Investing venture capital might never again be as fashionable to U.S. corporations as it was in the late 90s. Still, as the dust settles on what has been a four-year-long industry shakeout, it’s clear that while corporate arms looking to generate big returns have mostly disappeared, investors with primarily strategic venture programs have not only survived but are taking advantage of a favorable climate for backing and acquiring technologies.
The numbers underscore the new cycle’s beginnings. About 166 corporate VCs spent $1.3 billion on 476 deals last year, according to the MoneyTree survey conducted by PricewaterhouseCoopers, Thomson Venture Economics (publisher of VCJ) and the National Venture Capital Association. Compared with the 2,155 deals totaling $16.9 billion that 472 distinct corporate VCs sewed up in 2000, the wholesale drop off in activity is dramatic.
For those looking for a silver lining, corporate VCs did 19 more deals in 2004 than they did in 2003, and they invested about $32 million more. And, despite the recent closures of venture units by Applied Materials, Boeing and Dell, the VC industry has seen the emergence of new entrants, such as Amgen Ventures, a $100 million fund that backs emerging biotech companies, and the $100 million Xilinx Ecosystem Venture Fund, launched last December to zero in on programmable system design technologies.
“Corporate VC follows the market in absolute terms, and during the trough of disillusionment that the market was experiencing over the past several years, the resolve and commitment level of many CEOs was tested,” says Sarah Perry, who retired in January from her post as senior vice president with Visa International, where she served as the head of its VC program for nearly 10 years. Many who were concerned with short-term, quarterly profits exited, says Perry, but as lousy long-term syndication partners, they will not be missed. “We’re at the start of another big growth wave, and I say, Tourists, go home.'”
That corporate VC appears to be turning a corner probably owes to several things. First, many corporate VCs that entered the field have since lost the support of management and are now gone. Says Mark Heesen, president of the National Venture Capital Association: “What you see with a number of these [corporate VC arms] is a new CEO comes in and looks at the company’s costs, and even if it’s a very small percentage of the overall budget, it could stick out like a sore thumb in a cost-conscious age, as well as to raise questions, like to whom do the venture people report? Is it research and development or corporate development? And why are we going out and buying technologies when we’re trying to develop them in-house?”
Boeing Ventures, for example, last month ended its five-year tradition of backing external venture funds as part of a broader strategy to identify snazzy new technologies of use to the aerospace giant. Boeing spokeswoman Anne Eisele says that while not “directly causal,” the ouster of former Boeing chairman and CEO Phil Condit last November (he was replaced by former McDonnell Douglas CEO Harry Stonecipher) has translated into various programs getting jettisoned. Boeing had invested $250 million in 30 venture funds.
Outfits that invested primarily to generate quick, meaningful returns are also largely gone, including Dell Ventures. Dell spokesman Lionel Menchaca says that the 6-year-old arm-which had always emphasized returns rather than identifying startups that played into Dell’s overall corporate development strategy-called it quits last December because Dell’s investors were seeing fewer startups than in its early days, as well as facing fewer sizable funding opportunities that could have translated into big wins. Indeed, though Dell Ventures once invested vigorously, buying stakes in 22 companies in 1999, its pace had slowed to one new investment in both 2003 and 2004.
Finally, there is little incentive for corporate venture firms lacking resolve to stay in the business. On the contrary, shops like Lake Street Partners, a direct secondary investor that bought the bulk of Dell’s venture assets, are making it quite easy for reluctant corporate investors to ditch the asset class finally and clear the field.
Lake Street is not revealing what it spent for the portfolio-which consisted of 10 companies that it purchased in January 2004 and another 10 that it bought at year’s end. But while the portfolio represented a little less than $100 million of invested capital, it holds some potential gems and likely commanded a price reflecting as much. For example, Dell sold its stake in 2Wire, which makes gateways and modems for the DSL market and is garnering increasing interest from Wall Street as it expands into the set-top box market. Two others are BlueArc, a manufacturer of a high-end storage systems that has raised $150 million from Dell and Meritech Capital, among others; and Ehealthinsurance.com, which has raised $86 million over three rounds from Dell and Kleiner Perkins Caufield & Byers, among others.
“Right now, it’s a seller’s market, there’s no question,” says Ken Sawyer, managing director of Saints Capital, a direct secondary-investing firm that last year bought the venture portfolios of Tenet Healthcare and Primedia. Sawyer says that offering prices are being bid sky high due to greater competition within his industry. Further, he suggests, with a number of direct secondary shops out raising new funds, they are putting more of their limited partners’ older money to work than they might otherwise. (Saints itself is raising a new fund. Earlier this year, W Capital Partners, which is structured similarly, closed its first fund with $250 million in commitments. Morning Street Partners, an affiliate of secondary advisory firm Columbia Strategy, is also out fund-raising.) “In one recent case,” says Sawyer, “a technology portfolio sold for more than anyone is anticipating that its companies will generate, strictly to establish [the firm] as a contender [for future business].”
Meanwhile, corporate venture arms that haven’t thrown in the towel seem more purposeful than ever about their corporate VC programs. Warren Holtsberg, who runs Motorola Ventures, says Motorola is having no trouble investing in the range of its annual target of $100 million, which it tries to spread among six to 10 new companies yearly. In fact, he says, it has generated returns each year including last year, thanks to the sale of five of its portfolio companies, three of them to Motorola. For example, Motorola and other investors made about five times their investment in Foundstone, an Internet security consultant in which Motorola invested back in 2001. The company, which had $17.3 million from OVP Venture Partners, Motorola Ventures and others, sold to McAfee for $86 million in cash. The venture arm did even better with its investment in Magic4, a mobile messaging company. For their $13.8 million investment in Magic4, Motorola, 3i Group and Philips Venture Capital Fund received nearly a 6x return: The startup sold to OpenWave for $82.6 million in cash and stock.
Meanwhile, Motorola picked up for an undisclosed price MeshNetworks, which had sold peer-to-peer mobile routing software and raised $51.2 million from Motorola Ventures, Redwood Venture Partners, 3Com Corp., Apax Partners and others. Motorola also gobbled up 4thpass, a developer of software for managing wireless applications that raised $8 million from Motorola Ventures, Nextel Ventures, OVP Venture Partners and others and which sold for $22 million; and XtremeSpectrum, an ultrawideband chip developer. Xtreme Spectrum sold for an undisclosed price. It had raised $38.6 million from Motorola Ventures, Novak Biddle Venture Partners, Granite Ventures, Cisco Systems, and others.
“I see significant opportunities right now,” says Holtsberg, who estimates that Motorola, which invested in 20 new companies last year and conducted 10 follow-on rounds, will invest more than $100 million this year in the ever-heating markets of handheld devices, wireless applications and networking (particularly as it pertains to the home and automotive industries), marking the first time in the venture unit’s history that it will have surpassed that target.
Motorola Ventures’ strategy is simple, says Holtsberg. Though it is concerned with both strategic and financial investments-he wisecracks that “if an investment doesn’t make money, it isn’t strategic”-the group sticks with technologies that the company understands, like semiconductors, networking technology and wireless handsets that offer both present as well as future value for Motorola.
Of course, Intel Capital, the most active of the corporate VCs, drew the same conclusion long ago, though Intel is even more adamant that financial returns are of secondary importance to promoting the use of its own products.
Consider the early bets that Intel made on Linux, the open-source operating system. While Intel Corp. benefited directly from Intel Capital’s stakes in startups like VA Software and Red Hat, such investments also helped Intel to dominate the chip market for Linux servers, a more prized outcome.
No Place Like Home
Intel’s digital home strategy underscores its emphasis on getting Intel inside more than PCs. Its far-flung investment team is scouring the globe for software and hardware developers that are creating smarter digital TVs, set-top boxes, PCs, and hand-held gadgets, as well as those that are creating ways to deliver content more quickly.
So far, the company has set aside $200 million to get there. Since announcing its strategy last January, Intel has made investments in 12 new companies, including, most recently, Gteko, a networking and support software company based in Ra’anana, Israel.
Intel’s venture arm isn’t averse to thinning its portfolio. Last year it sold pieces to Lake Street Partners twice. “Every four or five years, it just makes sense to lighten the portfolio when not everything is a good fit,” John Miner, head of Intel Capital, said at the time.
Harvard University Professor Josh Lerner, who has long studied corporate venturing, says to expect more of the same from the large corporate VC arms that now dominate the corporate venturing landscape. “The activity of corporations doing traditional venture investing in conjunction with procurement and other processes hasn’t died down. They’re still saying, We want to buy new software; we want to be involved in the process somehow.'”
Meanwhile, those corporations that are opening venture arms today are ostensibly learning from their forebears. Though Lerner sees corporate venturing as almost inescapably cyclical, NVCA’s Heesen is optimistic that some valuable lessons have been learned and are being implemented. “For a long time we had a lot of corporations that, because of Wall Street, were looking only at the short term and what they could bring to the market every quarter in terms of earnings.” Today, he says, new venture arms are emerging in spite of concerns about their numbers, and they are focusing on the technologies that best suit their long-range corporate plans.