings more efficiently, can big companies look outward to venture capital for tools, techniques and partnerships?

In this SVIC interview Pavel Cherkashin, managing partner at Mindrock Capital, answers that question and much more.

ABOUT OUR GUEST

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Pavel Cherkashin

Pavel Cherkashin is a venture fund executive, writer, former business-angel and an entrepreneur with a track record of developing technology startups into successful businesses. A venture investor with $200M under management, he is also a former executive at Microsoft and Adobe. His chief focus today is on helping great startup founders succeed on a global scale.

INTERVIEW TRANSCRIPT

Rahim Rahemtulla:
Hello, everyone, welcome to this Silicon Valley Innovation Center interview. I am your host Rahim Rahemtulla and we’re very glad that you could join us today. My guest on today’s program is Pavel Cherkashin. He is the managing partner at Mindrock Capital. And, Pavel, we are delighted to have you with us today on the program.


Pavel Cherkashin:
Thank you.

Rahim Rahemtulla:
And I think the best place to start our interview is probably with the title. And we gave this program the title of “What Can Corporations Learn from Venture Capital?” So Pavel, let’s just dive right in, start right there because, as we all know, corporations do struggle with innovation, they struggle to come up with new ideas to test them out and to get them to market, whereas if you look at venture capital, they seem to do this for a living, in a sense.

Pavel Cherkashin:
That’s right.

Rahim Rahemtulla:
They invest in startups doing innovative things, they help those startups grow, they help them bring their products to market, they seem to do it pretty well day in, day out. So what do the corporates need to do if they want to emulate that sort of success?

Pavel Cherkashin:
Yeah, first of all, you need to look at the world of corporates and startups as two different islands. And they’re different in the way they approach risk versus return. So a startup has nothing to lose: they come up with an idea, they maybe raise some money, they try and, if they succeed, they become a corporation, if they fail, they just close it down and move on. So they have nothing to lose. For a corporation, there’s always a lot to lose. And the positive outcome of any potential partnership or a project could be lower than the risk of the damage that this can do. So corporate people are always very cautious about this. They have their compliance, they have their legal requirements and a lot of other stuff. So venture funds are sort of a bridge between those two islands. They understand how corporate compliance and the decision-making process works. At the same time, they know and appreciate how to deal with startup founders and support them in complete uncertainty.

So it’s impossible for a corporation to think like a startup. And in most of those big companies, they go through several steps and mostly fail through those steps of doing their own accelerator or starting their own venture fund or putting money into somebody else’s venture fund and then not knowing what happened to their money, building their research and development center and trying to innovate internally. All of those steps normally take a lot of time, but they end up with the with the same outcome. The corporation is just not fit properly to deal with uncertainty, and innovation is all about uncertainty. But at the same time, the corporations are the main source of innovation in the way that they come with their real-life challenges. When you look at the startup community, you have a couple million people out there, very brilliant people willing to do something, but they just have no ideas to implement. And it’s up to the corporations to decide what they really need, what they want, what they’re ready to pay for.

And so what we do as a venture fund, in many cases, we would reach out to corporations to get their problems and challenges and understand what’s on their agenda. What are the top unsolved problems that they have? It doesn’t mean that we can solve the problem, it doesn’t even mean there is a solution out there, but the whole beauty of dealing with startups is that you can take a challenge or take a problem of a company, package it into sort of a requirement or a wish and throw it into the crowd of the startup founders and let thousands of the best minds in the world compete for free to solve the problem and the one who wins will get the partnership, the contract, the investment. The prize is quite big, but you need to prove that you have a solution and you need to be the first and the best to do so.

So that’s like a simplified version of how this market should work and how it works in many of the industries, but most of the corporations still don’t understand this. They are still are thinking about innovation as something they can seed and grow within their perimeter rather than sending this information out into the world of the startup founders, let them compete and let them come with the best innovation. And venture funds will guide that process once they know what the corporations need and have access to the startup founders.

Rahim Rahemtulla:
Yes, no, I mean, it’s very interesting, I think. So does that mean, then, if you are a corporation today and you obviously understand that there is a need for innovation, but then instead of sort of engaging directly with the startup ecosystem or perhaps working on your own to source, to find startups that are already out there who you might want to work with, instead you could take a different track? You could then look to venture capital instead and tell them what your problems are and then let the venture capital firms source solutions? So it’s sort of a different process, a different mindset, I think, than what we might have heard before.

Pavel Cherkashin:
Yes, that’s exactly the case. So one way, a more traditional way, is to engage directly, but it has several difficulties. First, startups don’t really like working with corporations directly because corporations can kill the startup spirit. So in many cases, the best startup founders will be very cautious accepting any investments or doing any strategic partnerships. Second, corporations are very slow and it may take years to build a deal together with a startup. And also with this high level of uncertainty, it’s also not clear for the corporation what they really need to be doing. Should they do an investment in this company or should they launch a pilot project? Or if they sign a deal and the company increases in value 10 times, then it’s probably going to be too late to do the investment. So you need to build a structure that will take the risks away from the corporation – at least during the initial phases – but at the same time keep the door open for them to do the investment or the acquisition of a company or strategic partnership. And that’s what works very well through venture funds.

The only problem, I mean, many of the corporations keep working with the venture funds, but the normal approach or the more traditional approach would be for the venture funds to ask corporations to put money into them as limited partners or as investors into venture funds, which is very nice and a great source of capital for managers like ourselves, but it doesn’t solve the problem of improving innovative work for the corporation. Because in most cases, or in all cases, the corporation, the source of capital, will have very limited or no control over what is happening with the funds. In many cases, they don’t even have the information right about their own capital. So they don’t learn anything by putting money into this. And to learn something, it needs to be a little more sophisticated model.

When the corporation is coming as a potential investor or a client, or a hiring partner, there could be different options. And it could start with a pilot project where there’s no direct engagement between the corporation and the startup, and the venture fund or a venture partner is facilitating this initially to take away all the risks. But, at the same time, some financial instruments options or something else can be put in place to secure potential future investments or acquisitions from the corporate partner.

Rahim Rahemtulla:
Sure. But so corporations then need to come to the table and demand more than simply an investment opportunity. They just want to put some money in, but they don’t just want to put money in and have a return – they actually want to get something more out of that investment. They want innovative products at the end of the day.

Pavel Cherkashin:
Yeah.

Rahim Rahemtulla:
They want technology. But how does a venture firm react to this? I mean, presumably, it can be in their interest as well to have a corporation take a more active role in working with the startup.

Pavel Cherkashin:
Yeah, it used to be uncommon for venture funds to allow a corporation to engage in the operational process. And, in most cases, when you say venture fund, you immediately think of a pool of money where investors put money into the fund and then the manager is operating the fund and making the investments and the distributions. In the modern world, it’s changing a lot because, as I said, first, the corporations come with their needs and with their specific problems and requirements and this turned to be a huge asset for venture capital. So this is something that corporations still don’t understand but, in reality, they control a lot of insights that this market need and they can put those insights on the table during the negotiations.

And second, as you have noticed, there is no clear single tool for a corporation to deal with innovation. You don’t know if an investment, for example, is the best option, or if partnership is the best option. When, let’s say, an oil company is looking into innovative products, an innovation for them could mean something that produces high-quality petroleum at lower costs than the oil, for example. Or it could be alternative energy or electric vehicles, for example. And investing directly into the electric vehicle business for an oil company could mean an internal conflict of interest with their existing business, it could mean some risks associated with the new business. And also, it’s not clear if it’s the best way, the best use for the money. And, at the same time, the electric vehicle company is probably not going to be very happy having a large oil company directly on the cap table. But if there is a way to do a pilot project to understand that the electric vehicles could be a good alternative to gas vehicles in the near future, understand who those potential companies are, find those companies, do a pilot project and, at the same time, negotiate a potential framework for future development, including maybe investments, maybe strategic partnerships, maybe joint manufacturing or joint business development, there are a lot of options out there.

In many cases, just hiring startup founders and turning them into a corporate branch could be an option as well, like an equity hiring. So the range of tools is very wide and the corporations shouldn’t limit themselves to just putting money into the ecosystem hoping that this money converts into innovation.

Rahim Rahemtulla:
No, and I think getting a VC on board surely makes a lot of sense there, because I suppose venture capitalists, in the eyes of startup founders and the startup community tend to have – I don’t know if you agree with this, Pavel – tend to have more credibility than corporate investors. Isn’t that the case? So, in some sense, the corporation, by aligning itself with a VC, that can be a good thing for their image, for their outreach in the startup community.

Pavel Cherkashin:
That’s correct. So for any startup founder, having a venture investor on board with a good name and reputation and history is a huge benefit from the valuation perspective, from the experience perspective, from the network outreach perspective. Having a corporate onboard could be a benefit in some cases, but it could be a threat as well. It could be a risk of not being able to raise more funding from other corporations. It could be a risk of running into certain compliance issues of the company or certain procedures that were developed a hundred years ago and still haven’t changed. So there’s a lot of risk associated with corporate investors or corporate partners for a startup and that’s why, by default, they would prefer to work with a venture partner. And if a venture manager or venture partner for the startup can, in addition, bring a connection to corporations and can be sort of an interpreter or assistant in dealing with those corporations, that’s an additional benefit both for the founder and for the investor and, in the end, for the corporation.

Rahim Rahemtulla:
Sure, sure. And I mean, do you feel at the moment that the sort of balance of power, if you will, is still not with the corporations, in that sense? And that they are still sort of not necessarily seen as the player of choice or the partner of choice in the entire ecosystem? And, if so, do they have work to do to change that going forward?

Pavel Cherkashin:
It’s an ongoing process. If you’d asked me two or three years ago, corporations weren’t seen as a material force on the market. They were always present, but they were always in a position of asking for a favor, pretty much. They would follow where venture investors would lead them. Now it’s changing a lot. So over the last couple of years, corporations are gaining much more expertise in the field and much more power primarily because they learned about being vocal about their problems so they can convert their challenges into requirements and give the community its tasks. So that instead of building another version of Instagram with more filters or this new feature, the founders will actually think about industrial innovations and the need for more new solutions that those corporations require. So I think, if the trend continues, in two or three years corporations will have a huge leverage on this market.

Rahim Rahemtulla:
It’s interesting, Pavel. I read recently in the news, there’s a lot about how we’re getting a lot of IPOs now of the big unicorn companies, Lyft, Uber, Airbnb, so on and so forth. And some of the thinking there goes that we are not going to see big disruptions in those industries again anytime soon and so now a lot of the big returns could come from more specific industry cases, so agriculture, AgTech, Insurtech, these slightly more narrow cases, arguably less sexy. It’s not going to be the next Airbnb, it’s not going to be Uber, it’s not going to affect every single consumer out there, it’s not gonna be Netflix, but these more specific industry cases are where we could see a big, big upside. And that’s sort of seems to chime with what you’re saying to a certain extent too, where startup founders, entrepreneurs are going to start looking at these more specific industry cases. And that’s got to be good news, I think, for the corporations out there who are involved in these sectors.

Pavel Cherkashin:
Well, I completely agree with you on the trend, but I have the opposite conclusions out of this. So, look at what Airbnb did to the hospitality industry or Uber did to the taxi industry around the world or what the internet did to the paper media business in the last 20 years. So every single industry in the world will go through this transformation sooner or later. So there’s a long list of industries that have seen no or very little innovation in decades or even centuries. Like, take banking, or take the oil industry, or take metallurgy, or you name it, transportation. For every industry, there’s an opportunity for a huge change, which means a lot of new leaders will emerge, a lot of existing leaders will die, and the decision is being made now. So if you work for an industry that is at least 50 years old, you should seriously consider looking at what opportunities are coming your way and what threats are coming together with those opportunities. And it’s now the time to decide, do you want to be part of this revolutionary change? I mean, first, is this revolutionary change coming to your industry? Are you there yet? The second, do you want to be a part of this revolution or do you want to wait for somebody else to take it?

So for us, as venture investors, we don’t really care; we can either work with existing leaders or we can build new leaders for any particular industry. But for existing players in those industries, they need to be aware that some other guys are getting billions of dollars from venture pockets to disrupt their industry and change it forever in the next decade. So it would be a crime for them not to at least be aware of what’s going on.

Rahim Rahemtulla:
I mean, when you put it like that, Pavel, it does sound quite dangerous for the corporations, I suppose. And as a VC, you say there, for you, it sort of cuts both ways. You guys are, as you say, you are the bridge, you’re in the middle there – you can reach backwards, you can reach forwards and you can work with all the different partners. In a sense, it sounds like the message for corporations is that they really they need to get on board now. They need to start making these partnerships with VCs, because if they don’t it’s sort of a dangerous situation to be in because the VCs ultimately will go forward anyway without them with the startups.

Pavel Cherkashin:
That’s absolutely right. So the good news for them is that the opportunity is there. They have the money, they have the knowledge, they have the expertise, the connections, the market control. So they still, in most cases, corporations still have a lot of power to make the change for themselves, first of all, and for their industry. But the opportunity is not going to be there for long. And the history of companies like Uber have shown that it takes less than a decade to change the market landscape forever with just sufficient resources and funding, which all of those companies are going to get if they if they prove the innovation is there. So I agree with you that now is the time for the corporate managers to make their move.

Rahim Rahemtulla:
Yes. Because, at the end the day, isn’t it the case, Pavel, the capital, the money is sort of agnostic. The money doesn’t know if you’re an old established corporation or a great new startup – it doesn’t have any sentimentality. And then it’s almost, in most cases, going to choose the growing Uber, the startup, to follow, isn’t it?

Pavel Cherkashin:
Absolutely right, yes. So this capital can come from the corporates, but it can come from any other source as well. And the venture business has access to huge capital derived from building previous businesses and now that all those companies go public, all this capital that the founders accumulate is going to get back into the venture business to fund the next generation of startups.

Rahim Rahemtulla:
Fantastic. Well, Pavel, it’s honestly very finely poised, it’s an extremely interesting time, I think, to be involved there in the startup ecosystem, in the venture capital world. Unfortunately, that’s where we’ll have to leave our discussion today, but we thank you very, very much for joining us here on the program.

Pavel Cherkashin:
Thank you. Thank you, it’s a big honor for me to be here.

Rahim Rahemtulla:
We’ve really enjoyed having you. And to our guests watching, we thank you as well for tuning in today to listen to my interview with Pavel Cherkashin. We do hope you have enjoyed it. And maybe it’s piqued your curiosity, you’d like to find out more and if so just know that you can always reach out to Pavel, he’s on LinkedIn and all the usual social media channels. Come and check us out at Silicon Valley Innovation Center, that’s siliconvalley.center, our website, of course. We run a Venture Capital Academy program that is taking place in July, so you can really get immersed in the world of venture capital and the startup ecosystem and hear more from expert speakers just like Pavel. But for today, I think that’s where we’ll wrap things up. So we do thank you very much for tuning in. And we’ll see you again very soon. Goodbye.

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