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Originally published in Entrepreneur
Innovation and iteration keep today’s leading corporations from becoming obsolete: Companies that put a strong focus on coming up with and testing new ideas have a better chance of surviving in a competitive climate.
This is also the reason why innovation teams and venture-creation programs, like AB InBev’s ZX Ventures or Michelin’s Global Incubators, are gaining popularity. But when innovation teams build new ventures, they should ask themselves whether it makes more sense to operate these businesses internally or to spin them out as new, separate companies.
Businesses of all sizes, after all, have created spin-out companies. Netflix spun out its “Netflix Box” division, which became Roku — a company that now has a $4 billion-plus market cap. Fog Creek Software (now Glitch) spun out Trello and Stack Overflow. Cisco spun out — and subsequently acquired — three different startups from the same group of founders.
Why? There’s the obvious answer, of course: Startups move faster than internal projects. But, there are other, more strategic reasons to launch a venture an arm’s length from your current company. For businesses trying to understand the pros and cons of a spin-out, here are some important things to consider:
Spinning a new idea out into a separate business can enable you to more easily attract the talent you need in order for your new venture to be successful. Large corporations, for example, sometimes have a hard time attracting the people needed to build a venture from the ground up.
Ask yourself honestly if you think your current company can attract the founders and technical talent that a new startup can. Particularly if your new venture involves a new business model, product or user different from that of your core business, a spin-out may be the answer. Creating a spin-out company also enables you to more directly align success-based compensation with equity/stock options and other tools that are at a startup’s disposal but are more difficult for large companies to implement.
If your new venture focuses on an industry or vertical that is beyond your company’s experience, or a scenario where regulation is still a moving target — like blockchain, cannabis and data privacy — exploring that venture internally may expose you to too much risk.
This is doubly true in highly regulated industries like banking, finance and healthcare. Startups in those spaces can test ideas and take risks that established players just aren’t able to. Spinning an opportunity out into a new company mitigates the risks the core company faces and gives the new venture more room to grow outside of the founding company’s internal or industry-specific regulations.
Too often, a new venture that competes with key partners, distributors or suppliers may be too damaging to the core business to pursue internally. For example, just weeks before the “Netflix Player” was scheduled to launch, Netflix abandoned the project. Leadership felt that launching a device that competed with hardware like Apple TV would irreparably damage relationships with potential key Netflix distributors.
Instead, the team was spun out as a separate company; thus the Roku box was launched.
If you find yourself thinking, this is going to make important people very angry,” building the venture internally may expose you to too much risk. Spinning the venture out, rather than owning it fully, allows you to protect relationships that are key to your core business.
You may hit on an idea with the potential to create immense value for the consumer but an idea that doesn’t align with your current company’s focus. If you find yourself struggling to fit a high-potential idea into your company’s overall strategic priorities, your impulse may be to scrap it.
Rather than choosing not to pursue it, however, you might spin it out into a separate business. Doing this allows your current business to benefit from the new venture’s potential upside while still maintaining its strategic direction.
Building a startup can be expensive, and has no guaranteed payoff. A startup is, by nature, an experiment — it could be worth a lot or nothing at all. In venture capital, we know that one in every ten companies we invest in will outperform all of the others. To capture returns, we need to have a large enough portfolio to find those outliers. The same is true of internal ventures. The larger your portfolio, the more likely you are to capture a return on your investment.
Rather than invest your own resources into a single, internal venture, use those same resources to spin out a few companies. Each of those new startups will then be able to leverage external capital from other investors. By spinning out multiple companies, you will exponentially increase your ability to capture the potential upside of new venture creation from the same investment of capital and people power.
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Ben Yoskovitz is a founding partner of Highline BETA, a venture capital and a startup co-creation company, and the co-author of Lean Analytics. Ben uses his 20-plus years of experience at startups (including VarageSale and GoInstant) and large companies (including Salesforce) to bridge the gaps between them.
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