Corporate Venture Capital (CVC) programs are being developed at an unprecedented rate. In a bid to stay on the innovation curve, companies are launching new CVC arms and experienced CVC programs are urgently being resupplied with capital.
Startups have never been in such ‘demand’. VC investment by corporates is on track to reach an all-time high in 2021. €34B has already been invested in 1H21, 1.6x the investment level of 1H20.
In the US, the last three years have seen double the number of corporate investment deals compared to 2013. Nearly 1,000 unique corporates have already completed a deal in 2021.
Across Europe, VC investment by global corporates hit a record €5.7B in 1H21, double the €2.8B invested in 1H20.
What is driving this surge in interest and how can founders tap into this growing pool of capital?
Big Tech now dominates Corporate R&D spending
Global Tech companies have reached a combined enterprise value of $35 trillion. Technology equities now eclipse all others, fuelled by almost relentless growth in recent years as user experiences have become digitized.
Tech is no longer a discrete sector. It now enables multiple sectors, as more and more markets go online.
Tech companies now dominate corporate R&D spending. In the US, spending by US Tech is 2x that of US Industrial. Companies such as Apple, Microsoft, Amazon, Google, Facebook and others invested almost $200B in 2018. Many of these companies were themselves VC funded. As a result, their DNA is far more aligned with those of emerging Tech businesses than those of their Industrial sector forefathers.
Across Europe, the picture is somewhat different. R&D spending by European Tech companies is equivalent in size to European Industrial, at around $40B each. Automotive, Pharma and Telecom are still the strongest contributors here, representing a different heritage compared to that of US companies.
But the good news for founders is that US corporates are just as likely to invest in a European startup as one nearer to home. Unlike their VC counterparts that often must operate within national boundaries, corporates are far more likely to take a global perspective.
The startup advantage
When established markets are disrupted and fragment, this spells opportunity. A window opens up where startups can stealthily slide in and make a land grab. The accelerated shift to the cloud in B2B software over the past 12-18 months has been one such example.
How is it that so many upstarts are able to steal a march while established businesses struggle to respond? We often attribute this to speed and agility - startups are just able to respond faster.
But why should this be, when their resources are so much more limited? Established companies will often have way more cash, people and experience than a small business. Jeff Immelt, former CEO of conglomerate GE and now startup investor and advisor, puts this down to culture.
For corporates to compete in the innovation game they need to change their culture, but they just can't do it fast enough. That's why so many big companies instead look to collaborate with and invest in startups.
Founder-CEOs sometimes underestimate the competitive advantage that the startup culture brings. Developing a set of core values and rituals that encapsulate the culture often plays a vital role in the growth strategy. Attracting and retaining top performers is one tangible way a great culture acts as a magnet.
Two of the biggest differences between corporate culture and the startup culture are attitude to risk and transparency. Startups are known for encouraging risk-taking, even at the lowest levels. For example, by employing 'fail fast' methods in solution development, where experimentation and iteration becomes a fine art. Corporates generally discourage risk taking, even at senior levels. Startups also thrive on transparency, information sharing, and rapid communications, which all support the development of trust. Corporates, on the other hand, generally work on a 'need to know' basis.
Immelt notes that in 2000, Industrials and Financial Services together represented about 40% of the S&P 500 by value. Now it's 15%. Tech companies have become the primary value creators. "Size is a huge advantage when the momentum is going the right way but is a huge disadvantage when the momentum stops."
Scale is still a weapon that corporates can possess, but even this is under threat in high growth sectors. Every week, some major new VC fund is announced, ready to pump ever greater amounts of cash into the next scaleup. Cash resources are no longer a guarantee of scale advantage for established businesses. The pressure further mounts on corporates, who are now lining up in ever greater numbers to partner with - and invest in – startups and scaleups, desperate to share in the innovation culture.
What kind of corporate are you dealing with?
Corporates are increasingly active in targeting startups to 'outsource' certain R&D efforts. This has proven more cost-effective than setting up new internal research business units. The perils of outright acquisition at too early a stage are now also now well known. Instead, the ‘collaboration + investment’ approach can pay huge dividends for all parties. However, founders engaging with corporate investors must navigate the process with great care. Not all corporates are equal. Looks can be deceiving.
Many established CVC teams experienced in the art of VC deal making will appear much like their VC counterparts in approach, even though their underlying motivations may be different. But corporate investors that don't operate within this VC-like operating structure have the potential to disrupt and delay the funding process - although not wilfully. They are just less practiced in the process.
In the majority of corporations, minority investments still come under the purview of the M&A department. Scott Lenet, Co-founder and President of Touchdown Ventures, a company that manages the venture capital programs of many leading corporations says; "..it’s natural to view investing and acquisitions as part of a continuum that ranges from partial control to full control. I believe there’s some validity to this thinking." But he warns that VC investing is very different from M&A. The sourcing and diligence activities vary, transaction terms are deceptively different, and the post-deal management of an investment has little in common with what happens following an acquisition.
Often, these 'M&A hosted' minority investment initiatives appear clumsy, even aggressive. M&A execs frequently operate with the mindset of an acquirer, forcing unnecessarily rigorous due diligence and investment terms that look to assert too much control. The classic one being right of first refusal, otherwise known to VCs as the 'kiss of death' for a startup.
Non-CVC engagements take more time
To protect against such risks, founders should immediately establish what category of corporate investor they are dealing with. When compiling the investor target list, any that do not fit the established CVC model should be clearly identified as they will need greater attention.
First, things won’t happen quickly. Big corporates simply aren’t able to operate at startup speed. They will often need to build a consensus with a large number of people, many of whom will be preoccupied with running their operational businesses. The due diligence process will take longer and be much more technically weighted. They will need time to evaluate the technology and work out how they can best leverage the relationship. Even if a compelling investment case has been built, one hiccup in the business elsewhere may become a big distraction and the process could grind to a halt.
The message here is simple – if you want to make things happen before your startup runs out of cash, start the process early and secure a champion for the deal at executive level.
Second, a non-CVC corporate will simply be less practiced in the art of minority investing. There will be many more places where the deal will potentially break down compared to an experienced CVC fund. The power of syndicating can really pay dividends here: If the lead investor is an experienced VC that knows how to rally the other co-investors behind a standard term sheet, a founder’s life can be made a lot easier. Often the lead VC's lawyers will be much more founder friendly and au fait with the venture investment process, which is another expedient. In return, the corporate's evaluation of the product can often act as a proxy for the normal technical due diligence step that may no longer be needed.
Whilst the total amount of investment by corporates is increasing sharply in absolute terms, there are strong headwinds emerging. Corporate % share of overall VC investment has been in decline for the past 5 years. It currently stands at around 17% globally and 14% for Europe.
Why is this so? Corporates are having to fight harder for a share of the cap table as non-traditional investors such as the big investment banks, PE funds and hedge funds - like Tiger Global - are muscling into the VC scene at late stage.
European Startups reported that between 2016-18, Corporate VC as a % of total funding stood at 37% on Megarounds (>$100M). From 2019-21 this has fallen to 26%. As a result, corporates may have to consider earlier stage participation to take a meaningful stake. At Series A, corporates take around 15% of total funding and this has remained steady for the past 5 years. This could potentially start to increase if they get squeezed out of later rounds.
Collaboration is essential
Corporate VCs are now active in nearly every industry, from those already online like Mobility and Food, to those in the transition such as Education, Health, Housing and Banking. Many big companies have now realised that scale is not always an advantage. Entrepreneurial dynamism is thriving, born partly from a realisation that scale is now available ‘as a service’ – for example via Foxconn (manufacturing), AWS (hosting) or the Facebook Platform (distribution). A small group of smart people can now quickly become a threat to an established player.
The Entrepreneurial Age, written back in 2013, was an insight ahead of its time, stating: “The organizations with the greatest entrepreneurial capability will collect the most customers and greatest profit. They will also attract the best talent, who will continue to build the best products, with the greatest distribution and highest profits, which will attract the best talent and so on….leaving competitors without the people needed to stage a comeback.”
Big corporates realise they must now pursue a more collaborative approach with entrepreneurs. Partnering with startups is becoming an essential capability. For many it’s the only viable way to tap into the innovation culture. As a result, many new CVC funds are being developed and strengthened. The price to play is going up so expect bigger allocations and earlier stage interest to increase.