It has been hard to ignore the recent negativity surrounding traditional venture capital investment in Europe. Venture capital firms (VCs) invested only €951m ($1.2bn) in 219 deals for European companies in the third quarter of 2011 – the lowest quarterly deal count in Europe since Dow Jones VentureSource’s records began in 2000.
But despite the downturn, valuations in the technology sector in particular are growing rapidly. According to accountant Ernst & Young’s Global Technology M&A Update for the second quarter of 2011, the value of technology deals rose by 69% over the same period last year.
Consequently, early-stage technology companies have a particular and immediate interest in access to capital so they can take advantage of the current mergers and acquisitions (M&A) boom. Given that the debt markets remain pretty much closed for business with the eurozone worries and VCs are struggling to invest, what are the other capital-raising options?
Corporate venturing has been on the rise for much of the past decade and is a potential solution for many early-stage technology companies.
It solves the main problem traditional VCs face when investing in technology companies – traditional VCs’ funds have a limited lifespan, usually 10 years, meaning there is pressure to invest in the first half of a fund’s life and exit in the second. Yet many start-up technologies require more than a five-year gestation period in order to prove or commercialise their technology and so there can be a fundamental disconnect between the VC and the company.
Corporate venturing is often seen to have greater strategic value for a company than traditional VC investment because it establishes a business partnership between the investee company and the corporate venturer. It also allows the company access to the resources and experiences of a much larger organisation.
From the corporate venturer’s perspective, it provides access to the kind of innovative ideas many large corporations struggle to develop internally, either because their own researchers and developers may not have the time to explore these ideas, or because the big corporate culture is not conducive to encouraging this type of innovation.
However, there are potential pitfalls. One complaint is that corporate venturing leads companies to adopt an exit-driven business strategy rather than focusing on the long-term growth and development of the company and its technology.
Second, a corporate venturing partner will often have a strong say in the strategic direction the company takes, and its technological development focus, meaning its aspirations may be narrowed.
Some corporate venture partners may insist that various sweeteners be put in place, such as the right of first negotiation in any new financing or acquisition discussions, which can severely impinge on the company’s ability to realise growth and obtain new investment, create new partnerships or even find an exit with a party other than the corporate venturer.
Last, there is a risk of inadvertently tainting the intellectual property of the company with third party ownership rights, which can lead to uncertainty as to the origin of some ideas.
Overall, therefore, corporate venturing is not a one-sizefits- all solution. It is critical that interests are aligned if the partnership is to succeed. However, when structured correctly and with the appropriate protections in place, it can be a rich source of capital for technology companies.
Indeed, for some companies it may be the only real source of investment capital available.
Tips on finding corporate venture partners
l Experienced management team: investors will be keen to see management can implement the right strategy to take the company forward, with help from the corporate venture partner.
l Intellectual property rights: technology is what the investor is buying and ultimately the company needs to ensure its assets are well protected, including from the corporate venture partner.
l Communication: between the entities is key to building and maintaining the relationship, and this should be documented.
l Environmental impact: many traditional technology investors now have a dedicated spend for clean-tech so are looking at companies that produce energy saving and clean technologies, and are responsible consumers of energy.