The venture capital ecosystem deployed £25bn across Europe in 2019. It was a record year with companies raising over $36 billion and European start-ups raising $7 billion more than previous year. Year-over-year growth tracks at 25 percent. Since 2015, the amount of money raised by European start-ups has more than doubled.
The share of overall European deals involving Corporate Venture Capital (CVC) participation was also at a historic high. CVC accounted for 18.3% of the continent's VC deal activity compared to 12.7% in 2010. CVC has become an alternative source of funding and support for entrepreneurs raising capital and it is growing as a result. What is Corporate VC and how does it differ from Institutional VC?
Corporate VCs can be organised as an independent arm of a company or a designated investment team off their company’s balance sheet. The goal of a Corporate VC is largely the same as an Institutional VC: to invest in high growth companies that drive value for the parent company.
Technology and healthcare giants have held a venture presence for a long time. Google Ventures, Cisco Investments, Dell Ventures, Intel Capital, and Johnson & Johnson Innovation are all marquee names in the space. It is the recent influx of new Corporate VCs, ranging from financial firms to car manufacturers (GM invested $500M in Lyft and Orange Digital Ventures invested Monzo) that stand out as the new entrants to the market.
Much of the growth in Corporate VC activity can be attributed to the slow economic recovery, driving companies to seek alternatives to traditional R&D to boost growth. Corporate venture investments are a vehicle for the company to go into riskier and more disruptive R&D. Since most invest off the balance sheet, it gives the company more scale in R&D than just its P&L while providing access to markets and talent not otherwise available.
Institutional VCs are managed funds with £25 million to £1 billion under management to invest in companies with high growth potential. This capital comes from limited partners, the fund’s investors, and are managed by general partners, who make investment decisions. 80% of all venture funding is deployed by Institutional VCs but just 4% of those firms raise 44% of the total venture capital. Institutional VCs make investment decisions by understanding the dynamics of the industry they are investing in.
What you need to know about Corporate VC
Despite all that, CVC is a widely misunderstood and mistrusted category of venture capital. Amongst entrepreneurs, it has a reputation for being fickle and coming with onerous strings attached. In theory, corporate venture capital provides start-ups with both funding and a powerful industry ally with valuable experience and know-how. In practice, however, corporate venture capital is far from straightforward.
You, the entrepreneur, need to understand that corporate venture capitalists usually want your brand or business because they are worried about your products or services disrupting their sales. They would rather incubate you than develop something in house. You’re siphoning away a revenue stream that used to be theirs and they want their money back. Whatever the underlying trends, their strategy is to buy new brands that threaten the status quo. They’re venture capitalists buying growth but they are also defending their dominance.
The pros of CVC for an entrepreneur are outlined below;
- Corporate VCs can be more patient and have a longer-term investment horizon than traditional VC investors. A corporate VC almost always gets its funding from the parent company’s balance sheet and so isn’t beholden to limited partners or a 3-5 year fund cycle like traditional VCs. This allows them to take a longer-term view on building value.
- CVCs may have fewer, or different, control provisions than purely financial investors. Most will take a minority stake in order to avoid having to report their share of earnings and losses. They also frequently forego a board seat in order to avoid the appearance of control which can require consolidation on financial statements.
- Investment from a corporate VC can give your business instant credibility and a strong industry-related endorsement. This can be leveraged to attract customers and talent.
- You are building a relationship with a potential acquirer and potentially laying the groundwork for a future successful acquisition.
- Last but not least, a corporate partner can add a ton of value. The parent company can bring significant sector-specific expertise, connections and talent to the table. The parent company can also provide channel access, product integration and other support to accelerate product development and market penetration.
The downsides to taking corporate venture capital are not insignificant and you should consider them carefully.
- Corporate VCs are not purely financial investors. They can have strategic directives handed down by the parent company which may put them at odds with other (institutional) investors. We’ve seen corporate VCs block financially beneficial acquisition offers and financing rounds that didn’t align with their strategic interests.
- Corporate VCs have a tendency to overvalue a portfolio company, especially when they are the lead or only investor. This can deter potential co-investors and make it difficult to raise subsequent financing rounds at a higher valuation. This can also lead to a down round and all of the ugly things that come with it.
- Corporate VCs can include non-standard terms in their deals. For instance, they may want a ‘Right of First Refusal’ to acquire your company. This can scare off potential acquirers who don’t want to run the risk of being pre-empted by your investor who has a Right of First Refusal.
- Some potential customers and business partners may be competitors to your corporate investor and they may be put off doing business with you.
- A corporate VC’s funding comes from the parent company and the availability of follow-on funding may be tied to the fortunes and changing interests of the parent company. If the parent company’s fortunes or performance take a dive the corporate VC may not have capital available to participate in subsequent financing rounds in your company.
Tips for making a success of CVC
Only you can decide whether corporate venture capital is right for your business. You must take a balanced look at the issues before approaching corporate VCs for funding. If you’re going to pursue corporate VCs here are a few suggestions that will help make the venture successful:
First of all, find out how the VC arm and the corporation work together. How is the VC group evaluated? Are they purely ROI-driven or do they have strategic directives from the parent company? How do they make investment decisions? The more they behave and are judged as a purely financial investor the better alignment you’ll have among your investor base.
It is important to understand the structure of the fund and its ability to follow-on in future funding rounds. Do they maintain reserves and to what extent are they affected by the performance of the parent company?
Always push for standard terms and avoid Rights of First Refusal on acquisition or any other non-standard terms that may limit your options in the future the road.
Understand and be clear about what other benefits you want to get out of the relationship such as channel development or product integration. Some corporate VCs are very detached from the parent company and may not be able to deliver these benefits or value. Make your expectations clear from the outset.
Also, as with purely financial investors, do your due diligence. If possible, speak with the CEOs of some other portfolio companies funded by the corporate VC. You need to know what kind of investor and partner they’re going to be.
A final thought on corporate venture capital
In closing, it’s important to keep in mind that the mission, goals and objectives of corporate VCs vary dramatically between firms and it’s important for to do your homework before pursuing investment. You must consider carefully whether they are the right partner for you and your business and the partner that will help you achieve your goals, whatever they may be. As with any financial transaction, I also strongly recommend that you consult with your attorneys and other business advisors.
For help and advice on third party funding please get in touch with me.