The business of venture

After a rush to establish corporate VC arms at the start of the dotcom era, many have had limited results. Yet other corporate VC groups have become leaders in the industry, in Asia and elsewhere. Corporate VCs talk about the business of venture capital.

Objectives and performance

Different objectives appear to be the main drivers in the divergence in experiences of corporate vs traditional VC firms. Corporate VCs (in general) have two ultimate objectives in mind – strategic and financial – while independent VCs have just one – financial. Independent VCs can enthuse about the challenge and delight of building great companies, but their business is ultimately financially-driven and focused on delivering returns. A corporate VC's strategic goals however, are usually focused on building some aspect of the parent business, outside immediate financial concerns. "Most corporate VCs in general are measured by their strategic impact versus their financial returns," as Ray Wu, former MD and head of HP's new business ventures organization and in charge of internal incubation and investment at Cisco Systems, and now an angel investor and entrepreneur, points out.

But the divergence can be overstated. In the view of Spencer Tall, MD at Allegis Capital and co-founder of Asia Pacific Ventures, for most corporate VCs, the financial and strategic goals are "almost equal. On paper they're not: the corporate strategy should outweigh the financial return. But at the end of the day, these are dollars coming off the balance sheet. And corporate VC groups that do return money tend to survive longer than those who don't."

Another important defining characteristic of corporate venture firms is how far the business operations of an investee are linked to those of the corporate VC's parent. As Harvard Business School professor Henry Chesbrough notes in his widely-regarded essay on the subject, "Making Sense of Corporate Venture Capital," a corporate VC's investee "might make use of that company's manufacturing plants, distribution channels, technology, or brand. It might adopt the investing company's business practices to build, sell, or service its products."

With the vast range of companies and business goals, corporate venture strategies are inevitably not a one-size-fits-all model. John Ball, founding MD of Walt Disney-affiliated Steamboat Ventures, lists some of the many types: "direct investment, JVs and commercial partnerships, corporate-sponsored spin-outs, and sector-specific fund-of-fund investing.  Combinations of these approaches may or may not be appropriate depending on the strategic objectives."

The track record of corporate VC

Opinion differs on how well corporate venture performs in principle – or has performed in practice. Some see the sub-sector as benefiting from recent difficulties in the financially-driven independent sector. "Given the capital constraints for traditional VC firms and other pressures, corporate venture capital is taking a leading role," asserts Sudheer Kuppam, Managing Director at Intel Capital. But according to Tall, "It was two years ago. The driver at that point was the economy going into a tailspin and a lot of VCs sitting on the sidelines." Since then, he maintains, "we're seeing a resurgence of VC activity."

Statistically, corporate venture capital has not shown significant development post the dotcom bubble. Data collected by PricewaterhouseCoopers and the US National Venture Capital Association shows that, from a peak of just under 16% in 2000, the corporate share of total US VC investment fell back by 2003 to a range of 6-8%, where it has stayed ever since. And Dow Jones Venture Source recently tracked $296 million of US corporate VC deals in 1H10, versus $871 million in 1H09. Arguably, this is simply taking the situation back to pre-dotcom historic norms. But it also argues that large companies have not found the corporate VC approach a compelling way to power innovation for their organizations.

One recurrent problem for corporate venture is the issue of disruptive technology. Corporate VCs, the argument goes, are less likely to fund truly revolutionary business models, as these may threaten the existing operations or even the ultimate rationale of the parent company. Skype, held by eBay for four years before being sold on to a Silver Lake-led investor group in 2009, and Sequoia-backed Google-bought YouTube are two signature examples, whose business has been the subject of legal and other challenges from companies and regulators. And Spencer Tall cites the example of an enterprise software company facing the challenge of cloud computing opportunities. "It's going to be really hard for you to cannibalize your core business. It makes much more sense to have that develop on the outside and then buy it in or partner with it than try to develop it internally with all the barriers that may be created."

Yet there is a counter-argument: that corporate VC allows large companies to benefit from innovation while keeping it sufficiently distanced from competing interest groups within the parent organization. Steamboat's John Ball points out that his business owes its foundation in 2000 to, "a strong belief and expectation that the media and entertainment sector was facing significant disruption and enormous growth opportunities resulting from innovation in web-based and mobile technologies. Indeed, this innovation has translated into huge new market opportunities in consumer Internet and digital and social media."

Furthermore, corporate VCs' performance versus their independent peers may have had worse press than it deserves. "From a financial returns perspective, traditional and corporate VCs are on a par," Wu feels.
Corporations also should take care to give their VC arms their independence, and if possible set them up as separate business units. Recent research by David Benson of Brigham Young University and Rosemarie Ziedonis of the University of Oregon concluded that the shareholder value lost as a result of a parent company's purchase of a business invested in by its corporate VC arm was closely tied to how integrated the VC division was within the parent corporation. Apparently, a corporate VC's ability to screen and evaluate investment propositions effectively increases the more independent it is.

Conglomerates in Asia and elsewhere certainly seem to see the continuing value in corporate venture capital. In late September, Singapore Telecommunications Ltd. announced the foundation of its own corporate VC firm, SingTel Innov8, with a fund size at launch of S$200 million ($154 million), "to collaborate with leading innovators, developers, government agencies, R&D organizations as well as other equity providers around the region to promote innovation. It will work closely with these partners to identify and explore new ideas and technologies, fund and support promising companies."

Wu sees other Asian corporations continuing to build their own VC arms in the West. "A lot of these guys play more in the US," he notes, citing especially the Asian export-driven companies, who use this avenue to access Western IP, brands and markets. "They create the corporate VC because they need that extension in the market."

Strengths and compatibility

Corporate venture often aims to accomplish more through its investments than independent peers. "There are multiple aspects to what a corporate VC can accomplish," Wu affirms, listing "access to proprietary technology, IP, reach to new markets, talent, knowhow, potential to do M&A" as some. "The corporate partner can be incredibly helpful in terms of market insights," adds Tall. "You get the advantage that they're looking at everything in the marketplace."

Says Kuppam, "Corporate VCs offer portfolio companies expansive access to global channels, as well as technical and architectural assistance building the company."

Another, less obvious, advantage of corporate VCs is that they are more strategic in nature and less financially return-oriented." They have single LPs – typically the corporation," says Tall. And, they have a different investment approval process. Corporate VCs may simply be less beholden to the pressures and priorities of independent VC general partnerships, often dictated by fund life cycle issues that can lead them to make sub-optimal decisions for their companies.

A corporate VC's less fund-constrained approach can also make it a less consistent investor. "They can be very much one-off investments. For an entrepreneur, that can be a disadvantage as well," cautions Tall. Especially for follow-on funding rounds, "you don't know if that money is going to be there from a corporate entity." This is not a universal problem, though. "We have not had those issues with the groups that we work with. They step up and we step up," he adds. In fact, the specific circumstances of any particular deal or firm are usually the final decider.

But corporate and independent venture capital need not be in conflict. In fact, the two can complement each other and fulfill different purposes in the growth of a young company. Corporate and independent VCs often fit very well together in funding rounds and consortium investments, in an industry already used to co-investment and partnerships. "In today's day and age, they function well right alongside regular VCs," avers Tall. "They're fantastic, actually."

Corporate and independent VCs can also play effectively at different stages of the VC cycle. "Corporate VCs in the emerging markets may even have a leg up in the mezzanine round," Wu argues. "In the early stage, it's very much the traditional financial VCs." Partly, he maintains, this is a question of deal size, with corporate VCs sometimes finding difficulties with the smaller ticket sizes. But it also relates to how a company's growth tallies with the goals of a corporate VC. "They tend to focus more on the later stage because the financial and strategic objectives can be accomplished at the same time."

Corporate VC in the Asian context

Corporate venture capital has had rather a schizophrenic experience in Asia Pacific. Alongside the headline expansion of major Silicon Valley VCs into Asia Pacific, the region has also seen some significant early entry by corporate or corporate-connected VCs, with SAIF Partners (launched back in 2001 as a JV between Cisco Systems Inc and Softbank Corp.) and IDG Ventures as two key precedents. But major technology innovation clusters in the region, particularly Japan, seem to have succeeded without developing anything like the Western-style VC model.

North Asia has never been very easy territory for any kind of VC. "Korea and Japan place a lot of restrictions and from a traditional venture startup perspective it's not easy," notes Wu. Japan especially he finds, "is very restrictive., but offers great opportunity if the VC can partner well in the region."

As a whole, though, Asia Pacific is a region where corporate VCs are almost compelled to participate. "For the technology sector in particular, the role of corporate VCs across Asia will become more important due to reasons mentioned earlier – access to global resources, including R&D and product development," Kuppam argues. "In Asia, PC penetration and broadband penetration rates are low compared to the West, so the opportunity is huge."

"The VC market in China is evolving rapidly, with increasing amounts of capital being allocated to the region both by financial and corporate venture investors," notes Ball. "Given our strategic objectives alongside Disney, we believe it is vitally important to be engaging early with emerging leaders in TMT markets, whether that's in the US, Asia or Europe."

Corporate VCs' preference for later stage deals also can fit Asian opportunities well, especially for the high-growth markets. "In China and India a lot of the investments happen to be late stage, and a lot of these companies would like to have a strong brand behind them before they go IPO," remarks Wu. "The brand is very leverageable for a lot of the corporate VCs."

Increasingly, brands are not only Western, though. Jonathan Chee, former head of the Principal Investment unit at PRC telecoms major Huawei Technologies, reports an increase in interest from would-be investees dating from  late 2009. "Many target companies approached Huawei and try to get funding from us."

"There is a great opportunity for corporate VCs and emerging companies in China to build win-win relationships," Ball feels. "Not only is there an opportunity to collaborate in domestic Chinese markets, but there is an increasing desire for Chinese companies to expand their presence in overseas markets."

Ultimately, corporate VCs are going to have to continue to build out in Asia because, as Wu confirms, "the globalization of a large company has shifted from inside the US into emerging markets." The corporate VCs, like their corporate parents, are going to have to play in this environment if they want to harness the growth and the major markets of the future.

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• Topics
• Venture
• Performance
• Early-stage
• Technology
• Sudheer Kuppam
• Intel Capital