Reed Elsevier Ventures is one of the few corporate funds set up in 2000 – the heady days of the dot.com bubble – to be celebrating its 10th anniversary this year. Diana Noble, above left, former partner at Schroder Ventures (now Permira), was persuaded to lead it, and first to join her was Tony Askew, centre. Kevin Brown, right, followed Askew across as a principal and was promoted to partner the next year. Noble stepped down as managing partner at the end of 2004 to join the William J Clinton Foundation and Askew took the reins. Here, in a two-part series over the next two months, the three of them talk to editor James Mawson about how the ventures team was originally structured and its approach to investing.
Mawson: What persuaded you to establish a corporate venture team?
Noble: I had previously been a partner in an independent fund and was initially sceptical that investing could work within a corporate setting. And the dismal record of most corporate funds bore this out. So it is fair to say it was the challenge that attracted me. I wanted to see whether a well-architected structure and the right team could negate the different cultures and motivations that typically divides a venture team from its corporate host and instead harness the deep sector knowledge to provide genuinely differentiated capital and an approach that would be valued by the best early-stage entrepreneurs.
Askew: We developed the approach together. I have a technology, media and telecoms background with Random House, and Cellnet (now O2) building their new media and wireless internet businesses and later had turned down a partnership with Andersen to join Diana at her previous fund. Overall, I was intrigued by whether it was possible to build an attractive portfolio across a broad geography of US, Europe and Israel tapping into the enormous wave of telecoms, media and technology innovation.
Mawson: Knowing what you know now, would you recommend corporate venturing to any company?
Noble: It is a highly challenging model to deliver but, done well, it provides a deep insight into external innovation that is difficult to achieve any other way. Company culture, risk tolerance and time horizons conspire against innovation at large corporations. Internal innovation efforts generally lead to incremental add-ons, not orthodoxy-flipping, gamechangers.
If companies accept they will not monopolise the next generation in their industry, how do they at least build a bridge to the innovators? And a bridge that identifies them early, allows open learning about what they are doing and why, and enables a range of relationships, from knowledge sharing to commercial partnerships to acquisition, to evolve naturally over time. Corporate venturing is exactly that bridge.
Askew: The alternative approach is to hire a business development team but it can never bring the same depth of insight. In that sense it is a kind of a mirage. The dialogue will be much more closed and suspicious without the independence of a venture team and there is little incentive for an early-stage company to open its doors and reveal its strategies and vision to a behemoth in its industry without the lure of capital. The investment due-diligence process drives a far deeper understanding than pure business development conversations. And a board seat as an investor provides a ringside perspective into the strategy and evolution of the emerging company.
Mawson: Why do you think this works at Reed Elsevier?
Askew: Corporate venturing works best when innovation is significant enough in a company’s industry to really engage and/ or scare senior management. This is what typically provides the initial impetus and helps galvanise the activity. Reed Elsevier certainly sits in the midst of tectonic shifts in its industry – in business models, in technology and in customer expectations.
On the other hand, compared with some other media groups, Reed did not really have the brand name that would attract dealflow by itself. But, on reflection, its lack of real brand recognition and drive to reinvent itself were both positives. The first left us a relatively free hand to build our own brand of venturing distinct from the host, and the second played well into our message concerning entrepreneurial insights and innovation.
Brown: The pace of innovation is what drives the scale and quality of dealflow. Back in 2000, Reed’s management had only a partial view of the rapid and disruptive developments shaping its industry, particularly those driven by private companies.
They had the typical, poor-quality, passive dealflow that most corporates had in 2000 and our first few months were mostly taken up with saying no nicely to all of this. Developing a strategy to identify the more interesting companies that were not naturally going to reach out to Reed took much longer. Another important consideration is that venture investing sits more comfortably within a business that is used to partnering.
This was not always the case with Reed Elsevier, whose traditional model was predicated on full ownership and control. However, they did recognise that they did not find it easy to engage with small companies or understand the entrepreneurs’ perspective, and that having a venture team gave them a mechanism for doing this.
Mawson: Let’s talk about the objectives you set for the fund. How did you think about your financial and strategic approach?
Askew: The first point is we never counterbalanced the two. If a company was interesting financially then it had to have relevance in Reed’s broader markets, otherwise we would lose all the benefits of staying focused on our sectors. And if it was strategically interesting, we would never water down our financial criteria, because ultimately we were motivated by generating carried interest.
Mawson: What were your financial criteria?
Askew: We set ourselves the same targets as if we had been an independent fund raising external capital. We aimed to be in the top quartile of all funds, whether independent or corporate, established in the same time period, based on the European Private Equity and Venture Capital Association’s measure for net returns. We have achieved this and hopefully we will even do better. We have returned more than all the capital invested in 21 companies from 10 exits so far and the remaining portfolio of 11 is valuable, some already profitable and growing strongly.
Mawson: What about the much-discussed strategic criteria?
Brown: Although we agonised a lot over this in the early days while we were building internal credibility, today we are much more relaxed. Our philosophy is that most corporations, including Reed, make decisions heavily influenced by their current orthodoxies, whereas most venture capital firms, including us, make investment decisions based on market trends. Sometimes these views coincide, which is when corporations do well, but mostly it takes time for a company’s orthodoxy to change and that is a big part of the value that we bring – an early view on the shifting direction of the market beyond the "here and now" that drives all big companies.
Noble: When we started, we were quite structured in our thinking and divided potential investments into Horizon 1 (an existing or imminent commercial relationship), Horizon 2 (where a business unit clearly wanted a relationship in time) and Horizon 3, where no relationship was envisaged but where the venture team felt valuable learnings could be gained in both directions. At that time, we tried to concentrate on the first two, so that we could demonstrate strategic relevance internally and not promote too many investments that would result in head-scratching among our corporate colleagues.
Askew: Over time though, we have deliberately stretched this. Our value, strategically, comes from our activities across the board and not just from investments made. Because we have now engaged for over 10 years with entrepreneurial companies across Reed’s sectors and close to them, we have developed a valuable perspective on the evolution of technology, customer needs, data consumption and other critical areas.
We also track trends of where capital is flowing to fund innovation. In measuring strategic impact, as long as you are making good financial decisions by investing in companies that have a relevance in the host’s market, then you are strategic. So much of what we learned and that Reed has taken from our activity has come from participating in the journey, as it can take years for strategic relevance to become apparent.
Mawson: How do you build internal links between the venture team and a widespread group like Reed Elsevier to ensure this knowledge genuinely flows between you?
Brown: This is something that evolved over time. In the early years we set up a formal structure to build these links. We asked each of the major business units to appoint a venture associate, typically the strategy or business development director.
These would be our main interface with the unit and also act as a broad internal advocate for Ventures to allow us to concentrate on investments. We drew the associates into our world by involving them in deals, introducing them to interesting management teams and organising regular Venture Associate Days – opportunities to feed back market knowledge and share Ventures’ skills and approach, for example workshopping private company valuation methodologies.
Askew: We ended up phasing out this role, as the strength of our relationship with the business unit chief executives developed and became more direct – for example, organising regular trips for senior executives to visit Silicon Valley to meet entrepreneurs, and participating in senior management offsites.
One pitfall that had to be navigated was that once our reputation grew internally as a sensible team with reasonable judgement, we started to be viewed as a resource available to the corporate to be consulted for general strategy, mergers and acquisitions or internal innovation.
We had to tread carefully in being helpful where we could be, which always had a benefit in building internal relationships further, but also managing our time so that we spent the time we needed externally to support our main objective – a financially successful portfolio.
Mawson: How did you build the right Ventures team to deliver the financial and strategic objectives?
Noble: For anyone questioning whether to favour VC or corporate backgrounds in the team, there is no doubt in my mind. Venture capital skills are paramount in corporate venturing. The judgement and mindset necessary to build a strong VC portfolio are just different from those developed in a corporate environment.
Each investment professional has to be able to span a range of capabilities: to filter proposals quickly, identify the core issues and run a process able quickly to reach a conclusion; to understand a sector, often in huge flux, in depth and be able to identify the early-stage companies able to create value; to judge an entrepreneur and their team at the same time as building an open and candid relationship with them; to drive a hard financial bargain on valuation and rights of each class of shares; to understand that legal agreements can seriously affect the value each investor creates relative to each other and relative to the management team; to stay deeply involved through all the twists and turns of an early-stage company and to know the best way to support management, when to challenge and, in extreme cases, when to consider a change
Askew: Ultimately our brand is our behaviour. We deal with many stakeholders, including Reed, entrepreneurs and investors, and ensure our structure, ownership and investments are transparent to all. This requires individuals who are able to influence strategic thinking at the highest level, balance buying and selling, manage around turf wars, soothe egos, orchestrate and facilitate the meeting of minds and yet lead and drive a tough commercial negotiation and be assertive in managing portfolio decisions.
These individuals are hard to find. Kevin and I have worked together for over a decade investing in more than 20 companies, and Tom Drummond, of our Silicon Valley office, has been with us since he left Cambridge six years ago.
Mawson: Where do you stand on compensation?
Noble: Tony mentioned the stability of the team, which in my mind has been a major factor in our success. You will never attract or retain the right people without paying VC-equivalent compensation, including carried interest.
The differential between a high and poorly-performing funds outweighs by many multiples the additional running costs and share of upside given to a strong team with the right skills. This is exactly the equation that investors make in the VC market between different funds – the best performers with higher fees and carry will always be more highly subscribed than the average performers with lower fees and carry.
Askew: Although carry marks out the team as different from corporate colleagues, Reed Elsevier has always recognised it is an integral part of the model, so it has never become an issue.
Mawson: How big is the team?
Askew: The smaller the team the better, as this increases focus and personal responsibility and means that everybody has to be ruthless in setting priorities.
Noble: It is also relevant in the context of the group. We never had more than five professionals in the team to cover US and Europe. Venture capital is extremely cyclical and we never wanted to end up in a position where realisations, or the absence of them, or writedowns affected the group’s results publicly.
Mawson: CEO support is often cited as critical to the longevity of any CV fund. How did this work at Reed Elsevier?
Noble: Chief executive support is completely fundamental to the success of a corpo rate venture team, particularly during the down years of the cycle when the portfolio looks less healthy.
Crispin Davis, who had in 2000 joined as CEO of Reed, took the trouble to really understand how I wanted to do corporate venturing and convinced me he was in it for the long term. And this was a major factor in agreeing to join in the first place. Initially, we agreed Ventures should report to him, not because he wanted to be hands on, but because it would demonstrate his personal commitment internally and externally. He was unwavering in his support throughout and this set the tone for the rest of the board and the senior management team.
Brown: Also, the range of our strategic activities and our proven financial track record have enabled us to build a broad base of support across the business unit leadership teams, not just the corporate teams and group CEO. The primary focus for the fund has always been on delivering financial and strategic value as a standalone entity rather than looking over our shoulder at Reed Elsevier organisational changes.
Askew: There have been two subsequent changes of group CEO which we have had to navigate, but neither has been problematic. Reed Elsevier’s current chief executive, Erik Engstrom, was until recently the CEO of our Elsevier business.
He had therefore already worked with us for a number of years and is a believer in what we do. Since taking over, I have reported to the group chief financial officer Mark Armour, who has headed our investment committee from day one.
This reflected our maturity as an investing entity. Mark is a supporter of our approach and this relationship has been fundamental to our lengevity. He understands the dual challenge of running an investment business while delivering strategic value and has enabled us to build a platform from which to operate as a financially-focused VC in a corporate context.
Fact box
Reed Elsevier is one of the world’s largest media companies, publishing content and information solutions for professional markets worldwide.
Year 2000
Chief executive: Sir Crispin Davis
Revenue: £3.75bn
Profit: £800m
Operating businesses: LexisNexis, Elsevier Science, Reed Business Publishing, Reed Exhibitions, Reed Education (UK)
Year 2010
Chief executive: Erik Engstrom
Revenue: £6bn
Operating profit: £1.5bn
Operating businesses: LexisNexis, LexisNexis Risk Information & Analytics (inc Choicepoint), Elsevier Science, Elsevier Health, Reed Business Publishing, Reed Exhibitions
Reed Elsevier Ventures invests in high-growth media, information and technology businesses in the US, Europe and Israel.
Year 2000 Investment team: Diana Noble, Tony Askew, Kevin Brown, Valerio Massimo, Tom Aley
Year 2010 Investment team: Tony Askew, Kevin Brown, Tom Drummond
Venture capital invested: $125m-plus
Number of investments: 21 (US: 18, Israel: 2, UK: 1)
Number of exits: 10 (returning more than all capital invested in portfolio)
Selected investments:
Healthline Networks (www.healthline.com), consumer health information services
Palantir (www.palantir.com), analytics platform
Martini Media (www.martinimedianetwork.com), ad network for the online affluent
Babylon (www.babylon.com), translation software/services, initial public offering TASE 2007)
Netli (www.netli.com), application delivery network, acquired by Akamai in 2007
Financial performance: Upper-quartile fund by net IRR against Cambridge Associates Benchmark of all US VCs