Once venture capital-backed startups themselves, today’s tech giants know a thing or two about VC seed money. It’s fitting that many of them have created corporate venture capital groups of their own. These CVCs help their owners experiment and nurture new technologies and ideas in the early stages, without requiring the commitment of an acquisition. The CVC strategy often augments a company’s research and development efforts as well as complementing its M&A strategy. Middle-market dealmakers would be wise to track the VC investments of the five companies: Amazon, Google, Intel, Microsoft and Salesforce, as we highlight in a related story: Venture forth: How five of the biggest tech companies explore new territory through early-stage investments. Michael Frankel, a managing director at Deloitte New-venture Accelerator, spoke to Mergers & Acquisitions about some of the other benefits CVCs can again from venture capital tech investments.
Why have many technology companies launched their own venture capital units?
In a period of accelerating technology innovation and investment, it’s critical to stay aware of new technologies, offerings, data and analytics types and business models in your space, and adjacent spaces. Potential competition or disruption can come from any number of different approach vectors. New technologies can make your own technology uncompetitive. Alternative business models can make your own method of delivery unattractive to clients. New sources of data and insight can radically change your customers needs. For all these reasons, technology companies (really most companies) are looking for ways to get better and earlier access to the startup space. While corporate venture capital (CVC) is only one method, it can be a fairly powerful one.
What are the benefits, what are the risks or downsides?
There are four primary benefit themes from CVC. Each carries its own challenges and risks. And different CVCs put different emphasis on each one.
There is the direct financial return from the investments (similar to traditional venture capital). For the corporate this presents some potential challenge. First, unless the corporate is investing a fairly massive amount in the fund, even attractive returns will not likely be financially relevant and ‘move the needle’ for the corporates overall financial performance. Second, to the extent that the corporate is trying to balance financial returns with the other benefits I’m about to discuss, it can constrain their ability to make investments purely based on maximizing financial return. Generating a market-leading financial return is challenging in and of itself. Venture capital is a competitive space filled with a lot of well-funded players. CVCs have the advantage of being able to offer portfolio companies ecosystem relationships, but they also have some constraints that traditional VCs have like potentially wanting to avoid investing in competitive offerings/technologies or limiting their focus to sectors that are relevant to their business.
There is the market intelligence gained by close association with the target companies. This can take the form of formal board or board observer seats or advisory board seats. It can also take the form of a more informal but deep and regular set of discussions and exchanges of information. The challenge with market intelligence is similar to that of any source of insight – it requires effort to nurture and farm. Without dedicated resources that regularly engage the portfolio company, the amount of valuable intelligence will be limited. Similarly, without an active effort to deploy that market intelligence in the corporates operations, it might be extracted but never have any impact on the core business.
Potentially much more impactful is the use of CVC to source and solidify ecosystem relationships for the corporate. In this situation, the corporate uses CVC investments to target early stage companies with which it wants to establish a deep relationship. This could be anything from licensing their technology or co-developing a new offering, to reselling their solution or even leveraging their product for internal use as a differentiator or source of efficiency. And in many cases the corporate will want this relationship to be at least somewhat proprietary. To execute this kind of ecosystem relationship requires substantial dedicated resources at all stages of the process. Up front the CVC needs to work closely with the business to select sectors/capabilities/types of companies and then target the ideal choice. The business that will own the partnership will need to work very closely with the CVC and portfolio company to establish and then maintain the relationship – like any deeply entrenched ecosystem partnership. In the absence of dedicated resources and focus by both the CVC team and the relevant business, there is a substantial risk that the CVC will not create (or if created won’t sustain) valuable ecosystem relationships with portfolio companies.
Finally there is the natural path from investor to acquirer. While CVCs often think of investments as a way to get closer to, and learn more about, acquisition targets, in my experience that conversion to M&A target is not as common as people expect. The bar is high for a complete acquisition of a company. It has to meet criteria from technical and product alignment to culture fit and agreement on financial terms. Ironically, a CVC investment and the boost of an effective ecosystem relationship can help boost the portfolio company trajectory to the point where it’s no longer affordable. Effective leverage of CVC for M&A targeting also requires an active engaged dialogue between the CVC team, the M&A team and the relevant business to ensure that the CVC strategy maximizes the likelihood that a portfolio company will become an attractive M&A target.
What’s a typical path (or paths) for this type of investment? (Meaning, at what stage do they invest, how much, what happens next, do the eventually buy it, if so what percentage do they typically buy, etc)?
Stage of entrance varies by CVCs but generally skews to earlier stages of investment. Well funded and scaled businesses are less likely to need the CVC capital and more likely to want to avoid being formally or informally tied to a particular large player in the space. CVCs also tend to target more modest check-sizes, particularly as in recent years much larger venture funding rounds have proliferated. CVCs are most likely to enter in Series A and B when a foundational offering has been established and technology has been validated but the business has not yet scaled. That’s also when the relationship with the CVC can be most valuable to a start-up that is seeking market access and insight about customers. Post-investment, the nature of the relationship with the CVC will vary based on the CVCs primary strategies (see above).
How are their corporate venture capital, CVC, initiatives connected to their M&A strategies?
As I mentioned above, CVC efforts are usually tied at least somewhat to M&A. At the very least, the M&A team will keep an eye on the CVC portfolio and evaluate for potential acquisition. However, some CVC efforts are much more active in considering follow-on acquisitions, while for others it’s a rare occasion since they’re more focused on ecosystem partnerships, market intelligence or pure financial return. I think the most common scenario is that both the CVC strategy and the M&A strategy are driven by the overall growth strategy of the company – they’re both tools in driving that growth.
How is CVC connected to their R&D efforts?
Sort of the same answer as for M&A. There’s always some dialogue but how intense and aligned will depend on the core CVC strategy. In an organization focused on rapidly evolving their technology/offering, there is likely to be more of a focus on market intelligence – particularly new technology/offering intelligence – in their CVC. In those cases, the companies R&D focus will have a big influence on the CVC focus – driving it toward areas where the company is trying to stay abreast of the latest trends. This naturally drives toward either ecosystem partnership or M&A as the CVC uncovers early stage companies with IP that fits into the growth plan of the company. One of the challenges here is making sure that line of communication is open and regular. The better the CVC team understands the R&D aspirations and efforts, the better they can align their investment strategy.
As with most things in CVC, dedicated resources (not just in the CVC but in the business) and an active regular dialogue, are critical to extracting the full value from the CVC investments.