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CORPORATE VENTURES AND RISK

MANAGEMENT: FOR BEST RESULTS,
TURN UPSIDE DOWN
STEPHEN A. ALLEN
PROFESSOR OF MANAGEMENT
HOLDER OF THE PAUL AND PHYLLIS FIREMAN CHARITABLE FOUNDATION CHAIR

“Risk is good. Not properly managing your risk is a dangerous leap.”

—Motorcyclist Evel Knievel, from a hospital bed

June 5 was a day of reckoning for the Alpha venture team. Its appropriation request for $40
million to launch a smart material for tracking airline baggage was being reviewed by the
Corporate Investment Committee. Supported by a 70-page business plan and a set of sensitivity
analyses identifying key return drivers, the project forecasted a base case internal rate of return of
23 percent. Or was that best case? Whatever.
Later the same afternoon, the team’s leader returned to its work area with news that the
appropriation request had been approved and that senior management had complemented the
team on the clarity and format of its business plan. An example of best practice? This is unclear
because we are observing the wrong moment in the life of the Alpha venture. In fact, much of its
return potential and risk had been determined by a series of decisions taken by the venture team
several months earlier. And its actual return depended on team members’ (or their successors’)
ability to actively manage the venture under changing conditions over the next several years. These
observations provide the underlying theme for this paper—that the most powerful opportunities
for impacting odds of success lie at identifiable stages in a venture’s life cycle and that venture
champions’ ability to recognize and exploit these opportunities lie at the heart of value creation
and capture.
What follows is an essay on risk at the level of the individual corporate venture, how to
visualize/gauge it, and alternatives for managing it [1]. Its target audience is practicing venture
champions, operating in the middle of large firms. Its objective is to render concepts and tools
from the areas of strategy, corporate finance, and venture capital investing in forms that
champions can comfortably apply at critical moments in the development of their ventures.
In other words, the intent is to translate from theory to practice, rather than advancing theory.
The form of this translation is based on more than 15 years of experience by the author in
conducting executive workshops and MBA electives on developing corporate ventures and
strategic investment decisions in large firms [2].

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A PRIMER ON VENTURE RISK

Corporate entrepreneurs know intuitively that risk comes with the territory. Yet, their mental
models of risk are often fuzzy, underspecified, and subject to denial. A more explicit definition of
venture risk, its dimensions, and drivers can provide a foundation for determining how and when
it can be most effectively managed [3].

It’s Generally Substantial

How risky are ventures relative to the hundreds of capital projects a large corporation undertakes
each year? Post-investment audits by a major U.S. chemical company are indicative.1 Based on a
sample of 50 projects undertaken over several years, the company’s financial staff found the
following mean ratios of actual to forecasted net present value by type of investment:

Cost reduction 1.1 Sales expansion 0.6 New products 0.1

One interpretation is that new product ventures were 11 times more risky than cost reduction
projects. It is also likely that the distribution of winning and losing new product ventures was not
all that different from that observed in venture capital portfolios: many losers or marginal projects
and one or two big winners.

Several features of new product investments (and corporate ventures, more generally) account for
their higher risks, along with their substantial return potential:

• Significant commitment of resources, the size and timing of which often cannot be fully foreseen
at the outset. Spending overruns are common in volume ramp-ups, adoption of cutting-edge
technologies, and siting facilities in unfamiliar national settings.

• Exposure to significant opportunities in novel environments. Many ventures involve some

combination of new customers/market segments, unfamiliar competitors, new product features,
and/or new process technologies.

• Multiple drivers of potential returns. Many cost-reduction projects involve a few return drivers,
most of which are relatively well-understood. Returns on ventures are typically driven by a
complex interaction of several market and technological factors, which evolves over time.

• Ambiguous boundaries and spillover effects. Unlike independent start-ups, many corporate
ventures impact performance of other company units—e.g., by leveraging existing or shared
resources or by cannibalizing older product lines. Some ventures may also entail growth
options—i.e., the initial project opens opportunities and creates capabilities for developing
subsequent ventures.2

Downside Is Not the Only Side

Ask an audience of executives for a working definition of risk, and more than half will offer
something close to that found in “Webster’s Dictionary”: “the chance of injury, damage, or loss;
dangerous chance; hazard.” A few will argue for a wider perspective: the chance that an outcome
will either fall short of or exceed one’s expectations. This perspective, depicted in Figure 1, permits
one to develop a crude estimation of venture risk as the spread between Scenarios I and IV. [4]

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FIGURE 1

VISUALIZING RISK: FOUR CASH FLOW SCENARIOS FOR A CORPORATE VENTURE

+ I
II
CASH
FLOW
III

0 TIME

–
I TOOK LESS TIME AND MONEY AND
SUCCEEDED. IV
II BASE CASE.
III TOOK MORE TIME AND MONEY AND
SUCCEEDED.
IV TOOK MORE TIME AND MONEY, THEN (Adapted from Sahlman, 1997)
CRASHED AND BURNED.

Visualizing risk in this manner conveys an important message: risk management should be about
taking actions in the face of downside and upside prospects over the life of a venture.

Recent experiences of Immunix Corporation demonstrate the stakes that can be involved in
managing upside risk.

The company launched Enbrel, a gene-based treatment for rheumatoid arthritis

in 1998 with a revenue target of $500 million by 2000. Analysts considered the
target extremely aggressive.

By 2000, Enbrel was experiencing a revenue run rate of $725 million, trials for
other applications were underway, and Immunix had run out of capacity (the
first stage of which had been outsourced). While investment plans were
accelerated, complexity of the production process entailed a three-year lead time.
Immunix will have foregone revenue of some $350 million (with gross margins
of 70 percent to 80 percent) during 2001-2002 and opened a gap for competitors
who hoped to enter the market during that time frame.

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Management reckoned that to have avoided these lost revenues, it would have
had to commit $400 million to a large facility of its own during 1996 to 1998, a
period during which it was still conducting Phase III clinical trials and two years
before it received FDA approval. As a pre-revenue biotech firm, Immunix and its
majority owner, American Home Products, were not willing to put this
additional investment at risk to protect the upside.

The moral of this story is not whether management made the right call but that upside risk is
very real.

Three-Dimensional Insights
A first step in understanding a venture’s risk profile is to mentally decompose risk into three
interacting components: [5]
Risk = (Exposure)(Uncertainty of Cash Inflows)(Time)

Exposure is a function of the size and timing of outlays undertaken to launch the venture,
including pre-revenue R&D and commercialization expenses and investments in fixed assets.
Within constraints dictated by technological and market characteristics of the project, managers
typically have a wide number of choices regarding size, scope, and speed with which they proceed.
Exposure is often gauged by total outlays required before revenues begin or by time to cash flow
breakeven. A more creative approach is a “learn-to-burn ratio”: how much cash are we willing to
burn through to learn X, Y, and Z about venture attractiveness and whether we should continue
investing?

Uncertainty can relate to both exposure and the onset, ramp, stability, and duration of net
operating cash flows. It reflects time-to-market, level of market acceptance, competitor responses,
and efficiency of venture operations. Some uncertainties can be resolved by management action
(e.g., a well-conceived marketing campaign). In other instances, management may choose to wait
for others—suppliers, complementors, competitors—to resolve uncertainties before it proceeds
with further commitments.

Both exposure and uncertainty are time dependent. Yet, standard discounted cash flow calculations
employed by large companies treat risk as time invariant. Finance theorists have advocated
employing different discount rates, both for different stages of ventures3 and for different elements
of the cash flow footprint.4 Large firms have been reticent to adopt these techniques, seemingly
due to their added complexity and concerns about determining valid discount-rate differentials.
By way of contrast, the staged investment typical for venture capital-backed start-ups does re-price
risk across stages of a venture’s development.5 [6]

Even though most corporate capital budgeting systems do not incorporate the finer grained view
of risk described above, this need not deter venture champions from using these insights in
planning and actively managing projects.

WHEN AND WHERE KEY DECISIONS ARE MADE

Risk gets designed in or, alternatively, encountered at various stages in the life of a corporate

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FIGURE 2
FIVE-STAGE MODEL OF VENTURE DEVELOPMENT AND
MANAGEMENT IN A LARGE COMPANY

I. OPPORTUNITY IDENTIFICATION, EXPLORATION

➡
➡

II. VENTURE DEFINITION, SCOPING, STRUCTURING a Impetus refers to

efforts to build
➡
➡

support for the

venture among key
III. VENTURE ELABORATION AND IMPETUSa internal and external
stakeholders.
➡
➡

IV. DETAILED JUSTIFICATION, AUTHORIZATION, FUNDING

➡
➡

V. EXECUTION, TRACKING, ADAPTATION TO CHANGING CONDITIONS

➡

venture. Recognizing these key decision points or events lies at the heart of active management of
the venture. It is at these points that simple risk analyses can pay off handsomely.

While hundreds of articles have been published recommending increasingly sophisticated methods
for valuing project returns and risks, there is relatively small literature examining how ventures
are actually conceived, justified, and implemented.6 These studies portray venture development in
large companies as a decision process of multiple, overlapping stages in which planning
assumptions are made, tested, and progressively refined. Along lines suggested by this research,
Figure 2 depicts venture development and management as a five-stage, iterative process—
beginning with opportunity identification and culminating in execution, tracking, and adaptation
to changing conditions. This process map provides a basis for exploring where key decisions are
made and where creative financial analyses are likely to yield the most potent insights.

Formal Justification Is Just That

While the need to justify a venture before top management (Stage IV) creates an important
discipline, this is seldom the point at which a venture’s character or its funding requirements are
determined. Surveys of practice indicate that in most firms more than 80 percent of projects for
which appropriation requests are prepared are approved.7 These findings suggest three
interpretations:

• Venture champions seldom submit proposals unless they have a high likelihood of approval.
Association with a rejected proposal can be a career-limiting experience in many firms.

• At Stage IV senior management’s degrees of freedom in influencing the character of a venture are
limited. The risk-return profile of the venture has been designed in at earlier stages. While top

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management has the power to send the project back to the drawing board, it does so at the risk
of delays and additional costs.

• Senior management influences the character of ventures by direct involvement at earlier stages
and/or by control of incentives for venture champions and their bosses.

Curiously, both companies’ capital budgeting procedures and textbook treatment of investment
decisions focus on the justification stage. Yet, if this is the first point at which venture champions
have devoted significant efforts to risk-return analyses, they have been flying without financial
radar during some of the most critical stages of their project’s development.

Articulating the Business Idea

Stage I—opportunity identification and exploration—centers on a broad-gauged analysis of the
nature and scope of a potential commercial undertaking. It typically requires limited seed funding
for pre-commercial R&D, prototype development, and/or market research. This stage should
produce a credible articulation of the venture’s business idea—i.e., how it hopes to organize
and/or develop a set of capabilities and technologies, resulting in initial products/services, which
create significant value for which customers are willing to pay. The business idea becomes the
equivalent of a genetic code for generating a more detailed strategy.

While cash flow and risk analyses are unlikely to play a role in Stage I, learn-to-burn disciplines are
merited. Simple, time-insensitive estimates are likely to center on exploring prospects for a viable
financial footprint. Can pricing support a reasonable operating margin? Is revenue potential
sufficient to deserve attention by a large company? Capital intensity, which depends in large
measure on detailed plans for the value chain, may still be under debate.

Locking in the Go-to-Market Plan

Most of the work of structuring a venture occurs in Stages II and III. In Stage II, champions begin
to translate market and technological possibilities into a detailed go-to-market plan. While reality
testing and bargaining with internal and external stakeholders occurs in both Stages I and II, these
activities move into high gear in Stage III. Substantial effort is devoted to presentations and
documentation of assumptions aimed at securing support up the corporate hierarchy and from
customers, suppliers, channels, and regulatory bodies. In many instances, these efforts also include
negotiations with sister units which control resources vital to the venture’s success (e.g., sales and
service personnel or supply of components). Reactions of these various parties may lead to
significant rethinking of how the venture is configured.

During Stages II and III, a series of choices are made which will define the venture’s initial scope,
financial model (i.e., how it is intended to make money), and the ease with which it can be
adapted to changing conditions. These choices, which go to the heart of strategy development, can
involve product design, target markets, channel selection, size and timing of capacity, selection
among alternative process technologies, and levels of vertical integration versus outsourcing across
the value chain.

While dozens of detailed choices are involved, typically there are five or six key choices which can
make or break the venture’s returns. These key choices tend to get made in a piecemeal and

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iterative fashion, as market and technical knowledge accumulates. For this reason, financial and
risk analyses need to proceed in parallel. While early efforts will necessarily be crude, these
analyses can become increasingly granular as venture development progresses. Guidelines for best
practice:

• Bring financial analysis into play as early as practical and before key choices have been locked
in solely on the basis of technical and market considerations. Venture champions are under
pressure to meet deadlines and milestones, and their initial bias will often be to throw money at
their problems. Financial analyses which parallel (rather than follow) the choice process can do
much to avoid projects with lazy (underutilized) capital and inflexible cost structures.

• Use financial analyses to help venture team members adopt a businesswide perspective.
Different members of the team typically try to optimize their part of the venture around limited
criteria—e.g., production engineering may want to maximize economies of scale, ignoring
whether and at what price the capacity can be sold or the asset intensity that is built into its plan.
Financial analyses should help the team to look at revenue-cost-asset tradeoffs.

• Develop risk-return profiles for both key decisions and the overall venture. Despite the
uncertainties, most venture teams tend to gradually lock in to a base case scenario for key choices
and the overall project. More often than not, base case equals best case. The objective of a sound
financial analysis is not to maximize base (best) case return but to maximize return potential
under conditions of uncertainty. This requires identifying and modeling a credible range of
outcomes for key choices and the overall project.

Potential impacts of timely financial analyses have been documented by McKinsey. This consulting
firm has a practice/analytical process dubbed “Clean Sheet Capital Design” aimed at helping work
through the range of choices encountered in Stages II and III. In five case assignments involving
capital intensive projects in chemical, mining, building materials, and mobile telephone businesses,
the CSCD process helped venture teams to increase expected net present value of their projects by
35 to 80 percent over initial plans. These improvements were based on identification of capital
savings of 15 to 45 percent and revenue improvements/cost reductions equal to 20 to 35 percent of
the capital expenditure base.8 The CEO of one client company reflected on the power and
challenges of improving venture development processes:

Initially, our engineers found it frustrating to have their judgment challenged

and to be required to explicitly evaluate the risks associated with new ideas. They
could not see the need to have commercial people involved who challenged the
economic consequences of engineering decisions. Finally, they preferred the
sequential process (design first, then estimate) rather than an iterative,
participatory process imposed to achieve predetermined cost targets.

We succeeded in these efforts through persistence—we set clear, whole project

goals; we brought a few outsiders into the challenge processes and demonstrated
that sometimes there are different, insightful ways to improve designs; we trained
the engineers in simple financial forecasting; and we arranged people into
multidisciplinary teams.

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Execution: The Value of Active Management

When senior management approves a venture proposal (Stage IV), it is saying that it believes
return potential merits risking significant outlays. Senior management is also implicitly betting
that the venture team has the capability to actively manage the project under conditions of
uncertainty and ambiguity (Stage V). In the words of venture capitalist Arthur Rock, “Ideas are
a dime a dozen; only execution skills count.”

While few would disagree with the value of active management, little has been written with regard
to what is involved and how to do it. Anecdotal evidence on winning and losing investments
suggests the following guidelines for best practice:

• Project-focused systems for monitoring results and reviewing continued validity of key
assumptions are critical. In many instances, after approval, a venture’s results become buried in
budgetary systems for a wider business unit. Project monitoring should be against both operating
milestones9 and financial targets. Caterpillar, Inc. represents a best practice benchmark.10

• Active management involves both striving to meet pre-set targets and candidly admitting when
external developments have invalidated earlier planning assumptions. In this sense, active
management seeks a balance between disciplined control and learning/adaption.11

• Venture champions should be prepared to significantly revise the scale, scope, and timing of
activities in light of new evidence. This can range from accelerating or decelerating ramp-up of
capacity, product redesign, and new marketing programs to partial or full abandonment of the
venture. Many organizations resist large and rapid deviations from plan. Venture managers need
to have clear justification for such moves.

• Adapting the plan is generally a lot easier (and less costly) if economically justifiable flexibility
has been designed into the venture. Flexibility will be treated in a subsequent section.

• Risk analyses play a vital role in active management. They point to areas where contingency
planning and adaptive responses are likely to have the most impact. And they need to be revised
as new information becomes available during project execution.

The economic stakes that surround active management can be illustrated by two abandonment
decisions. The first example shows costs of lack of active management:

In late 1979, ITT Corporation recorded a $320 million write-off for closure of a
chemical cellulose plant in Port Cartier, Quebec. Total loss on the venture,
including cumulative operating losses, was $600 million.

Original plans, which were approved by senior management in June 1971, called
for a facility with capacity of 240,000 tons to be sold as raw material to producers
of rayon fiber. Construction costs were estimated at $120 million, with the plant
coming on stream in mid-1974. Base case NPV was $77 million.

In the event, the plant came on stream six months late at a total cost of $250
million (an overrun of $130 million). Reasons for the overrun were difficulties

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encountered in carving a facility out of a wilderness location, an underdeveloped

process technology, and protracted disputes with construction workers.
Explanations notwithstanding, simple arithmetic indicates that the project
should have been abandoned when the construction overrun exceeded $77
million (the base case NPV forecast)—and probably before, if changing project
risks were factored in.

Instead of abandoning the project and taking a non-cash write-off of $197

million plus incremental termination expenses, ITT kept spending on a value-
destroying venture for five more years. The loss to shareholders from lack of
active management was $403 million.

The second example demonstrates more timely action:

In August, 1998, Siemens AG announced a charge equivalent to $562 million for

shuttering a memory chip plant in Tyneside, England. The plant had come on
stream 15 months earlier and was still at start-up phase. The deal breaker for the
venture centered on worldwide oversupply and dramatic price erosion for
memory chips, conditions not expected in the original plan. For example, prices
of DRAM chips had declined from $50 in 1995 to $2 in mid-1998. Siemens
management believed that prospects for improvement in pricing over the life of
the facility did not merit accepting further losses, which were running at an
annualized rate of $246 million in 1998. Management estimated the value of
abandonment at about $223 million annually over 3-4 years.

RISK ANALYSES WITHOUT ROCKET SCIENCE

Drawing Cash Flow Pictures
Most large U.S. and European companies require discounted cash flow analyses to justify ventures
(Stage IV). Is the base case, or expected, return sufficiently attractive to commit significant
resources? Yet, if the organization focuses primarily on expected value of the venture (base case
NPV or IRR), at time zero, it misses the far more powerful potential of cash flow analyses in
helping venture champions shape and actively manage their projects across their entire life cycles.
The objective shouldn’t be precise valuation, but how to increase the odds of winning.

Cash flow analyses provide venture champions with a time-sensitive tool for visualizing the
potential economic unfolding of their projects. They impose an explicit and internally consistent
framework (or language) for portraying alternative outcomes for a venture. This permits managers
to transparently identify key assumptions, trace their potential consequences, and ask “what if ”
questions. At the simplest level of analysis, they permit visualizing how key decisions and future
developments can impact revenues, costs, and investment over time.

Crystal Ball Not Required

The object of the exercise is not forecasting precision, but informed judgment. Most managers
recognize that, as a venture actually unfolds, it will be subject to a veritable Murphy’s Law of
changing conditions. Venture risk analysis is much more an exercise in disciplined scenario

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development rather than the sorts of forecasting and budgeting used to manage established
operations on a day-to-day basis.

Merck is often cited as a sophisticated user of financial analyses to improve venture management.
Its CFO, Judy Lewent, describes the logic of its efforts as follows:12

DCF style analysis is used not for reaching go/no go decisions, but for optimizing
allocation of resources in the scale-up effort. Prior to that point, given the
uncertainties associated with new product development, it would be lunacy in
our business to decide we know exactly what’s going to happen to a product once
it gets out. However, we do make a continuous effort to develop and apply
financial analysis tools, which, rather than governing decision making, can help
decision makers deal with the high uncertainties in new drug development in
ways which are consistent with the construct of returning the cost of capital.

Simple Scenario Analyses

While a number of sophisticated techniques are available for mapping and gauging venture risk
and return potential (e.g., decision trees, Monte Carlo simulation, real option modeling), simple
cash flow scenarios will generally be adequate for the needs of most venture teams. Steps required
to develop these simple risk analyses are:
• Develop a base case scenario, reflecting what is believed to be the most likely pattern of cash
flows and NPV for the venture.
• Identify the 5-6 factors which (a) are most potent in driving base case NPV and (b) about which
there are significant uncertainties. These are the value drivers. While sensitivity analyses can help
to identify and confirm the importance of these factors, managerial experience in the industry or
analogous businesses will be the best basis.
• Develop 2-3 alternative cash flow scenarios, reflecting (a) different levels and time patterns for
each value driver and (b) different combinations of outcomes for the multiple drivers. The
scenarios should be logically consistent combinations of outcomes for drivers, not a random
combination of additive sensitivities. Again, managerial experience is vital in developing logically
consistent and credible combinations.
• The range of NPVs across the scenarios will provide a rough measure of venture risk. The wider
the spread, the higher the risk. Given the uncertainties and ambiguities which surround many
ventures, this approach may not fully capture the full range of potential outcomes. Nevertheless,
it is far superior to a single forecast.
Detailed mechanics of translating strategy assumptions into an internally consistent cash flow
scenario are beyond the scope of this paper. Rappaport and Mauboussin provide a user-friendly
treatment.13

Outputs and Insights

Results of these simple scenario analyses can be pulled together in three ways:

• A summary risk-return profile. Figure 3 shows one way to format such a profile, based on the

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FIGURE 3

NORTEL NETWORKS – GAMMA VENTURE RISK-RETURN PROFILE

AND COST TO PLAY

NPV = (5.21) NPV = 31.28 NPV = 78.35

WORST CASE = BEST CASE = BEST CASE =

PASSIVE ACCEPTANCE MODAL PROSPECT UPSIDE REGION
➡

COST TO PLAY:
1996 (3.70)
1997 (2.32)
1998 (7.25)
1999 (17.10)
______
30.37

author’s analysis of a venture under consideration by Nortel Networks in the late 1990s. Scenario
NPVs are enclosed in clouds to communicate that they reflect a “return region,” rather than
highly precise valuations. The “cost-to-play” numbers are estimates of size and timing of outlays
required to achieve the risk-return profile—i.e., the company’s exposure. Management may elect
to terminate spending, depending on the venture’s ability to achieve certain operating milestones
during 1996-1999. As portrayed, the risk-return profile of this venture is relatively attractive.

• A menu of key risk factors. These are the 5-6 deal-breakers/show-stoppers which the venture
team recognizes it must closely monitor and actively manage.

• A risk-reduction plan. How has the venture been configured to minimize impacts of major risks
or to respond flexibly to them? While the full range of risks that will ultimately be encountered
cannot be foreseen at the outset, it is possible to reduce the number that must be dealt with in
real time.

RISK MANAGEMENT
While each venture will involve a unique set of issues in balancing risk and return potential, it is
possible to outline several generic approaches for dealing with risk: [7]

• Avoid it. Don’t invest. The range of uncertainties and required exposure is too large relative to
potential returns. Take a deep breath and just say, “no,” even though several competitors claim
this is “the next big thing.”

• Wait to invest. In some environments, waiting is tantamount to giving up the opportunity—e.g.,

in contests for establishing a technology standard. Yet, there is a substantial body of evidence
indicating that fast followers succeed far more often than first movers in a wide range of
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FIGURE 4
DIFFERENT STRATEGY CHOICES CAN CREATE DIFFERENT
RISK-RETURN PROFILES FOR A VENTURE
NPV

+ BC
BC LEGEND:
BC BC = BASE CASE NPV
UPPER AND LOWER
0 BRACKETS = NPVS
FOR BEST AND
WORST CASE

industries.14 Emotionally involved venture champions generally think it is “now or never.” This is
often not the case. However, fast followers have to be positioned to move expeditiously if key
uncertainties are favorably resolved.

• Bear the risks. The risks are large, but so are the return prospects. Just do it, do it big, and take
Prozac when indicated.

• Share risks with others. If the risks are unnerving but the return prospects are intriguing, why
not share the risks with others? There is a wide range of possibilities: contracts with customers or
suppliers that lock in costs, price, or volume over specified periods or under specified conditions;
outsourcing parts of the value chain; joint ventures. Insurance and government investment
incentives are also risk-sharing mechanisms. While sharing risk usually involves sharing returns,
the sharing formula need not be proportional. Advances in financial engineering and gradual
globalization of capital markets are creating diverse “markets” for the purchase and sale of risks.
Different parties have different capacities to bear different sorts of risk, and this can reduce the
total costs of bearing risks.15

• Build input/output flexibility into ventures. Flexible manufacturing technologies—e.g., flexible

automation and fast changeover assembly systems—can be used to mitigate both revenue and
cost risks. Whether the investments required to build more flexible processes are attractive
relative to economies of scale of more traditional approaches centers on an assessment of their
value in adapting to changes in markets for end-products and supplies.

• Spread risks over time. Sequential expansion of production capacity and in building sales and
service infrastructure can limit exposure to technological and market risks. Whether such a
strategy makes sense is a matter of both risk-return analysis and assessment of likely moves of
competitors.

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• Truncate losses/marginal performance. Moves can range from downsizing parts of the venture
(e.g., certain products, capacity levels, or parts of the value chain) to complete withdrawal from
the business. Decisions on downsizing and abandonment tend to be more effective if
abandonment criteria have been set before the fact. These can take the form of financial or event
milestones. Some firms do set such ex ante criteria, but many do not. There tends to be deep
emotional resistance by venture champions to developing the business equivalent of a prenuptial
agreement or living will at early stages of developing a project.

The challenge for venture champions is not simply to position projects to capitalize on
opportunities, but also to structure them to be adaptable to risk. For most ventures there is no lack
of possibilities for putting several risk-management approaches in place. As depicted in Figure 4,
a venture can often be structured to target quite different combinations of risk and return. The
challenge is to develop a creative balance which fits the risk tolerance of one’s particular company.

CONCLUDING THOUGHTS
Recognizing and managing risk are critical functions of entrepreneurship, be it the corporate or
start-up version. Great risk management does three things:
• It reduces downside prospects …
• … while preserving or not proportionately reducing the upside.
• It also places a credible value on opportunity losses. There are costs to doing nothing new in
most competitive environments, even though accountants don’t track them.

As suggested by the title of this paper, managing venture risks occurs in a fashion that is upside
down from conventional wisdom about how large companies make investment decisions.
Corporate entrepreneurs who create and manage venture risks live in the middle of the
organization, not the top. They create and manage these risks long before and after senior
management approves or rejects investment proposals. Arming venture teams with ideas and tools
for risk management is bound to pay higher returns than assuming that the finance staff can sort
things out during the formal justification stage.

NOTES
[1] I define a corporate venture as a material investment—of money and/or scarce talent—which has the prospect of
changing a company’s (or business unit’s) competitive position, opportunity set, or financial footprint. While this
generally involves new business development, it may also extend to new ways of doing business—e.g., substantial
reconfiguration of the value chain.
[2] Many of the workshops were conducted under the auspice of Babson’s School of Executive Education, which a
1999 Business Week survey rated as “top provider of entrepreneurship related skills, aimed specifically at
executives from large companies” (Enbar, 1999). Other Babson faculty playing leading roles in this corporate
entrepreneurship practice include Philip Dover, Christopher Hennessey, Kathleen Hevert, Julian Lange, William
Lawler, Mark Rice, and Neal Thornberry.
[3] Bernstein (1996) makes a credible case that widening acceptance of risk as something which could be measured
and controlled dates only from early in the last century.
[4] Depiction of Scenario IV may be too pessimistic, since management might abandon the venture sooner. Overall
risk can be summarized as the difference in NPV for Scenarios I and IV. Upside and downside risk can be
summarized as differences between NPVs for Scenarios I and IV v. II (base case). Many finance theorists would
advocate assigning probabilities to the scenarios and computing expected NPV to determine whether senior

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management should approve the venture. In my experience, ability to arrive at valid probabilities is suspect.
Furthermore, this approach generally places zero value on ability of champions to actively manage the project.
[5] This decomposition draws on the classic treatment by Knight (1921).
[6] This staged capital commitment also provides venture capitalists with options to abandon and, often, options to
participate in subsequent rounds in the event of upside developments.
[7] Several of these approaches draw on insights from the literature on real option analysis. For purposes of this essay, it
is not essential to detail the specific linkages with real options thinking to support merits on these generic responses
to risk.

ENDNOTES
1
Bower, J.L. (1986). Managing the Resource Allocation Process (Harvard Business School Press, Second Edition)
2
Amram, M. and Kulatilaka, N. (1999). Real Options: Managing Strategic Investment in an Uncertain World (Harvard
Business School Press; Baldwin, C.Y. and Clark, K.B. (1992) “Capabilities and Capital Investment.” Journal of Applied
Corporate Finance, Summer.
3
Hodder, J.E. and Riggs, H.E. (1985). Pitfalls in Evaluating Risky Projects. Harvard Business Review, 01/85-02/85.
4
Lessard, D.R. (1985). Evaluating Foreign Projects: An Adjusted Present Value Approach. in Lessard, D.R., ed.,
International Financial Management (Wiley); Luehrman, T.A., (1997 ) “Using APV: A Better Tool For Valuing
Operations.” Harvard Business Review. 05/97-06/97.
5
Sahlman, W.A. (1998). Aspects of Financial Contracting In Venture Capital. Journal of Applied Corporate Finance.
6
Bower, J.L. (1986). Burgelman, R.A. (1983). Corporate Entrepreneurship and Strategic Investment: Insights From A
Process Study. Management Science. (19, 1983); Leifer, R., McDermott, C.M., O’Connor G.C., Peters, L.S., Rice, M.,
and Veryzer, R.W. (2000). Radical Innovation: How Mature Companies Can Beat Upstarts (Harvard Business School
Press).; Mintzberg, H., Raisinghani, D., and Theoret, A. (1976). The Structure of Unstructured Decision Processes.
Administrative Science Quarterly.
7
Gitman, L.J. and Forrester, J.R. (1982). A Survey of Capital Budgeting Techniques Used by Major U.S. Firms. Financial
Management. Winter.
8
Carter, J., van Dijk, M., and Gibson, K. (1996). Capital Investment: How Not To Build The Titanic. McKinsey Quarterly,
4.
9
Cooper, R.G. (1990). Stage-Gate Systems: A New Tool For Managing New Products. Business Horizons. 05/90-06/90.
10
Hendricks, J.A., Bastian, R.C., and Sexton, T.L. (1992). Bundle Monitoring of Strategic Projects. Management
Accounting. 02/92.
11
McGrath, R.G. and MacMillan, I.C. (1995). Discovery-Driven Planning. Harvard Business Review. 07/95-08/95.
12
Morone. J. and Paulson, A. (1991). Cost of Capital: The Managerial Perspective. California Management Review.
13
Rappaport, A. and Mauboussin, M.J. Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business
School Press, 2001).
14
Cottrell, T. and Sick, G. (2001). First Mover (Dis)advantage and Real Options. Journal of Applied Corporate Finance;
Lieberman, M.B. and Montgomery, D.B. (1988). First Mover Advantages. Strategic Management Journal. 9; Tellis, G.F.
and Golder, P. (1996). First to Market, First to Fail?: Real Causes of Enduring Market Leadership. Sloan Management
Review.
15
Brealey, R.A., Cooper, I.A., and Habib, M.A. (1996). Using Project Finance to Fund Infrastructure Projects. Journal of
Applied Corporate Finance; Stulz, R.M. (1996). Rethinking Risk Management. Journal of Applied Corporate Finance.

ADDITIONAL REFERENCES
Bernstein, P.L., Against The Gods: The Remarkable Story of Risk (Wiley, 1996).
Enbar, N., “Where Big Shots Learn To Think Like Hotshots,” Business Week, October 18, 1999.
Knight, F.H., Risk, Uncertainty, and Profit (Century Press, 1921).
Sahlman, W.A., “Some Thoughts on Business Plans,” Harvard Business School Conceptual Note, 9-897-101, 1997.
Shao, L.P., “Risk Analysis and Capital Budgeting Techniques of U.S. Multinational Enterprises,” Managerial Finance,
22, 1, 1996.

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