Corporate VC: Pleasing the parent

The rise of Asia's financial technology start-ups threatens to disrupt the banking sector in a big way. Industry incumbents face a choice between adaptation and extinction. To keep up with the pace of change, many corporates are looking to venture capital as a way to access the creativity of the start-ups that threaten to upend the status quo.

Singapore's DBS Bank - a 47-year-old institution with S$400 billion ($300 billion) in assets - is one such beast. Like many large corporates across many verticals, it is looking to back next big thing in its industry. But DBS has not formed an in-house corporate venture capital arm. Instead it has teamed up with Hong Kong-based early-stage investor and incubator Nest and set up the DBS Accelerator.

"In the long term DBS is looking at investments where it can make an acquisition, but normally the company has to be a certain size to justify DBS' involvement," says Simon Squib, CEO of Nest. "What we try to do is organize and systemize the early-stage investing space which traditionally has been quite messy - we are a deal-flow platform."

The DBS Accelerator, which will launch from next month, is targeting eight start-ups operating across in across seven segments: banking, big data, banking infrastructure, mobile payments, risk monitoring, security and small and medium-sized enterprise (SME) banking. The idea is that Nest provides the space, the program and mentorship while DBS contributes additional resources and capital in return for access to the next big fintech innovation.

The DBS-Nest tie-up is just one of a number of ways corporates are departing from the traditional captive corporate VC model. The very definition of corporate venture capital is being challenged, both in terms of the nature of the parties' involvement and the strategies they are pursuing. The issue for corporates - and their partners - is finding a model that fits.

"Corporate venture capital in Asia has been led by early pioneers and now there is a wave of new entrants," says Tytus Michalski, managing director of Fresco Capital in Hong Kong. "Instead of a one-size-fits-all idea, it is important to match the business model to the needs and strengths of each individual company."

Given the various ways corporate-backed VC is classified, it is difficult to accurately convey the size of the ecosystem in Asia, but AVCJ Research data provides a starting point. For the purposes of this article it has tracked any Asia-focused early-stage fund that is managed by a VC with a corporate parent - so that includes corporate VC funds that also raise capital from external LPs.

The data indicate that corporate VC fundraising activity underwent a resurgence in 2014 with 25 funds receiving $2.24 billion on aggregate, compared with $923 million across 26 funds in 2013, and $763 million raised for 13 funds in 2012. It is worth noting, though, that two funds attracted half of the total capital raised: IDG China Venture Capital Fund IV and Legend Capital Fund IV, which raised a combined $1.09 billion. Both firms have for some time received commitments from third-party investors.

Changing models

To get an idea of the how corporate VC is evolving in the region it is worth starting with the traditional model employed by the earliest entrants. The most successful examples are the likes of US chipmakers Intel and Qualcomm. Most of their activity in Asia has focused on China. Of the $14 billion raised by 204 corporate VC funds in the region over the past 10 years, more than half has gone to 79 China-focused vehicles.

Intel Capital claims to have invested roughly $2 billion in Asian start-ups since 1998; $700 million of this has gone to 120 China tech start-ups. Qualcomm Ventures, meanwhile, has been active in the region since 2000 and currently has 33 current investments across and China, India and Korea. However, Intel and Qualcomm are exceptional examples. Industry participants note that plenty of other corporate VC units have struggled in the region.

Part of Intel and Qualcomm's success is down to the way their VC arms are structured. James Shen, vice-president and managing director with Qualcomm in Beijing, divides traditional corporate VC in the three categories: the strategic model, the ecosystem model, and then a hybrid of the other two. The first involves a corporate VC making investment decisions purely from a strategic standpoint, and focuses on how the target company can directly benefit the parent.

"In this kind of VC model, the team is often not very independent," explains Shen. "They will have a team led by executive vice president who will handle the corporate strategy and the decision making and it is mostly top-down, meaning the top executives already know the strategy, they target a certain kind of start-up, and ask the team to execute on the deal."

By contrast, the ecosystem model - which is closer to the structure adopted by Qualcomm and Intel - offers the team greater autonomy with regards to investment decisions. It is essentially a bottom-up approach whereby the team will source deals based on broader long-term corporate aim of building of the ecosystem, i.e. not just backing companies that are directly connected to parent's business.

Shen notes that this is largely a function of maturity, with the more established corporate VCs seeking investments that will benefit the ecosystem. The remit for these players is to keep tabs on the latest developments in their sector.

"One way a corporate justifies setting up a fund is basically for research scouting and trend watching," adds William Bao Bean, an investment partner at SOS Ventures, who previously worked for Singtel Innov8, the corporate VC arm of Singapore's Singtel. "If you have some skin in the game, the depth of the data you can pull out is much greater that if you are just reading a newspaper or doing meetings."

There third approach, which combines both models, is by its nature harder to capture. It involves targeting strategic investments that directly benefit the parent while looking to back the next macro trend. Shen notes that Chinese internet giants such as Baidu, Alibaba Group and Tencent Holdings fit into this category. For example, Tencent's investments in mobile taxi-booking platform Didi Dache and online listings and group-buying service Dianping could both be seen to help broaden the parent's own platform.

However, it is not only corporate money that is being put to work. Tencent launched the Tencent Collaboration Fund in 2011 with a target of $1.5 billion. One of the benefits of taking capital from outside investors is that it mitigates issues related to traditional corporate VC.

Bao Bean observes that the reason some corporate venture capital funds have not been successful is where corporates have been too focused on their own strategy. Their interests have consequently come into conflict with those of portfolio start-ups. He observes that many corporations often have a short-term outlook, focusing on the next set of annual or quarterly results, as opposed to the next 10 years.

"The board of directors will look at the j-curve and look at the early losses, and if the company overall is not doing well it would cut the corporate venture program leaving start-ups in the lurch," says Bao Bean. "As a result corporate VC has got a very bad reputation, which is why so many corporate VCs failed in the past."

This point is echoed by Ben Weiss, a venture partner with SoftBank Ventures Korea (SBVK). He notes that because the SBVK sources around half of its capital from outside LPs, there is a need to focus on producing a financial returns as well as achieving strategic goals. This helps align the interests of the corporate VC and the portfolio companies. For SoftBank, the benefit of having LPs is more strategic than financial.

"From SoftBank Japan's perspective, it is less about financial returns - it doesn't move the needle for a group that size - they are more interested in having the first look into new technologies," says Weiss. "But it is a better model in my view because they get value from the LPs as they often have very good contacts."

Another possible benefit of a more independent corporate VC arm is that the investment team is able to operate on performance-based model. One of the major shortcomings of some firms is that managers are not compensated as they would be in traditional VC funds. For example, some corporate VCs do not include carry. According to Bao Bean, VCs that compensate based on performance generally do better in the long term, while those who do not are setting themselves up for failure.

Venture war chests

It is worth considering, however, that not all forms of corporate venture capital fit easily into the above definitions. Industry participants note that a number of relatively young VC-backed start-ups recently entering the space employ another kind of hybrid approach: they are looking to cultivate close ecosystems that incur direct benefit to their parents.

The stand-out example is Chinese smart phone maker Xiaomi, which was set up 2010 and has its own corporate venture capital unit, Xiaomi Ventures. There also some interesting case studies outside of China such as Japanese game developer Gumi and Korea messenger app Line Corporation, which have both set up corporate VC units in Japan in the past year. This trend is arguably more prevalent in Asia than in the West.

"Asian companies are a lot more aggressive on the venture side and they use their investment arms as competitive weapons," Bao Bean explains. "They are creating ecosystems where you get partnership and investment. So for Xiaomi, if you don't take their money, you can't partner with them, but it you become part of their ecosystem, you get cash, distribution and monetization. It is a powerful combination."

Qualcomm's Shen also adopts the weapon analogy when referring to Xiaomi's VC activity. He also notes that what makes Xiaomi interesting is that Lei Jun, the company's co-founder, is also co-founder of Shunwei Capital Partners, which regularly participates alongside Xiaomi in ecosystem investments.

These start-ups are often developing smart hardware that is expected to complement Xiaomi's product line up. Huami, a start-up that manufactures fitness wearables for Xiaomi, raised $35 million from Shunwei and four others in December. Meanwhile, Xiaomi Ventures has backed companies such as iHealth, which is expected to help Xiaomi develop mobile health technology solutions.

"Xiaomi is not an R&D company - the way it innovates is through its go-to-market strategy and through its branding," says Weiss. "But through investments it can get a look at a company, form partnerships, and buy intelligence. It is a way to take a bite, without eating the whole cake."

Not all start-ups wanting to dip their toes in venture capital can draw on the experiences of a technological polymath like Lei Jun. Another solution is to establish a formal partnership with a pure VC player. A recent example of this is Chinese drone start-up DJI which brought in Accel Partners - one of its VC backers - to launch a $10 million fund targeting drone-related products and services that could add to its ecosystem.

"A number of start-ups try to have their own in-house people but the learning curve is often longer than they realize," says Shen. "Investing is not a half-an-hour decision, it is a science. By partnering with a professional team you will be more effective."

With various corporate VC models gaining traction in the tech industry, the next issue is finding start-ups that willing to take the capital. The benefit with partnering with these VCs is clear for start-ups. Among other things, they are able to leverage capital and resources of an investment company that may have an international network and a well-established portfolio of companies that may offer synergies.

Nobuaki Kitagawa, CEO of CyberAgent Ventures, adds that corporate VCs can help start-ups in tapping overseas markets. "If a start-up wants to expand their business to another market we can work with the start-up companies by using our business footprint," he says. "This is particularly important in the Japanese market."

Willing partners?

However, as mentioned, the obvious downside is that the strategic interests of the corporate clash with those of the start-up. This can lessened to a degree by having a corporate VC fund that operates with some degree of autonomy, but it does not erase all potential conflicts.

Weiss notes that it can be hard for start-ups to predict whether a corporate VC will make a follow-on investment. He recalls a story of corporate VC that operated across numerous verticals and backed a start-up that shared a strategic synergy with ones of its business units. However, the unit was subsequently sold off and the start-up became non-core overnight.

Other issues arise when multiple corporate investors are involved. Inevitably, some want to secure certain rights over the others: the right to launch a product, the rights to acquire the company, or even just certain observer rights which may create conflicts.

"If you have a potential customer in your board room, it can be very difficult to talk about doing business with their competitors, so you need to segregate board meetings and conference calls and take out relevant board members," says Weiss.

CyberAgent's Kitagawa echoes this point, noting that many start-ups are concerned that taking an investment from one company might make it difficult to work with other players in the same industry. Shen, however, argues that the level of comfort start-ups have with their corporate backers is also a factor of geography and culture. He observes that in China start-ups are more likely to see early alignment with larger internet players beneficial to their growth than their Western counterparts.

"Chinese companies are more likely to weigh up the pros and cons," says Shen. "There is much greater tolerance than there is in the US where people feel their options will limit if they align too early."

Nest's Squibb notes that it was the desire to bridge this potential misalignment of interest - and strike a balance between a corporate that supports and corporate that smothers innovation - that led to the model adopted by DBS. The firm has also partnered with life insurance company AIA Group to set up an accelerator that will back start-ups with technologies relevant to the insurance and healthcare industries.

The bottom line is supporting start-ups and then facilitating corporate access to that innovation without the need to commit the same amount of resources or have exposure to the same degree of risk associated with running an in-house fund.

"When I meet with start-ups, the problem they are trying to solve rarely matches the problems corporates are trying to solve - they speak a totally differently language." Squibb says. "So there has to be a communication buffer between the two universes. We try to understand both sides of the equation. If we can connect the dots, everyone wins in the long term."

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• Topics
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• North Asia
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