If you’re an entrepreneur or VC guiding a new venture, there is a good chance you will at some point be faced with the opportunity to bring a corporate VC into the company. This can be a classic double-edged sword.
You love the prospect of deepening a strategic partnership with an influential market leader, but you are concerned about some of the “special” terms they are asking for. You think you can get them to pay a higher valuation than a pure financial investor, but you are concerned that having them in your company might scare off their competitors who you want as your customers. Are you getting kissed by an angel or a demon? The answer, unfortunately, is it depends.
There are many positives to having corporate money in a startup, but there are also some risks. Taking a corporate co-investor is like doubling down: It can pay off big or you can lose it all. The twin realities are that: corporate VCs are here to stay, and more and more traditional VCs are co-investing with corporations. So how you interact with—and get maximum value out of—corporate investors can have a big impact on the venture.
During the bubble era, a number of corporations decided to play the VC “game” via venture units. It seemed like easy money, and if they were going to invest in market development or partner programs with emerging companies, why not get equity for it? When Intel reported over $2 billion in portfolio gains in one quarter alone (Q2 2000), it seemed like a proverbial money tree. Companies such as Dell, RSA, Accenture, Sun, and many other prominent tech titans started corporate venture groups in 1999 or 2000, only to exit a few years later when the bubble burst and that “easy money” had turned into red ink.
So that was the end of the corporate venture, right? Wrong. It turns out that during the post-bubble correction, the most active venture investor in the world was part of a corporation: Intel Capital. Companies such as Motorola, Siemens, Qualcomm and others continued to invest as well. For every Dell and RSA that exited over the last several years, there was a Unilever or a Chevron that was getting into venture capital. And while corporate participation in venture-backed deals rose from 6% in 1994 to its peak at 31% in 2000, according to the PricewaterhouseCoopers MoneyTree survey, the participation has remained very steady at around 20% since 2002, well above the sub-10% norm prior to the bubble.
Traditionally, VCs like to snicker at corporate venture units as being “dumb money” The widely read Paul Kedrosky called the September 2006 announcement by the NVCA that corporate venture investing was on the rise “a useful contrarian sign in venture markets.” If so, batten down the hatches. But is that more urban legend than truth? Josh Lerner and Paul Gompers of Harvard Business School wrote an excellent analysis of corporate VC performance in their seminal 1999 book “The Venture Capital Cycle.” In it, they looked at a sample size of nearly 20,000 investments by nearly 1,000 corporations and independent VC funds between 1983 and 1994. They concluded that while overall corporate venture valuations were slightly higher for investments where the corporation had a strong strategic fit, i.e., knew the space, there was little to no premium. And while individual corporate investments appear to be equally successful to those of independent VCs, for deals where there was a strong strategic fit the probability of success was actually higher for the corporate investment. So maybe that urban legend is just myth.
The good …
Corporate venture efforts are here to stay, and they may be pretty smart money after all. But what about risks? We have worked with a number of corporations as part of our Corporate IP Spinout practice—many of which subsequently invested in the spinouts. In our experience, there are indeed things that a corporate investor might—we repeat, might—do for an emerging company that can add significant value:
One of our portfolio companies entered into M&A discussions with a corporation that had previously invested in it, and the corporation used information obtained from board room discussions to drive a lower price.”
George Hoyem and Jim Huston, Blueprint Ventures
• Technical depth. Many corporate venture programs, especially those integrated into the company’s fabric rather than set up as a partnership, are able to tap into their corporate technical experts. This can translate into helping a startup get its technology adopted by a standards committee, for example.
• Rolodex. Large corporations have access to—surprise—other other large corporations. If a corporate venture program can tap into this, it can open doors no startup’s VP Sales can do on his or her own. But tapping into this Rolodex is easier said than done. If the corporate venture group only has relations with the parent company’s C-level execs, rather than the sales team, those promised introductions by the corporate venture group may be little more than lip service.
• Potential acquirer. Cisco is famous for using its minority investment program in the mid to late 1990s to invest in companies and then buying them outright. Of the 80 companies Cisco acquired between 1995 and 2000, 15 had previously received a minority investment from Cisco. But at least another five of those acquisitions were direct competitors of companies they had invested in.
• Strategic partnership. This one is the most tenuous justification. First, corporate strategies are notoriously fickle. Second, these relationships are often based on individuals inside the big company who could be re-orged into a new role. Third, big companies aren’t shy about asking a startup to invest a huge percentage of its resources in initiatives not conducive to the startup’s long-term prospects.
… the bad and the ugly
Corporate venture units offer many potential benefits but inevitably there is a cost. Some are infamous for demanding terms like a covenant not to sue for patent infringement or an actual intellectual property license from the startup in exchange for an investment. The corporate investor understandably doesn’t want to get into an IP dispute funded by its own money, but that’s a big trade-off for a startup. Some corporate VCs also demand a carve-out to prevent a drag-along in the event the portfolio company has a chance to be acquired by one of the corporation’s competitors.
One of our portfolio companies entered into M&A discussions with a corporation that had previously invested in it, and the corporation used information obtained from board room discussions to drive a lower price. There is also a danger that a corporate VC could scare off or block other potential acquirers who are competitors, especially if the corporate VC obtained favorable terms such as right of first refusal or even the right of notice.
Another concern: What happens if it turns out the best business strategy for the startup is to enter a market where it will compete with its corporate investor? If the corporation has had someone sitting on the startup’s board, it could obtain the G2 necessary to react and block the new entrant. There is also the overhead cost of maintaining the relationship. The startup needs to invest resources into the relationship with the corporate investor to get maximum value out of it.
Level the field
We like see a corporate VC that has done at least a dozen venture deals, has good references from co-investors and CEOs, and has a track record of doing follow-on investments.”
George Hoyem and Jim Huston, Blueprint Ventures
At the end of the day, we believe having a corporate investor in a portfolio company can be a good thing if the corporate VC does the following:
• Does not impose terms that could cap an exit (such as a ROFR).
• Asks for commitments from a startup that are reasonable and aligned with the startup’s long-term business objectives.
• Is willing to make firm commitments to add value to the portfolio company where those commitments have some kind of teeth.
• Is not a likely acquirer of the company. But if it is, make sure there are clear guard bands (e.g. no visitation rights to the board).
• Has a long-term track record of behaving well. (The same goes for the individual investment manager.) We like see a corporate VC that has done at least a dozen venture deals (and an investment manager who has done several), has good references from co-investors and CEOs, and has a track record of doing follow-on investments.
With some basic hygiene to protect portfolio companies from “corporate investors behaving badly,” we believe that corporate co-investors can be smart money, indeed, and worth the risk in many circumstances.
Jim Huston and George Hoyem are managing directors with Blueprint Ventures. Huston focuses on software, wireless, security and IT and comm. infrastructure. He is a 20-year veteran at Intel Corporation and was most recently Director of IP Acquisitions at Intel Capital. Hoyem focuses on software, wireless, security and IT and comm. infrastructure. They may be reached at firstname.lastname@example.org and email@example.com.