This series describes some of the legal, tax and financial structures employed in this evolutionary process. Not all corporate venturers will walk this path, but many will consider and implement aspects of this journey.
The first article (see the April issue of Global Corporate Venturing) considered a corporate entity’s first steps into corporate venturing, the various advantages corporate venturing can offer and group structural improvements, through on and off-balance-sheet accounting, and on and off shore entities.
This second article will show the corporate’s move to raise additional rounds of money in its new burgeoning portfolio, from itself and third parties directly into the portfolio companies, and into funds and onshore and offshore special purpose vehicles.
The third article will look at how the corporate venturing business can evolve into a standalone investment fund management business. The diagram represents a likely next stage in the development of venturing moves into an actual business activity and the creation of an investment division. At this point, the business has developed from a series of ad-hoc investments made on a case-by-case basis to the point where it is now a discrete business unit.
Investment division
Although a separate company may have been incorporated, as the investment division, in most cases the investment team would remain employees of the corporate, although some or all of them may now be dedicated to the corporate venture business on a full-time basis.
In addition, the corporate may now have allocated a budget specifically for the purpose of making venture investments and also have developed a more systematic process for sourcing investment opportunities and a more formal process or deciding what investments to make and the criteria to apply when analysing potential investments.
The corporate will now have started to build up its expertise in analysing and executing investment opportunities.
External Investors
External investors may now participate in some or all of the investments together with the corporate.
The participation of external investors offers a number of potential benefits. First, it increases the funds available for investment. This means the corporate can make a greater number of investments, thus increasing the diversity of its investments and reducing risk, and is potentially in a position to make larger investments, which may mean a broader range of opportunities are now within its scope.
Some of the earlier portfolio companies have now reached a stage where the investments have increased dramatically in size. The involvement of external investors may also facilitate access to a broader range of expertise than the corporate has available, again potentially broadening the scope of opportunities it can consider.
Initially, it is likely the corporate would invite individual external investors to invest in individual portfolio companies on a case-by-case basis. Such an arrangement would generally be informal, with the corporate identifying external investors based on their known interests and capacity to invest in specific investments.
Where the involvement of other investors leads to the corporate making a broader range of investments, this may also result in the corporate needing to place a greater emphasis on financial returns as opposed to investments’ strategic importance to the corporate’s existing business.
Portfolio company structures
External investors would typically participate by acquiring
shares in the relevant portfolio company, and potentially making loans to it.
Different investors may acquire different classes of shares, thus giving them different rights and entitlements to returns for their investment.
There are two key documents.
Shareholders’ agreement: This typically deals with how the portfolio company is to be run on a day-to-day basis, with certain decisions reserved for the consent of the investors.
Articles of association: These detail all rights attaching to shares, including any preference or return. They also govern the transfer of shares in the portfolio company.
Key decisions
Exit: This may be the point where exit strategy is first discussed. External investors investing through fixed-life funds will have a clearer view, which might clash with the corporate’s less financially-driven requirements.
Intellectual property (IP): Significant discussion may occur with external investors concerning ownership and licensing of IP, and how it fits with the corporate’s IP strategy.
First evolution of funds
As an alternative to the corporate and each external investor directly acquiring shares in a portfolio company, the corporate may establish a vehicle, such as an onshore or offshore limited partnership, to invest in the portfolio company.
In this structure, the fund would negotiate the terms of the investment in the portfolio company, and the corporate and external investors would participate in the limited partnership or other vehicle, which would govern the relationship
between the corporate and the external investors. This arrangement would facilitate different terms, for example, in relation to profits and governance, applying to the corporate and the external investors and keep those terms separate from the investment in the portfolio company.
It is more likely this arrangement would be used where the corporate has invited a number of external investors to participate in an investment as this structure facilitates the pooling of their funds while being relatively straightforward from the perspective of the portfolio company.
The investment manager
Structure: Both the corporate’s investments and the fund’s investments into portfolio companies might be managed by the new investment division. An investment manager will usually be structured as either a limited company or a limited liability partnership (LLP).
Brand: The corporate may now create a new brand for the investment division. This may start to identify a separate financial services business.
Financial Services Authority (FSA): The management of a fund or a "collective investment scheme" (FSA term) is an FSA-regulated activity. In addition, raising finance or arranging transactions with external investors are also regulated activities. At this point regulatory advice should be attached and, if necessary, FSA approval sought.
Morph into financial services company
As this switch begins to occur, the corporate may consider setting aside a budget and targeting specific investments. This would enable the investment arm to take more risks and invest in different sectors without damaging the corporate’s core business.
Limited liability partnership
One of the main reasons for opting for an LLP is that is can be placed separately outside the rest of the main corporate structure. This will enable the Corporate to build up value and assets off-balance sheet with a view perhaps to obtaining external or other investors in the Investment Manager. LLP’s are tax transparent, unlike limited companies, but share similar traits to companies (such as limited liability). If it is likely that the Investment Manager will make losses, the Corporate might prefer o consolidate the manager so as to obtain the benefit of such losses.
Trade marks and domain names
As with all new businesses ensuring that you have the correct intellectual property clearance and protection (e.g. licences and approvals) in place is critical to protecting your business and any goodwill built up using the name or logo that you use.
First, the brand or name you wish to trade under should be free to use and register. This can be ascertained
by availability searches. Second, both trade marks and domain names should be registered at the
same time (preferably prior to launch) to avoid interference from cyber squatters and if either of these use the company name, they should be registered at the same ime that the entity is formed.
If the Corporate intends to sell off its investment arm business as a separate entity at a later date, one of the first tasks on a potential purchasers list will be to conduct ue diligence enquiries to ensure that adequate protections are in place to carry on the business. The value of the business may be affected significantly if ufficient protections are not in place.
FSA process
Threshold conditions: the FSA needs to be satisfied the corporate can meet and continue to meet these conditions and that the people running the corporate are fit nd proper.
Completing the application form: this can be done at the FSA’s website.
Professional advisers: depending on levels of experience and the nature of the proposed business, the corporate may require advice and guidance from lawyers,
auditors or consultants.
Timing: the FSA states it will make a decision within six months of receiving a complete application or within 12
months of receiving an incomplete application. If the application is successful the FSA will write to
you setting out the regulated activities the corporate has permission to carry on, including any requirements or
limitations.
For more information visit www.fsa.gov.uk/pubs/other/applying_authorisation.pdf
Contact Matthew Hudson <mhudson@mjhudson.com>