The big beast of venture capital

Photo by Samson on Unsplash

What do you think of when you think of venture capital? 

You might think of Andreessen Horowitz, Sequoia and other massive West Coast firms. And then there’s the rapidly growing ecosystem that stretches beyond traditional financial centres of London, New York et al to emerging hubs like Singapore, Jakarta, Warsaw and Tel Aviv. 

What you don’t think of is publicly traded companies spinning out venture capital operations to invest in privately held companies. But corporate venture capital (CVC for short) is big business. Whilst everybody was busy scrutinising blue chip venture capital and sovereign wealth funds, corporates have become major players in private markets.  

In the beginning. 

In 1914, Pierre S. du Pont, president of chemical and plastics manufacturer DuPont, invested in a 6-year old private business by the name of General Motors. After an explosion of demand for automobiles in WW1, DuPont’s board invested a further US$ 25m in the belief that the cash injection could speed GM’s development and expand the demand for DuPont’s own goods. It did. And it generated some rather juicy financial returns.  

This first foray into the world of corporate venture sketched out the model for others to emulate and plagiarise. DuPont’s bet combined strategic and financial objectives, and we continue to see this approach today from the likes of Intel, Qualcomm, Merck Microsoft and a raft of others. Modern CVCs might look almost indistinguishable from institutional venture capital funds, but under the bonnet they must weigh financial returns against long-term corporate strategy. CVCs don’t have free reign to invest in whatever they like. Accessing new technologies to accelerate existing operations, forging new partnerships and building a pipeline of acquisition targets are all prized goals. But it’s hard to be strategic when you're dead, so investments need to work on a basic financial level.   

A tale of two crises. 

From somewhat inauspicious beginnings, the CVC industry has matured and solidified. Corporate venture outfits are more comfortable with the vagaries of the economic cycle; they understand that exogenous shocks like COVID-19 present compelling opportunities to enter investments at attractive valuations. Lessons from earlier crises have been internalised, leading to stronger corporate structures, clearer separation from parent companies, and investment mandates that are more flexible and diversified. 

It hasn’t always been this way. The corporate venture bubble burst in the run up to the Dot Com collapse, with nearly one third of companies investing corporate funds in startups in September 2000 downing tools twelve months later. During the same period, the amount of corporate money invested in start-ups fell by 80%. 

This decline in investments is part of a pattern of boom and bust. After a slow recovery, CVC activity once again plummeted in 2008, as corporations sought to steady the ship in the face of a global economic meltdown. Many CVC arms were shuttered for good, filed under “noble experiment” and never mentioned in the boardroom again. It seemed that corporate venture was forever doomed to be correlated to the economic cycle. 

The ultimate balancing act. 

But the Global Financial Crisis was also a period of profound creativity and rebirth. In the radioactive fallout of the subprime crisis, many of today’s unicorns were founded and the tech narrative as we know it began to gather real momentum. Now the hard work done by founders who confronted those apocalyptic underlying conditions is bearing fruit, and corporate venture arms are awash with cash, enabling them to invest in the next growth drivers and pass the baton to a new generation of ultra-ambitious founders. 

Today there are nearly 2,000 CVC firms in existence and last year alone, they raised US$ 41 billion in investment funds, mostly from their corporate parents. This figure is perhaps lower than we thought it would be, but it’s still significant and we must expect it to grow strongly in the years ahead as a new generation of businesses (mainly tech unicorns) scale and mature. CVC units employ different types of funds and investment strategies, and they’re set up on different lines. Cisco Investments makes direct investments and acts as a limited partner in a number of independent venture capital funds. Microsoft Ventures is an internal dedicated fund. 

Helluva year. 

2020 has been one helluva year. An educated observer might have expected CVC deal flow to fall in line with broader private markets activity in the long shadow of COVID-19, but it didn’t happen. Corporations seem to be sticking with CVC, regardless of the pandemic. Indeed, through the crisis CVC investment activity has remained robust; investment was resilient in Q2 2020 even as venture activity overall fell. Through Q2, CVC invested nearly $33 billion, meaning that CVC is on track to surpass 2019’s levels.  

But what’s really interesting to us is that Pitchbook reckons CVCs participated in over half of venture capital deal value in the first half of 2020. If true, that’s a stunning insight and one that proves that CVC is a much more dominant player in private markets than most people think. 

The big picture. 

Sifted – the rapidly growing media company covering Europe’s burgeoning startup scene – describes the rise of CVC as an “arms race”, and funds in this space are certainly becoming larger and more aggressive. Median CVC fund size has exceeded US$ 75m every year since 2014 and median AUM for active units is edging towards US$ 200m. 500 Startups even reckons that US$ 50m is the minimum commitment required to build out a “useful” corporate venturing initiative.  

Some view the entire exercise with scepticism. Sifted has argued that: 

“Most corporations launching a new venture initiative are turning to corporate venturing out of some degree of weakness — often the inability to internally develop new business models and technologies or exploit emerging market opportunities.” 

And Fred Wilson of Union Square Ventures has been scathing in his assessment of CVC:  

“Corporate investing is dumb. I think corporations should buy companies. Investing in companies makes no sense. Don’t waste your money being a minority investor in something you don’t control.” 

These are certainly bold and provocative statements. But don’t corporate venture operations reflect a fundamental willingness to confront the world on its own terms, embrace innovation and diversify commercial risk? Isn’t it better to be humble and admit that you can’t do (or build) everything, rather than hubristically seeking to compete with challengers across multiple industry verticals? Your answers to those questions will depend on where you sit at the table, and how you put food on it. 

A sceptic might argue that this is ultimately about FOMO leveraged by ambitious individuals within an organisation who want to be investors rather than operators. In this case, it’s must less about humility than about trying to be a great investor without actually being one.

Build it and they might come. 

There’s corporate venture investing, and then there’s corporate venture building.  

Without getting too bogged down in obscure semantics (something we actually enjoy doing), we like the concept of venture building and think the distinction is worth noting. Corporate venture building sits somewhere between full fat accelerator programmes and corporate venture funds that take minority stakes in startups. Microsoft might be one example, but perhaps the prime example of this is none other than Tencent, whose exploits in investing in startups have been well discussed.  

The idea behind this kind of balanced approach is that financial investment is not enough – to have an impact in key strategic areas, corporates need to roll their sleeves up and collaborate closely with startups, leveraging their operational infrastructure, talent, intellectual property, commercial partnerships and other key assets. Often this involves taking majority stakes in startups that align closely with the mothership. 

Yet there also exists an inherent conflict, which makes this much harder than it theoretically sounds.

Large corporates struggle with innovation because, like any complex system, they need to work hard to maintain homeostasis: there are infinitely more ways of being dead than being alive. On the other hand, the startup system accepts the high likelihood of death. It doesn’t matter so much because when the startup dies, its constituents float back into the primal soup of the startup universe and quickly reconstitute something new.

This fundamental cultural difference does mean that corporates have a tendency to smother the startups they work with. “Arms length” might be the better choice as a default option; but for those corporates who do manage to find that delicate balance, the benefits are enormous.

The ultimate cliché. 

Disruption is now a cliché. It’s been packaged up and corporatised by legions of thought leaders, promising Disruption-as-a-Service to incumbents who cannot innovate quickly enough to compete with tech-enabled challengers.  

Whether or not you agree with this hyperbolic assertion, it’s fair to say that innovation is highly prized by companies everywhere. It’s become a standalone industry, complete with an ecosystem of service providers, paying clients and media coverage. In the fertile chaos of private markets, there is nothing more corporate than CVC. But regardless of snobby scepticism, successful companies rely on their venture arms to source innovation in lieu of slow moving “moon-shot” proprietary projects, facilitating diversified exposure to a portfolio of disruptive interests. Think of it as a hedge on the future.  

The big beast of private markets. 

Corporate venture capital (and its cooler cousin, corporate venture building) occupy a unique space that overlaps public and private markets. This is a fascinating, underreported area and one that is surprisingly accessible to those who can be bothered to do some digging. After all, publicly traded companies and their subsidiaries are compelled to publish their investments.  

On our travels in private markets we have built some fantastic relationships with HNW individuals and family offices, but one nut (of many) we are yet to crack is corporate venture. We are determined to change this in the months ahead. We must, because corporate venture is becoming the big beast of private markets. And those who want to thrive in these strange and exciting times must learn to live with it.