Corporate venture capital

Overview

Corporate venture capital (CVC) is the investment of corporate funds directly in external startup companies. CVC is defined by the Business Dictionary as the "practice where a large firm takes an equity stake in a small but innovative or specialist firm, to which it may also provide management and marketing expertise; the objective is to gain a specific competitive advantage." Examples of CVCs include GV, Intel Capital, and Salesforce Ventures.

Definition

CVC refers to the investment of corporate funds directly in external startup companies. The definition of CVC can also be clarified by distinguishing it from other forms of investment. An investment made through an external fund managed by a third party, even when the investment vehicle is funded by a single investing company, is not considered CVC. CVC is not synonymous with venture capital (VC); rather, it is a specific subset of venture capital. In essence, Corporate Venturing is about setting up structural collaborations with external ventures or parties to drive mutual growth. These external ventures are startups (early-stage companies) or scaleups (companies that have found product/market fit) that come from outside the organization. Due to its hybrid nature involving both elements of corporate rigidity and startup culture, managing a successful CVC unit is a difficult task that involves a number of hurdles and often fails to deliver the expected outcomes.

Objectives

As Henry Chesbrough, professor at Haas School of Business at UC Berkeley, explains in his "Making Sense of Corporate Venture Capital" article, CVC has two hallmarks: (1) its objective; and (2) the degree to which the operations of the start up and investing company are connected. CVC differs from private VC in that, in addition to financial returns, it commonly seeks to advance strategic objectives. Strategically driven CVC investments are made primarily to increase, directly or indirectly, the sales and profits of the incumbent firm's business. A well-established firm making a strategic CVC investment seeks to identify and exploit synergies between itself and the new venture. The goal is to exploit the potential for additional growth within the parent firm. For instance, investing firms may want to obtain a window on new technologies, enter new markets, identify acquisition targets, or access new resources. Financially-driven CVC investments are investments where parent firms are looking for leverage on returns. The full potential of leverage is often achieved through exits such as initial public offering (IPO) or sales of stakes to third parties. The objective is to exploit the independent revenue and profit in the new venture itself. Specifically for CVC, the parent company seeks to do as well as if not better than private VC investors, hence the motivation to keep its VC efforts "in house". The CVC division often believes it has a competitive advantage over private VC firms due to what it considers to be superior knowledge of markets and technologies, its strong balance sheet, and its ability to be a patient investor. Chesbrough points out that a company's brand may signal the quality of the start-up to other investors and potential customers; this may eventually result in rewards to the initial investor. He gives the example of Dell Ventures, Dell Computer's in-house VC division, which made multiple Internet investments with the expectation of earning favorable returns. Although Dell hoped the seed money will help its own business grow, the primary motivation for the investments was the opportunity to earn high financial returns. Reaching strategic goals is not necessarily in opposition to financial objectives. As literature demonstrates, both objectives can go hand in hand and offer complementary motivations. In the long run, all strategic investments produce financial added value. This is not to say that, occasionally the short-term concordance between financial and strategic objectives might be questionable. For instance, a strong focus on achieving short-term financial goals might have a counterproductive impact on the ability to achieve long-term strategic objectives, which would in turn reduce long-term financial returns. In lieu of this dilemma, parent firms first screen venture proposals for strategic rationales. Then when an investment proposal fits strategic objectives, corporate firms analyze it according to financial investment standards, using methods analogous to independent venture capitalists. A recent empirical study has examined the degree to which European incumbent firms emphasize on strategic and financial objectives. Results show that 54% of European parent firms invest primarily for strategic reasons, yet with financial concerns, 33% invest primarily for financial reasons with strategic concerns and 13% invest purely financial. None invest solely for strategic rationals. In comparison with an American study, results show significant differences in investment styles. In fact, 50% of US parent firms invest primarily strategic with financial concerns, 20% financial with strategic concerns, 15% purely financial and 15% purely strategic. As a rule, incumbent firms, whether European or American, invest primarily for strategic reasons. The second hallmark of corporate VC investments is the extent to which companies in the investment portfolio are linked to the investing company's current operational abilities. For example, a start-up with strong links to the investing company might make use of that company's manufacturing plants, distribution channels, technology, or brand. It might adopt the investing company's business practices to build, sell, or service its products. An external venture may offer the investing company an opportunity to build new and different capabilities—ones that could threaten the viability of current corporate capabilities. Housing these capabilities in a separate legal entity can insulate them from internal efforts to undermine them. If the venture and its processes fare well, the corporation can then evaluate whether and how to adapt its own processes to be more like those of the start-up. Although it happens far less than commonly thought, the CVC parent company may attempt to acquire the new venture. (1969~99) 20 Largest venturing firms (from Dushnitsky, 2006) 1. Intel 2. Cisco 3. Microsoft 4. Comdisco 5. Dell 6. MCIworld.com 7. AOL 8. Motorola 9. Sony 10. Qualcomm 11. Safeguard 12. Sun Micro 13. J&J 14. Global-Tech 15. Yahoo 16. Xerox 17. Compaq 18. Citigroup 19. Ford Motor 20. Comcast

Types of Investing

By combining the two dimensions of CVC investing - strategic and financial objectives - four distinct investment motivations and strategies can be outlined. A. Driving Investments This type of CVC investing pertains to the investment that involves a strategic driver. Driving investments are pursued by CVCs for strategic alignment that is tightly linked between the investment company's operations and the startup company that is being invested in. The purpose of this investing option is to advance the strategy of the current business. The CVC looks for key growth areas within the startup companies and then hopes to combine them with the company's initiatives. Appropriately selected investing and alignment can benefit the investing company by furthering the corporate strategy. On the other hand, this could result in failure. Closely linked investments essentially roll into the current strategy in place. This would not be useful in dealing with already disruptive strategies in place, or in finding new ones when the investing company needs to update processes when trying to keep up with a changing environment. Thus, if CVCs are looking to “transcend current strategies and processes,” they would need to look to other investing strategies. B. Enabling Investments Enabling investments are also made for strategic purpose, but in this case, they are not linked closely with the investing company's operations. The thought process is that a tight link is not necessary for a successful investment to help the investing company to succeed. Although this may seem counterintuitive, the idea is to take advantage of complementary products. Enabling investments complement the strategy of the current business. Ideally, the popularity of the investments will help to create demand for the investing company's products by stimulating the industry in which the products are used. The limits of enabling investments are that they will only be successful if they “capture a substantial portion of the market growth they stimulate”. C. Emergent Investments While Emergent investments do not promote current strategies, they do link tightly with the investing company's operations. If the business environment or company's strategy changes, the investment could become strategically valuable. This design helps create a sort of option strategy that is independent of financial returns. Emergent investments allow investing companies to explore new untapped markets that they are unable to enter due to their focus on the current markets they serve. Investment products can be sold in new markets to help gather vital information that could not be otherwise obtained. If the information looks promising, the company could look to shift towards this new direction. Emergent investments are initially made for financial gains but could ultimately result in strategic gains as well. On the contrary, if they do not prove to be important for the company strategy, they should be left untouched to generate whatever financial returns possible. In summary, emergent investments require “balancing financial discipline and strategic potential.” D. Passive Investments Passive investments are connected to neither the investing company's strategy nor their operations. Thus, these investments do not help the investing company to actively advance their own business and can only provide financial returns. Essentially, passive investments are no different from typical investments whose financial returns are contingent on the volatility of the private equity market. Due to the lack of any strategic advantages with this kind of investing, passive investments are not very practical or advantageous.

Stages of financing

Corporate venture capital firms provide funding to startup companies during various phases of development. Each phase has its own financing requirements, and CVCs will often indicate the stage of financing needed and the types of investments they prefer to make. Later stages of financing usually mean less risky investments, and investment in these companies typically costs more because of higher company or product valuations. Investments in startup companies are expected to provide CVCs with a return on investment within 4–7 years, whereas investments in established companies are expected to have a shorter 2- to 4-year period. A. Early-stage financing In this stage, the startup company basically has a concept. Capital is used to carry out market research and product development. Startup financing can be used to establish management, research and development, marketing, and quality management teams and buy additional equipment and resources. An extension of early-stage financing is First-Stage Financing, where companies can start manufacturing and sales processes to initiate a product launch. B. Seed capital funds This phase finances early stage companies. The startup is still shaping its concept and production and service are not yet developed fully. Investment money can be used at this time to construct a working prototype. Additionally, the funds can be used to further market research and legal issues such as patents. Investment firms only expect 20% of companies to succeed, moving to second round of financing. In this stage, the company can often be moved to another round of funding or even a series of funds that take over the management of the investment. Investing firms expect a high percentage of the business and often provide funding in stages that is dependent on the startup company reaching set milestones. For example, a venture capital may agree to $5 million during this phase, but may pay out the funding in 1/3 installments based on the startup meeting set milestones. Finally, CVCs often look to promote or insist on specific executives to manage the startup at this time. C. Expansion financing Second-Stage: Companies already selling product are funded at this stage to help in their expansion. One to ten million dollars can be provided to help recruit more employees to establish engineering, sales, and marketing functions. Companies are often not making profits at this time and thus funds can also be used to cover negative cash flow. Third-Stage or Mezzanine Financing allows for greater company expansion. This can include further development of management, plants, marketing, and possibly even additional products. Companies at this stage are often doing very well, breaking even or even turning a profit. D. Initial public offering (IPO) When a company goes public, it is called an initial public offering. This is often the ideal scenario CVCs hope to achieve with an investment. The startup company's stock can now be bought and sold by the public. This is when an investing company can finally earn a significant return on its investment. For example, suppose a CVC were to invest or buy 50% of a startup for $5 million. If the startup then goes public for $100 million, the CVCs investment would grow to $50 million, or tenfold its initial investment. This is often the last phase where CVCs are involved. They look to sell their stock to cash in on the returns from their investment. Next, they look to reinvest in new ventures, starting from the beginning to invest in a new startup. E. Mergers and acquisitions Due to the current economic climate, IPOs have become a rarer occurrence recently, causing venture capital firms to look towards mergers and acquisitions. Acquisitions are the most common way venture-backed companies exit: of the 1,147 U.S. venture exits recorded in 2024, 1,083 were acquisitions, compared with 42 initial public offerings. This is a more realistic scenario, especially when startup companies do not look to function independently. Acquisition financing uses investment funds to acquire or buy another company. This may be completed by venture capital firms to align their startup with a complementary product or business line where the combined companies look to assimilate smoothly, creating advantages. Acquisitions could also work in the opposite direction where an invested startup is acquired by another firm. In this case, the CVC would be cashing in by selling its investment. Using the capital gains, it can look to reinvest with a new venture. Mergers are similar to acquisitions; however, in this case, one company is not buying another. Rather the two companies are combining to share resources, processes, and technology, which it hopes to leverage for several advantages such as cost savings, liquidity, market positioning and sharing burdens such as fund raising. Each individual CVC uses specific procedures and financing stages that serve its interests best. The financing stages presented above are only a basic format. CVCs can have more financing stages or even less. Thus, it is important that startup companies understand that the financing strategies employed by CVC that they are working with fit their needs.

Financing process

The financing process outlines basic steps taken by CVCs from initial contact with potential startup companies through the first round of financing.

Startup companies looking for financing make initial contact with CVCs. CVCs can also seek out potential startups looking for funding. Startup management team presents a business plan to the CVC. If the reviewed business plan generates interest, the CVC will ask the startup for more information including a product demonstration. Investors will also conduct their own due diligence to investigate and better understand the product, technology, market, and any other related issues. If the CVCs are interested in the proposed startups product or service, they will look to determine the value of the startup. They communicate this valuation to the startup, often via a term sheet. If the startup is happy with the offer, a purchase price and investor equity is agreed on. Negotiations can take place during this stage of investment valuation. Legal counsels from both sides agree to a finalized term sheet where business terms for the investment are specified. A closed period, referred to as a lock-up time period, is also established during which the start up company cannot discuss investing opportunities with other investment groups. This indicates that a pending deal is in the process of completion. Once a term sheet is finalized, both sides look to negotiate and finalize financing terms. Negotiations are conducted between the legal counsels from the CVC and the startup company. The startup legal team typically creates transaction documents that the CVC counsel reviews. Negotiations continue until all legal and business issues are addressed. During this time, the CVC conducts a more thorough investigation of the startup company, understanding the startup's books and records, financial statements, projected performance, employees and suppliers, and even its customer base. Closing of financing is the final step. This can take place immediately upon execution of the definitive agreements or after a few weeks. The additional time may be necessary if the CVC needs time to complete their due-diligence or based on the startup company's financial needs.

Introduction

This section discusses venture capital activities of healthcare providers such as Ascension Health, biotech firms such as Biogen Idec, and pharmaceutical companies such as GlaxoSmithKline, all of which are healthcare-related companies and have internal venture capital units or wholly owned subsidiaries focused on venture capital. The structure of corporate venture capital within the healthcare arena; the most common types of investments made; and the main reasons for which healthcare companies invest will be addressed, as well as the current trends and some predictions for the industry.

Structure

By definition, the corporate venture capital field is made up of organizations whose primary activities are not investing in other firms (see above). Since that definition rules out freestanding healthcare venture capital firms such as De Novo Ventures, as well as publicly traded firms, what remains are a limited number of organizational structure types used by healthcare corporate venture capital. The two main types are: 1) divisions within a larger healthcare company; and 2) wholly owned subsidiaries of larger healthcare companies. CVC units of both of these types often engage in partnerships with other firms. In most cases the other firms are limited partners and the primary company manages the fund and is the only general partner.

Types of investments

The largest segment of healthcare-related venture capital investments are made by the venture arms of firms who focus on biotechnology and pharmaceutical products, such as Eli Lilly and Company, GlaxoSmithKline, Takeda Pharmaceutical Company (TCP), Biogen Idec, and Roche. Because the top priority of many of these venture capital units or divisions is to fund ventures that may result in scientific and technological discoveries and advancements that may benefit their parent companies, most tend to invest in companies whose products or proposed products are similar to their own.

Reasons for Investing

There are a number of reasons for which a healthcare-related company chooses to pursue corporate venture capital, both strategic and financial. While most healthcare corporate venture capital companies or divisions seek to at least be budget neutral to their parent companies, strategic reasons are generally stronger motivators than financial ones. One primary strategic reason many healthcare-related CVCs cite for investing is to seek new directions and develop new products. For this reason the focus of most CVC units is broader than their parent company, as stated previously. CVC fund managers usually will examine a broad array of investment opportunities that are related to some degree to the activities of their parent company in the hopes that the technologies developed will complement the product line of the parent company or even lead the parent company into an area of the industry in which it previously had not been occupied. Another strategic motivation for engaging in corporate venture capital activities is to supplement and support the activities of the parent company. While all of the companies which were researched (with the exception of De Novo Ventures) also had research and development divisions and were actively pursuing improvements to their products, the leadership of these firms recognize that developments reached by other companies could certainly be helpful to them. This occurs most often when the firm in which the CVC division invests is focused on products or services that are fairly similar to those produced or offered by the parent company. This rationale applies not just to improvements on the products a company makes, but also the process by which it makes them. In fact, interviews with top executives at one firm reveal that the improvement of manufacturing processed is very much a consideration in their investments.

Current trends and predictions

The repercussions of the 2009 economic downturn have been felt throughout the field of corporate venture capital and healthcare has not been completely immune. For example, because of the scarcity of available funds within the biotech segment of the industry the valuation of private biotech firms is at an all-time low. However, the healthcare industry is seen as somewhat recession-resistant and this has encouraged some investors within the field. As such, while most major corporations with venture capital arms are keeping cash close to home, some of the first positive movement within corporate venture capital as a whole is coming from healthcare. The new venture fund recently opened by Merck Serono and the fund just closed by Ascension Health Ventures are just a few examples of the optimism that is slowly reentering venture capital within healthcare. The latest survey on the top 75 most influential healthcare corporate venture capital divisions shows they are increasingly influential and larger than many independent VCs. Another trend that may see more action as venture capital funds continue to be scarce is an increasing number of strategic partnerships between firms that are based not on exchange of funds, but rather on exchange of technologies or process information. These types of partnerships, also known as corporate in-kind investments, may become increasingly common as liquid funds become less available but technologies that have been developed are readily shareable. One specific example of this sort of information exchange is a partnership between a large, well-established company and a small, developing company who have complementary technologies or processes. Such 'David and Goliath' partnerships are already starting to emerge outside of the healthcare industry and will likely emerge within healthcare soon.

Sectors

Investments from venture capital firms and CVC in 1998 were mostly in software and telecommunications sectors. By 2006 the biotechnology and medical devices became the sectors with the most investments from both, venture capital firms and CVC. However, there has not been significant investments in health services and have actually decreased through these periods. Biotechnology CVC's investments in biotechnology are higher than those from VC firms. However, medical devices and health services had a is not a top sector for CVC investments as it is for VC firms. Other top sectors for CVC investments are software, telecommunications, semiconductors, and media/entertainment. Top sectors for CVC investment:

Biotechnology, Software, Telecommunications, Semiconductors, and Media/entertainment. Top sectors for VC investment:

Software, Biotechnology, Medical devices, and Telecommunications.