Many large corporations have set up, or are in the process of setting up, in-house venture funds. At the same time, early and later-stage companies are looking for “smart money” investors – funds that bring strategic and operational help along with cash. Are corporate venture funds the perfect match?
Yes and no. Corporate venture funds can provide industry expertise, market intelligence, production know-how and capabilities and distribution channels, in addition to funds. They can validate a company’s technology and market opportunity. These attributes also make corporate VC funds attractive for VCs, who see participation by corporate venture funds as mitigating risk, lowering capital requirements and providing expert partnerships. So what’s the problem?
Not all work out as planned. Many great partnerships between corporate VC funds and growth companies have produced excellent outcomes, but many others failed. The following are some reasons why:
- Many corporate VC funds (or CVC) are not really funds. They’re just a line item in the R&D or business development budget. They can be eliminated from year to year if the corporate sponsor runs into hard times or if the fund’s champion within the organization leaves or moves to a different position. The potential adverse consequences include: the corporate VC is not there with the “dry powder” to participate in future rounds of financings; and the corporation’s board representative disappears or is replaced by someone with lesser value – both adverse signals to VCs and adversely impacting the value of the strategic partnership.
- Many corporate VC funds have a mixed objective; Are they seeking to maximize financial return or to develop insight and opportunities into new markets and technologies? Without a clear objective, it’s hard for a large corporation to evaluate success and even determine the type and level of support to provide to the companies in which it’s invested.
- The compensation structure for VC funds vs. corporate venture funds is diametrically different. VC fund partners earn relatively low compensation, all of it coming out of the management fee that they charge to their funds. Most of their compensation comes from the 20 percent “carry” that they expect to receive from the VC fund’s profits from investments. In contrast, corporate funds pay their managers on the same basis as other executives, salary plus bonus, with greater weight on the former. Consequently, corporate funds attract a fundamentally different type of manager than VC funds – managers who may be more risk-averse or more political, than VC fund managers. This difference impacts the investment philosophies of the two types of funds.
- Many corporate VC funds are scrupulous in avoiding even the taint of intellectual property “leaks” between the portfolio company and the R&D group of their own organization. Others are less scrupulous. As a result, there are a number of cases where the corporate investor’s own R&D team appears to invent the same technology as the one being developed by the portfolio company. And what early stage company can afford to sue a large corporate investor for IP infringement?
- Some corporate investors insist on a right of first refusal as part of their investment requiring that they have the first opportunity to purchase the portfolio company if the latter is up for sale. This is seen by other investors as adversely impacting the ultimate sale value of the portfolio company.
Corporate VCs are here to stay – and are likely to grow in number and importance. But a careful look is required – at the corporate investor’s track record and investment philosophy – before entering into the relationship.