A decade after the dot.com bubble reached its peak and started to implode, this year corporate venturing has returned to its highest levels since the turn of the millennium.
And, unlike the period up to the end of 2001, when corporations increased their pace of investment at the close of the economic cycle, the end of the latest recession and start of a new period of growth has seen chief executives invest in venturing and innovation more broadly to find new products, channels and technologies to boost revenues and margins.
A survey of corporate venturing members at US trade body the National Venture Capital Association’s (NVCA) annual conference last month found half were “substantially” increasing the capital allocated and the number of deals they were doing.
Half of the 26 survey respondents were investing at least $50m a year. At this pace, their corporate venturing teams are managing a fund or equivalent pot of about $250m, given an average investment period of five years for a traditional closed-ended, limited-life venture capital (VC) fund.
Some have been investing far more. Arvind Sodhani, president of Intel Capital, the corporate venturing unit of semiconductor company Intel and the world’s largest VC operation, said at its 11th annual Intel Capital CEO Summit for more than 700 portfolio company chief executives and technology decision-makers held last month that it had already invested more than $200m this year.
The NVCA said corporate venturing made up 13% of all VC rounds in the first nine months of the year and 9% of the money invested (see chart).
Using data from Thomson Reuters, the NVCA and accountant PricewaterhouseCoopers said in the first nine months of the year there had been 321 US-based deals involving corporate venturing units investing an aggregate $1.4bn out of 2,498 rounds worth a combined $16.7bn once independent VC firms were included.
Global Corporate Venturing has tracked 99 US investment rounds, acquisitions and exits in October and November, out of a global total of 147.
The US remains the world’s largest economy and VC market, with four of the five $1bn VC regions in Silicon Valley in northern California; southern California, around San Diego and Los Angeles; Boston, Massachussetts; and the New York metropolitan area. The fifth area is the UK.
But dealflow and activity have become increasingly global in the past few years. Global Corporate Venturing has tracked deals across Latin America, Asia, Europe and the Middle East and Africa this year.
Of the 18 new investments it announced at its summit, Intel Capital said 10 were companies based outside the US and, since Sodhani became president in March 2005, Intel Capital has tried to find about half its deals outside the US.
Data provider Dow Jones VentureSource, which tracked fewer deals than Thomson Reuters under its criteria, said there had been 64 corporate venturing deals in Europe in the first nine months, and 224 in the US.
Although deal activity in Asia still lags behind Europe and the US, according to Global Corporate Venturing estimates, the greatest potential for growth is seen as being in emerging markets.
Half the 20 largest corporate venturing funds or programmes launched this year have been in Asia (see table). Led by Korea Telecom, which committed to a ₩1 trillion ($830m) Mobile Korea Renaissance Fund in the summer to invest in mobile technology in the country, programmes to invest more than $1.5bn in the wider region have been announced in the past year.
China, India and the rest of Asia and other emerging markets are also seen as important areas for US and Europeheadquartered companies to access future innovation.
Belgium-based chemicals company Solvay committed half the Korea Advanced Materials Fund investing in nanotechnology, drugs company Eli Lilly became a limited partner (LP – investor) in an Australian state-backed healthcare fund, while computer equipment maker Cisco said it would invest $200m in the next few years in India.
The scale of the Asia-based corporate interest in venturing has been driven partly by the strong returns from exits, especially flotations, as well as fast economic growth rates and cash-rich balance sheets. The region escaped the worst of the credit crunch over the past three years and buoyant stock markets and economies have encouraged investment.
The scale of the boom, however, has been reminiscent of the dot.com bubble in the US and Europe, when investors entered the corporate venturing market on the back of quick and large gains from internet-related equities.
The median investment period pre-flotation in China for a VC firm’s portfolio company was 2.6 years, compared with 9.4 years in the US and six years in Europe, according to Dow Jones VentureOne’s database quoted in the Ernst & Young VC Trends and Insights Report 2010.
In China there were 56 VCbacked flotations raising more than $10bn in the first half of the year, compared with 23 in the US raising $1.6bn and seven in Europe collecting $90.6m, the report said.
The first six months of the year was nearly as active as the whole of 2009, when there were 44 Chinese flotations raising $4.5bn, eight in the US ($903.6m) and three in Europe ($160.4m). Corporate venturing units were behind many of these Asian initial public offerings (IPOs). Intel said it had floated 12 companies this year, compared with two in 2009, and media publisher International Data Group (IDG) has been working on or completed more than five.
But two of the biggest have involved cross-border corporate venturing units listing portfolio companies in long-established stock exchanges (see table).
Japan-based conglomerate Softbank floated gambling group Betfair in London in the autumn. And, on the same exchange, South Africa-based media group Naspers’ Myriad Investment Holdings unit and China-based peer Tencent floated portfolio company Mail.ru, a Russia-based internet group that also contained stakes in some of the US’s most successful online companies, including Groupon and Facebook.
Its hard to believe a decade after the start of the dot.com implosion that an internet holding company could again list with a $5bn market capitalisation but, while most people lost their heads over what the internet would mean in terms of revolutionary change, Naspers and its partners kept theirs and continued investing through the downturn.
Global Corporate Venturing ranked Naspers as the most influential corporate venturing unit in the media sector for its sophistication, strategy and stakes in both Mail.ru and Tencent. (And, unlike electric car maker Tesla’s US IPO in the summer, Mail.ru did not require a government grant in a state bid to pick a winner, although there has been a blurring of lines between public and private enterprise in Russia as well.)
Mail.ru’s valuation has been built on its dominance in Russia as well as small stakes in some of the US’s fastestgrowing social media companies, such as Groupon and Facebook. If these companies, or peers such as Twitter or LinkedIn, decide to list, the handwringing will be over in the US about the state of IPOs.
That they have not needed to is indicative of the deep pockets of its venture investors, and speed of growth, meaning cash from an IPO, is less vital.
The pace of growth of online companies is signalled by former venture-backed portfolio companies, such as Tencent, which remains a portfolio company of Naspers, or search engine Google, setting up their own minority-equity investment divisions in less than a decade of operation.
Apart from Google, which earlier this year committed to investing $100m a year through its Google Ventures team in the US less than a decade after launch, most of the corporate venturing programmes in America have come from the large, wellestablished groups, such as car maker General Motors, media publisher Washington Post’s Kaplan education subsidiary and General Electric (GE), which launched two $200m funds for clean-tech and healthcare.
These companies were often reacting to rapid technological changes threatening disruption to established business models and also offering opportunities in other sectors.
Corporate venturing often fits within a wider business development programme of mergers and acquisitions (M&As), incubation of internal ideas, spin-outs and asset sales and joint ventures and licensing.
However, the long-term nature of venturing means established companies have combined strategies of using it to invest for the subsequent decade and acquiring others to infill product lines and acquire innovative ideas no longer generated after in-house research and development budgets were cut during recessions.
This longer-term view has started to be grasped by senior management – an increasing number of companies have teams with more than a decade’s experience.
Whereas in the 1990s more than half of corporate venturing units had a year’s experience, in the past decade more than 50% have four or more years experience, according to Gary Dushnitsky, associate professor at London Business School (click on link to see chart).
Although there have been fewer than expected IPOs over the past five years in the US, according to Harvard academic Josh Lerner, American companies have remained active acquirers of VC-backed entrepreneurial businesses. In the first half of the year, US businesses bought 182 VC-backed companies, just more than half the 357 acquired in 2009 and at a median price point of $50m, Ernst & Young (E&Y) said in its 2010 report.
Data provider Global Wealth Allocation said the companies in the MSCI all-countries world index were currently earning $3 trillion a year, up 24.5% from January, while technology companies Microsoft, Apple and Google each have more than $20bn of cash on their balance sheets.
With an estimated 6,000 VC-backed portfolio companies nearing the end of the standard investment timescale and fewer independent VCs able to raise new funds, corporations are finding it easier to join syndicates of investors backing entrepreneurial companies or to offer an exit opportunity.
Five months after its registration with the US Securities and Exchange Commission, Beceem Communications decided to sell out to peer Broadcom for $316m. This was three times Beceem’s aggregate venture investment, of which Intel Capital will collect more than $60m from its share in the company. E&Y said the median time to a trade sale for a US or European portfolio company was 5.3 years, less than that needed for a company to list.
As Marco Da Rin, a professor at Tilberg University, has shown (see bar graph), the 668 VC funds being raised over the past three years in the US and Europe are only a third of the number maturing – those that had been raised between 1998 and 2000. Given the 1998 to 2000 vintages raised $174bn, whereas the 2008 to 2010 equivalents have raised an estimated $48.55bn, the overall venture industry’s investment capacity has shrunk considerably.
This might not be a problem for investors. As one of the largest venture investors said: “From a macro perspective, I am worried about the capital in the ground [in VC]. The industry has been funded with about $25bn per year [in commitments to VC funds] for too long versus the $10bn needed.
“Too much money in funds has meant valuations have been high and so there are between 6,000 and 8,000 [VC portfolio] companies doing the walk of the living dead in a market where there are only 400 to 500 exits in a year. The math does not work and it is a challenge as, since 1999, 94% of funds have not returned the capital committed, although this is skewed by more recent funds.”
He and other VC fund investors (LPs) from traditional sources, such as defined benefit pension schemes, banks and insurers, and endowments and foundations, have been scaling down their commitments as a result. This has left more room for corporate venturing units to act as influential LPs in funds.
Being an LP has been seen as a traditional entry point for companies starting a venturing programme as it provides contacts and insights into how established and successful VCs operate.
A number of firms, such as computer group IBM, act as an LP just to avoid being seen as competition but remaining close to the entrepreneurs.
However, with the decline of traditional fundraising sources, other firms are creating closer ties to provide strategic direction for a fund while leaving implementation to independent firms in order to avoid the risk of internal interference concerning the best deal and exit strategy.
Eli Lilly committed $150m to three VCs earlier in the year, while Netherlands-based electronics company Philips invested about $50m to local private equity firm Gilde in order to cornerstone a fund investing in home healthcare and help the group expand into the US.
An alternative approach of grouping several companies in related but non-competitive areas to act as an LP bloc was also seen this year with Comcast, gaming group Zynga, online retailer Amazon and media investment bank Allen & Co backing Kleiner Perkins Caufield & Byers’ $250m sFund, which is a fund investing in social media.
All the companies bar Comcast had avoided setting up direct corporate venturing units so this was a way to dip their toe into the area with a specialist fund with a remit and strategy in which they are interested.
Netherlands-based industrial and food groups Royal BAM Group, CSM and Imtech did something similar by investing an aggregate $34m in the Icos fund for clean-tech and consumer deals, while 10 companies in Michigan, US, such as energy utility DTE, backed a $50m fund to invest in the local region.
The third approach of opening up a successful in-house fund manager to third parties to add scale without affecting the parent’s balance sheet was also seen when publisher IDG said it would raise $200m in its next two Vietnam-focused funds.
IDG’s strategy of being the sole LP in a country-specific fund before allowing other LPs into subsequent vehicles and then potentially spinning teams off to become independent has been developed over the past 20 years. The strategy has been used successfully in China and in the creation of Flybridge Capital Partners in Boston, America.
But there is still competition, and hence higher prices, for the best deals. Bruce Dines, head of Liberty Global Ventures, the corporate venturing unit of US-based cable company Liberty Global International, said: “The overall contraction of the VC market is at the lower end, with firms who often do earlier-stage investments.
“We have not seen much of a ripple effect from that at the [series] C investment phase, which is where most of our focus is. We did see some valuation adjustments in 2009, but they have bounced back reasonably well in 2010.”
Fenwick & West, a US-based law firm, said its Third Quarter 2010 Silicon Valley Venture Capital Survey of 107 deals between July and end-September found more than half showed an increase in price per share compared with previous financing rounds. The average price increase for the quarter was 28%, compared with 30% in the first quarter of 2010.
Healthcare and information technology are the two biggest sectors for corporate venturing, according to Thomson Reuters data, as well as the overall VC industry.
However, corporate venturing units surveyed for the NVCA conference last month said the sectors they were increasingly looking to invest in were technology, consumer and financial services and at an earlier stage.
And the combined industrial and energy sector, which covers clean-tech, saw a 16 percentage-point jump in the amount allocated to it compared with all sectors by corporate venturing from 11.7% to 26.7% in the first nine months of the year, according to Thomson Reuters.
Corporate venturing units were involved in 13.9% of all rounds, but were important in most of the biggest rounds in the sector (see table).
There were eight clean-tech deals in the top 25 largest investment rounds of the year involving corporate venturing units, just ahead of the media and healthcare sectors’ seven (see table). The top 25 deals, as estimated by Global Corporate Venturing, raised $1.7bn in aggregate in their latest rounds, more than half the estimated $3.3bn they had raised in their histories.
Although a fifth of the top 25 struck rounds just before announcing their IPOs this year, a number of the biggest commitments of the year were to early-stage companies, such as social gaming group Playdom, which raised $76m from a consortium including Disney’s Steamboat Ventures in its series A round, and $48m raised for chip maker Smooth-Stone from a syndicate including UK-listed peer ARM.
Disney acquired Playdom just a few months after the A round making it one of the largest exits of the year for a corporate venturing unit, and one of the best annual rates of return (see table).
Although some corporate venturing units, such as Cisco’s, have long been seen as a feeder for its acquisitions team, others have shied away from making an acquisition for fear of being seen by entrepreneurs or other VCs as a potential troll limiting options for other exit routes.
So, while Medtronic bought Ardian from its own portfolio, Eli Lilly acquired Avid Radiopharmaceuticals from its portfolio and Boston Scientific purchased Asthmatx, Safeguard Scientifics sold Clarient to GE and Avid to Lilly.
The healthcare sector dominated the list of biggest M&A exits, with six in the top 10. However, the sale of healthcare companies Asthmatx, Sadra and PregLem included performance fees of about half the purchase price. If these targets are hit, the top 10 deals could return more than $6bn to their primarily US-based investors and management teams.
Healthcare corporate venturing has provided historically strong and consistent returns compared with IT or other sectors, and has also been the most mature in its role within the innovation ecosystem from research to product development and commercialisation.
But with wireless communications and IT affecting medical technology, greater understanding of the human genome and biotech, there are fundamental shifts in the sector that are allowing in non-traditional investors.
Switzerland-based chocolate company Nestlé has invested more than $1bn in corporate venturing since 2002 through VC firm Inventages and also moved its global chief financial officer to the unit in 2005.
The investments have helped it explore whether and how much to use healthcare in its products before setting up a medical science division in the summer to start buying out its portfolio companies.
This long-term, consistent application of corporate venturing to the consumer sector, underserved by traditional VCs, and understanding the impact of developments in another space has been a sign of the maturation of the industry this year.
Colin Blaydon, director of the Center for Private Equity and Entrepreneurship and management professor at Tuck Business School, said at the NVCA conference that corporate venturers were looking at “those areas with less attention and more need of capital” than provided by established VCs.
This evolution of corporate venturing from a follower of independent VCs to a complementary partner has allowed firms to be able to shape third parties to fit the strategic goals of their parent organisations and provide operational help to portfolio companies.
As a managing director at Intel Capital said, the question they ask themselves internally before doing a deal is: “How can Intel give an entrepreneur an unfair advantage to succeed?”
Intel and other experienced corporate venturing units often collaborate with VCs or gain access to the most sought-after deals by bringing new deals to the community and offering the strength of geographic reach. Intel has offices in more than 25 countries, while IDG is active in Korea, Vietnam, India and the US and is examining eastern Europe or Brazil for future bases.
Disney’s Steamboat Ventures and Eli Lilly’s Lilly Ventures have also built strong teams in China, the US and other regions off the back of the parents’ network of offices and operations in a way independent VCs outside the top tier have struggled to replicate due to organisational or cash restrictions.
The shift over the past decade to being seen as partners equal or complementary to VCs has been a result of experiences gained in the 1990s and through the dot.com bubble bursting as well as a general increase in the professionalism of company management, corporate venturers said.
And the experienced corporate venturing units have delivered strong returns. Academics Gary Dushnitsky and Zur Shapira’s analysis of 13,000 VC rounds found corporate venturing units outperformed independent peers but returns would have been even higher if they have been paid based on performance.
Consultancy firm Cambridge Associates and the NVCA said the 10-year return on total venture investing was -4.2% at the end of the June, compared with 14.3% during the same period last year.
This performance difference and investment maturity is starting to affect recruitment (see related content). Some of the most successful entrepreneurs and business managers moved to take top roles at corporate venturing units in the year.
In April, Christoph Westphal stepped down as chief executive of Sirtris Pharmaceuticals, which was acquired by drugs company GlaxoSmithKline for around $720m two years ago, to become head of GSK’s corporate venturing unit, SR One.
Last month, Amy Banse, a well-regarded head of Comcast’s Interactive Media division was appointed head of its corporate venturing unit that is merging with the $250m Peacock Fund. The integration will follow Comcast’s acquisition of network company NBC Universal from GE.
And the importance of portfolio companies building strong and close ties with incumbents, either for sales and product development or for an eventual exit route, has led to an evolution in some VCs. Third Rock Ventures, which raised its second VC fund at $426m after being launched by senior managers from Millennium Pharmaceuticals, has professionalised its approach so it can work on early to later-stage healthcare opportunities in closer collaboration with existing drugs companies.
And in clean-tech, which often also requires significant amounts of time and investment and where the eventual market is controlled by the established utilities and energy companies, VCs, such as CMEA, have hired specialists to liaise with corporations on behalf of their portfolio companies but also within investor relations as they become a larger proportion of their limited partnerships.
CMEA hired Erik Sebusch for a new role as strategic relations partner from delivery company UPS, where he worked at its corporate venturing unit and then pension fund as an LP in private equity firms.
The issue of building a team and retaining and recruitment are especially challenging in corporate venturing compared with other business units or VCs. With venturing usually reliant on a parent company’s money and senior executives’ commitment through management reshuffles, achieving organisation stability takes time and is never certain.
Denmark-based industrial group Danfoss in the summer shut its highly-regarded external corporate venturing unit and Stig Poulson, its head, left after the group instead decided to boost intrapreneurship – encouraging staff to think and develop ideas.
Firms can also regularly switch between concentrating more on strategic or financial goals, with a commensurate impact on the types of portfolio companies or style of investing that is appropriate.
Beyond top-down decisions, corporate venturing units said they lost people because of a lack of promotion or career path and low bonuses, as their financial compensation is usually salary and moderate bonus rather than equity participation in their portfolio companies. Success at corporate venturing was seen as a path to wider corporate success by half the respondents to the NVCA survey in the autumn.
However, rather than losing people to VCs that can pay performance fees – called carried interest – corporate venturing units said people were moving to portfolio companies and they were seeing a number of job applications from independent firms struggling with fundraising and cutting teams. Ashish Patel, head of Europe, Middle East and Africa for Intel Capital, moved to one of his portfolio companies, AVG, to be a director of business development.
Blaydon at Tuck said there remained the issue of attracting the best people “who go to other VCs, rather than the person who cleans the copier”.
Blaydon said the NVCA’s survey found the best teams were those that were small, with corporate attention and strategic insights. However, many said they operated under a high degree of parental oversight and slower investment decision-making.
Although publicly criticised by entrepreneurs and VCs for slower decision making, many corporate venturing units in the survey said this mattered less than the operational insights they could bring. As Blaydon said: “The new mantra for entrepreneurs is not to talk to financial investors if they do not bring operating skills.”
Overall, he said success for a corporate venturing unit was still judged more by strategic than financial goals, which also suffered along with other VCs from a general lack of exits and being involved in some consortia that had invested more than they had realised.
In the spring, Vax-Gen agreed to acquire diaDexus for $21m in shares after the latter had raised about $180m since 2000, while Tranzeo Wireless Technologies bought Aperto Networks for a fraction of the $170m invested, according to news provider VentureWire.
For corporate venturers, the quantum of returns, whether money multiple or annual rate of return, is relatively less important than for independent VCs, but still important.
And the length of time portfolios are held means companies have about a decade between investing and exiting that is probably about three times the average tenure of either chief executive or chief financial officer.
With each change in senior personnel and annual budgets, the chance to work on strategic benefits between corporate venturing units’ portfolio companies and business divisions is both a blessing and a potential pitfall as strategies can change before an exit is realised.
Strategic success came from capturing trends and technology, not necessarily additional revenue or M&A targets, although developing corporate partnerships was helpful, the NVCA’s survey found.
Another corporate governance issue for teams was whether to take board seats or remain observers on portfolio companies. The confidence of established VC groups, such as Intel Capital, to be directors on third parties’ boards is difficult for others to follow given legal concerns.
The NVCA survey found board seats were controversial as it created a fiduciary duty to act in the best interests of a portfolio company while often being employed by the corporate venturing unit’s parent.
It also created concern about the information flow back to parent, which is a broader issue given a rise in litigation over allegations that confidential information has been passed or whether competitors were funded or business ideas stolen, according to insurer Chubb.
One high-profile legal case was over the potential dilution of online auction company eBay’s stake in third party Craigslist. eBay successfully fought against the dilution in a ruling.
But rising litigation has combined with a tighter regulatory environment since the credit crunch with planned changes in legislation in Europe and the US affecting the broader venture capital and leveraged buyout industry by requiring authorisation of managers and greater transparency and potentially taxes.
Corporate venturing units have often been shielded from these issues by their parents but more independent units are caught and the attempt to pass on higher taxes to LPs can weaken returns.
Specific tax breaks to encourage corporate venturing have also been cut in the UK, although in Australia a highlevel commission recommended the government set up a corporate venturing fund as one of the ways to boost innovation and growth.
Ireland set up a €500m ($660m) innovation fund chaired by Damien Callaghan from Intel Capital in order to encourage VCs and entrepreneurs to the island.
Companies, whether established or more entrepreneurial, and the VCs that back them are being targeted by a large number of countries as they seek to compete through offering money, other incentives or other qualities, such as lighter regulatory or fiscal burdens and training and support.