This is the first wave in corporate venturing’s often turbulent, 40-year history – more groups are starting at the beginning of an economic cycle and there was no mass exodus during the recession.
Given the upheaval in the independent venture capital industry, with declining numbers of managers and fundraising concentrated on a handful of top-tier firms, this trend puts corporations at the centre of the next generation of backers to entrepreneurs.
And rather than being concentrated in developed markets or certain sectors, research by data and information provider Global Corporate Venturing of the more than 83 corporate venturing programme and fund launches last year shows the desire to invest crosses all sectors, size of parent organisation and regions.
The scale and scope of fundraising, combined with unique analysis by Martin Haemmig at Stanford University of historical investment data provided by Dow Jones VentureSource, allows the trends to be identified and the reveals the plans of the new conductors of the venture capital investment world.
Fundraising
Corporate venturing’s direct and indirect investment in entrepreneurs’ privately-held companies over the past 40 years has been punctuated by extreme volatility. From the 1960s to the dot.com bubble around the millennium, were set up at the end of the economic cycle only to be closed a few years later at the nadir of the downturn.
Research by Gary Dushnitsky of London Business School showed between 2000 and 2009 there were upwards of 350 corporate investors and more than 40% ofthem had been in operation for four years or longer, nearlydouble the length of those in the previous three waves inthe 1960s, 1970s and 1990s.
There have been very few programme closures in thepast two years, despite the fall out from the credit crunchsince mid-2007. Data monitored by Global Corporate Venturinghighlighted the closure of schemes by Denmarkbasedindustrial group Danfoss and India-based mobilephone operator Bharti Airtel last year, with a handful ofothers inactive in the past two years but without a formalannouncement of suspension.
Most of these historical corporate venturing programmeshave been managed on behalf of established companiesfrom developed markets in the US, Europe and Japan.
New programmes
The latest, or fourth, wave, which started around 2005, hasbeen building momentum in the past 18 months as economies recover from the initial effects of the credit crunch.
Increasing numbers of corporate venturing programmes have been started by companies from emerging markets, especially Asia, excluding Japan.
Of the 49 programme and fund launches in 2010 by corporations, 17 came from US-based businesses and19 from emerging markets – the rest were in Europe and Japan – according to Global Corporate Venturing. Last year, about a third of the more than 83 fund launches came from US-based corporations and a similar number from emerging markets, primarily Asia, according to Global Corporate Venturing (see table).
Staffing and operations
Many of these programmes have been staffed with professionals drawn from internal business units and mergersand acquisitions divisions, as well as from venture capital firms, particularly for overseas offices.
Mike Dolbec, California-based head ofcorporate venturing for Korean conglomerate LG Electronics, said: "Based on my corporate venturingexperience with major international corporations,particularly Asian ones, they mature through three stages of the corporate venture capital model.
"Corporate venture capital 1.0 is to invest insomebody else’s fund. That is OK but does notdeliver what they expected. They soon find outit is not an intimate relationship that yields deep insight and perspective, nor does it help much with future dealflow.
"The next stage is 2.0, where corporations set up a local office in Silicon Valley but staffed with people whose careers have been in the home company and recently transplanted. Those people work out better but not always ideally.
"Because the innovation culture in Silicon Valley is so relationship driven it is difficult to penetrate the culture, become connected and learn the secret handshakes of the various innovation networks.
"Finally, 3.0 is the current trend – hiring native Silicon Valley people, especially experienced venture investors with previous operating experience here, who have spent their career in the network of people that you need to know in order to be effective to play the corporate venture capital game.
"The savviest international corporations are now skipping the earlier stages and going straight to 3.0, for example certain Chinese corporations and LG Electronics."
Investment goals
Corporate funds have become substantially larger in both emerging and developed markets and marked by having specific teams aiming for a hybrid of strategic and financial returns.
Often, groups have had more strategic goals if the corporate venturing groups report to the chief technology officer or chief executive, while financial returns can be paramount if they report to the chief financial officer. Corporations are also able to attract other investors to commit to their funds as a way of leveraging their money.
Akhil Awasthi, managing partner at Tata Capital’s Growth Fund, which manages six funds across the different stages of the corporate lifecycle, from start-up to distressed, for the India-based industrial conglomerate, said a maximum of 15% of its $2bn under management came from Tata.
He said: "We bring to the table a completely different execution from financial investors as [Tata has 90 operating divisions] and understands the businesses and the industrial secular as well as cyclical growth cycle. We also bring resources in the form of knowledge of supply chains, as well as people to help entrepreneurs fast-forward growth."
Fund sizes
The top 10 fund launches in 2010 committed $2.5bn, while the top 10 last year had $8bn in programme expansions. While 2010’s biggest fund was Korea Telecom’s $830m, last year’s biggest was nearly twice the size.
The $1.5bn committed by China-based online services provider Tencent to its Industrial Collaboration Fund, started in January, indicates the ambition of many businesses in emerging markets that are still driven by their own entrepreneurial founders.
Led by co-founder and chief executive Ma Huateng, Tencent’s fund has combined strategic goals to encourage third-party games and application developers to work on products for its platform as well as take stakes in businesses that might extend the reach of its services into e-commerce.
Global ambition
Tencent has also begun investing internationally, in conjunction with its own corporate venturing group as minority shareholder, South Africa-based media company Naspers, and indirectly through funds managed by third parties.
Tencent has taken minority stakes in companies in India and Thailand alongside Naspers, bought 10% of Russiabasedinternet investment manager Digital Sky Technologies and become a limited partner (investor) in South Korea-based Capstone Partners and local Chinese incubator Innovation Works.
This "hidden wiring" of mutual shareholding, limited partnerships and co-investments linking the top corporateventuring units with peers, sophisticated family offices, sovereign wealth funds and independent venture capitalfirms is at the heart of the new ecosystem of investors in entrepreneurial businesses.
Corporations are also playing a role complementary toother types of investors in the choices of deals they are making using their new-committed firepower.
Deals
Looked at through historical data, corporate venturing’s role in supporting entrepreneurs has been relatively limited.
Given their often short-term lives and interest in deal-making at the end of an economic cycle, corporate venturing units have had a reputation for being fickle and "dumb" money.
But with about 50 programmes having had more than a decade’s experience, according to Global Corporate Venturing’s database, and their resilience through the most recent economic downturn and increased investment since last year at the start of the latest cycle, this impression is starting to change.
Notwithstanding this future trend, the proportion of investments involving corporate venturing units as a percentage of all venture capital deals has broadly fallen over the past five years, according to analysis by Martin Haemmig at Stanford University using data supplied by Dow Jones VentureSource (see graphs above).
In both the US and Israel there were four percentage point falls between 2006 and the end of 2010, to 12% and 20% respectively, while Europe fell from 13% to 11% and China was down in most years, having started in 2006 at 11% of all venture capital deals.
The US remains the biggest market for venture deals overall and this extends to corporate venturing. Dow Jones VentureSource data shows there were 1,853 deals involving corporate venturing units in this five-year period. In Europe, there were less than half as many, at 745, while in Israel and China there were between 10 and 36 per year.
Sector analysis
But while corporate venturing units were involved in less than a quarter of deals, in some sectors they were more active as a proportion of the overall number of venture capital transactions.
Analysis by Haemmig using data supplied by Dow Jones VentureSource shows in the clean-tech sector corporate venturing units could be involved in often up to 10 percentage points of deals more than the average across all sectors.
This relatively higher involvement is often seen as a consequence of clean-tech higher capital expenditure requirements to achieve product development milestones and revenues and profitability.
Investment stages
The majority of corporate venturing deals are in companies after the initial start-up phase, often nothing more than an idea or business plan.
As defined by Haemmig, this is in entrepreneurs at the product or service development phase or in businesses with revenues but before achieving profitability (see graphs).
In any given year between 2006 and end-2010, fewer than 20 deals in any country are in start-ups, Haemmig found using VentureSource data.
This is starting to change, with China-based Innovation Works incubating companies while, in other emerging markets, corporate venturing groups are looking at less-competitive stages of investment.
Sarbvir Singh, head of the $50m Capital18 corporate venturing unit sponsored by India-based media group Network18, said it had been set up in 2007 during the height of the previous venture capital bubble in the country.
He said: "We looked at early-stage because when we started in 2007 any company with revenues and profits were being chased by at least five funds at what seemed like very high valuations. It made more sense to back seasoned professionals to build organically and this approach has paid off for us."
Of the first 10 portfolio companies at Capital18, therefore, four have been incubated.
But when looking at the amounts invested in these four stages, more than half of the dollars invested goes into businesses with revenues and often profits.
China is the most extreme, with 80% of the money invested from the 36 corporate venturing deals last year going to profitable companies, and almost all the rest into businesses with revenues.
Valuations
This is partly a consequence of Chinese businesses achieving profitability earlier than overseas peers but also because the market is seen as being so big and fastgrowing that it is better to follow the existing winners and provide them with the money needed to maintain market share.
But this competition for deals is forcing up prices even as corporate governance and other factors trail peers in developed markets.
Campbell Murray, a US-based managing director of Novartis Venture funds, which invest on behalf of the healthcare company, said: "We have investments in Asia but are cautious as valuations are often not cheaper and our fund is primarily interested in innovation.
"We value capital efficiency, but lower labour costs are not a key driver in finding solutions to intractable medical problems, which is our primary investment criterion. We continue to think there is a wealth of opportunities in the US and Europe and valuations are often reasonable.
"Of course, as people in nations like India and China ascend the scientific innovation indexes, so too will the opportunities to support them in creating new products, and it is likely our portfolio balance will evolve to reflect this over time."
Part of the relatively high valuations in some emerging markets has come from investors chasing established, profitable businesses.
Independent venture capital firms have also invested in profitable companies in China, and it is the only region in the past five years where the median pre-money valuation for an investment round was higher without a corporate venturer in the consortium than if there had been, according to Haemmig’s research.
In Europe and the US, a corporation’s shareholding in an entrepreneurial business signals it will be valued for the median deal at between twice and six times as much as if this element was absent, he added.
Exits
But if the pre-money valuations are higher with corporate venturing involvement, it is less of an expectation they will be the eventual buyers. In the five-year period between 2006 and the end of 2010, corporate venturing units acquired between 1% and 6% of their information technology portfolio companies (see graphs above).
Western corporations, however, are increasingly expanding into the high-growth regions with their own teams and investments, as well as indirectly through limited partnerships managed by third parties, with their parents occasionally buying up portfolio companies.
Earlier this year, media group Pearson took a majority stake in TutorVista earlier this year having previously taken a 17.2% stake in June 2009 as part of a $12.5m investment.
But while India is seen as relatively open to foreign investment and acquisitions, other emerging markets, in particular China, are seen as having more constraints on overseas acquisitions or have a buoyant stock market for initial public offerings (IPOs) and so a more limited market for mergers and acquisitions.
Richard Hsu, China head of Intel Capital, the corporate venturing unit of US-listed chip maker Intel, said: "In China acquisition of venture-backed companies is less active as the attitude is build, not buy, and the IPO route is so much more attractive for founders from a valuations perspective. Given the abundance of opportunities, retention of management teams is also an issue."
There is, however, expected to be an increase of corporate acquisitions of venture-backed companies in many markets as a source of innovation.
Yoshinori Ito, head of value-added investing at Japanbased Jafco, which made 106 venture deals in the 12 months to the end of March, said: "In Japan, we expect corporations to be an exit alternative as the Japanese IPO market is very sluggish and they can get access to the technology."
Cross-border investment
With emerging markets appearing to offer relatively better growth prospects for parent businesses and also have the potential to be a fertile source of innovative ideas, a number of corporate venturing groups are looking to invest more there rather than in domestic, developed markets.
John Ball, founder and managing partner of Steamboat Ventures, the venture capital firm aligned with US-based media group Disney as its founding limited partner, said Steamboat on average looks to do a deal each quarter in both the US and China, but in the future could increase its investment pace in China given the fertile market conditions.
But he warned international investing was difficult even as it was becoming more important. Ball said: "The venture capital industry is changing and a global perspective is essential. Cross-border investing is as challenging as globalisation itself, but we see more opportunities and advantages from being active in the US and China simultaneously.
"We expect to see more cross-border partnerships and mergers and acquisitions. Where there is market demand, deals will follow, albeit subject to political, regulatory and cultural hurdles.
"It takes time to build relationships and to understand the cultural and business practices and local regulations. This is the specific plan Steamboat has been working to in China for six years and we are definitely seeing the fruits of this hard work."
Emerging market innovation
These emerging markets are also competing on the quality of their innovation as well as the pace of economic growth or other factors.
Michael Jeon, head of Europe at Samsung Venture Investment Corporation, which manages the limited partner commitments from many of the Korea-based conglomerate’s subsidiaries, said: "If you look at Korea, in the past domestic start-ups may not necessarily have had the best technology, as it tended to come from places like the US or Europe. But domestic suppliers or partners offer advantages in a number of different ways – cultural and geographical closeness – and it be a more cost-effectivesolution relative to something that you might have to import.
"What we are finding more and more is that Korean companies are now producing technologies that are of very, very high quality, and if you put them anywhere in the world they would still be very, very competitive against their Silicon Valley or European counterparts. And at the same time, if we can communicate with them much better because of the language and cultural similarities than that is definitely an advantage for them.
"So it puts pressure on myself in Europe and my colleagues in the US but also more broadly on the world technologycentres of excellence. Silicon Valley companiesflying over to Korea face tougher competition than they would have in the past."
Asian century
Or, as Yoshitaka Kitao, chief executive of SBI Holdings, a financial conglomerate originated from Japan-based Softbank’s investment division, put it: "There is no doubt that the 21st century is the Asian century.
"In contrast to the developed countries of the west, emerging Asian countries such as China will boost their global prominence in terms of economic scale and future growth potential. Considering global demographics by country and region, China has a population of 1.3 billion and India 1.2 billion, with Asia as a whole accounting for approximately half the people of the world."
According to the International Monetary Fund, taking the nominal gross domestic products (GDPs) of the Asean+6 countries – the Association of Southeast Asian Nations, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Myanmar, Cambodia, Laos, and Vietnam plus China, Japan, South Korea, India, Australia and New Zealand – as representative of the Asian economies, their combined GDP is forecast to reach about $24.4 trillion in 2015, surpassing the North American Free Trade Agreement countries and the European Union to become the world’s largest regional economic bloc.
Kitao added: "In order to take full advantage of thismacro trend, the SBI Group will fully lever its know-how and experience accumulated through its operations in Japan, and the established global network with prominent local partners through the asset management business. We will work to export our financial ecosystem to become a truly global corporation, with its axis in the emerging market countries and a particular focus on Asia.
"We have no doubt that our future growth opportunities lie in the overseas emerging market countries. To fully leverage the high growth potential of these markets, we are transitioning ourselves to become the ‘world’s SBI’, by exporting our financial service businesses to these countries and by investing heavily in Asian emerging countries."
Global competition
In the global competition for innovation, corporate venturing groups are keen to help their domestic portfolio companies expand internationally as a way of helping the home country more broadly.
Toshihisa Adachi, president and chief executive at Itochu Technology Ventures, said: "I am relying on young entrepreneurs to aggressively make a new business globally.
"They have an eye on the global market and we are helping them to go to Silicon Valley. It is time to change Japan Inc from the legacy business models to being much more innovative, so we need younger people to make a real 21st century business model based on new concepts around the digital native generation and new ideas."
Compared with independent venture capital firms, corporate venturing units said the support of their parents helped them become global quickly.
The role of multinationals
Switzerland-based ABB set up its Technology Ventures corporate venturing unit in October 2009 and its deals have been international across Europe, the US and Asia from the start.
Girish Nadkarni, head of ABB Technology Ventures, said: "If we do deals in different parts of the world we always have somebody either locally in that country or somebody nearby who can help us understand the lay of the land, and do the required corporate, legal and other due diligence.
"The technology due diligence is done either locally or centrally, depending on whether it is something which an ABB business has the competence in or whether our corporate research centre has the expertise to look at it. Typically, the earlier the stage, the more we rely on our corporate research centre.
"One of the things we ensure is that ABB is value-added capital. It is not just the money we are bringing to the table, though certainly that is helpful, particularly in clean-tech companies looking to bridge the ‘valley of death’ [middevelopment funding shortfall].
"We put a business person on the board so the company benefits from a different perspective. The last thing the company needs is another venture capitalist on the board. This also ensures the ABB business develops some level of ownership or relationship with the company it is expected to support."
But as the idea of encouraging entrepreneurs and innovation globalises, the role of multinationals with the cash to invest and ability to use an international network of offices becomes an important competitive advantage over more localised investment firms.
Ralf Schnell, head of Siemens Venture Capital, the corporate venturing unit of the Germany-based conglomerate, summed up the new investment landscape. He said: "It is a huge advantage to be part of a global multinational as countries beyond India, China, the US and Europe become relevant entrepreneurial societies. Brazil, Turkey, Russia and eastern Europe are establishing venture capital markets. The industry is global."
This is an edited version of an article published in accountant Ernst & Young’s Global Venture Capital Report.