FOURTH WAVE: THE UNICORN ERA, 2002 TO PRESENT
While corporate venture capital fell off substantially after the bubble burst, it by no means disappeared. CVC as a percentage of total VC was halved, but CVC investment leveled out at about $2B per year through the first half of the decade, then began to increase again before dipping, along with the rest of VC investment, during the worst years of the global financial crisis — dollars from CVC-backed deals reached only $5.1B in 2009 — then took off when Silicon Valley began to boom again in the first half of the current decade.
In 2012, for example, total funding from deals involving CVCs was $8.4B, according to CB Insights — a significant increase from 2009, but still less than half of total CVC investment during the boom years. It remained at roughly that level in the following year before doubling in 2014, and then jumping nearly 70% in 2015 to an unprecedented $28.4B.
This trend reflects the broader increase in venture capital investment, which has more than doubled since 2011 and saw significant gains between 2013 and 2014 and 2014 and 2015. At this point, though, CVC is actually growing at a faster rate than venture capital investment in general. But it only captures part of the picture: corporate financings of private companies, done outside of a CVC unit, have also seen substantial increases in recent years.
With the new rise of CVC, critics have again surfaced. Sarah Lacy, editor of Pando, had a negative outlook, “At best, corporate VCs are a bit like minor league baseball teams. If you’ve got the chops to be a real VC, you’re either moving up or moving down. Either way, at many companies it’s a revolving door of talent and climbers.” (Fred Wilson, as we previously saw, also has his criticisms.)
The obvious impetus for CVC’s resurgence was the dual rise of social media and the smartphone, most prominently represented by Facebook and the iPhone. Together, internet and mobile accounted for 63% of CVC dollars by the final quarter of 2016. Healthcare now also regularly tops software and hardware, both tech boom darlings, as a destination for CVC dollars. Another factor encouraging CVC activity is that corporations are sitting on historically large piles of cash and global interest rates are historically low.
With the benefit of hindsight, two other events may have played a small role in nudging companies back into corporate venture capital. The first was Microsoft’s 2007 investment in Facebook, which was widely ridiculed at the time — ”Microsoft has to be seriously desperate to be considering this much of an investment for so little, even with its bags of cash to spend,” wrote Kara Swisher on the eve of the deal.
Microsoft paid $240M for a 1.6% share of Facebook at a valuation of $15B. The company is valued at more than $300B today and the investment connected the by-then tech stalwart with the hottest startup in the world in the process.
The second spark that helped CVC’s resurgence was Google’s 2008 decision to start Google Ventures, likewise derided by some. The outfit has since grown into one of the largest and most respected CVC investors — a strong endorsement of the idea from one of the world’s most successful and innovative companies.
Nonetheless, hype and exuberance have undoubtedly contributed to the enormous growth in CVC in the past few years, buoyed by the triumphant press surrounding new technologies, a rash of new buzzwords, and the omnipresent fear of disruption. Arvind Sodhani, who led Intel Capital for ten years, told The New York Times earlier this year, “CEOs who are worried they’re going to get disrupted want to have an outpost in Silicon Valley to discern where the disruption is coming from.”
The recent expansion of CVC investment is impressive. There are now, as we saw, roughly 200 CVC units active in any given quarter, a number that is more than 2x what it was just five years ago. Some companies that ditched their CVC units after the bubble burst have decided to give it another go. Dell closed its CVC unit in 2004 and reopened a new CVC unit in 2011. Microsoft, likewise, is revamping its CVC efforts.
Microsoft Ventures: Disciplined ambition
While Microsoft had an ad hoc corporate venture capital program in the 1990s, making minority investments in startups without a formalized CVC program, the new Microsoft Ventures unit represents an example of a mature model for corporate VC, pioneered by large technology companies and since adopted beyond the industry. Large write downs and losses following the tech bust, mentioned above, largely curtailed Microsoft’s ad hoc approach, although Microsoft did continue to make intermittent investments in startups, such as its 2007 investment in Facebook. At the beginning of 2016, however, Microsoft decided it was time to ramp up their investing activities and founded their first structured CVC program, Microsoft Ventures.
Nagraj Kashyap, formerly the head of Qualcomm Ventures, was brought on to spearhead the effort, and he has hit the ground running. In 2016, Microsoft Ventures invested in 18 companies, far more than Kashyap initially expected when he took on the job. The selection of Kashyap, who has been working in CVC for more than a decade, signified Microsoft’s intentions for the group.
Kashyap came from Qualcomm Ventures, which like Intel Capital, emulates many independent VC firms and is focused on maximizing its financial returns. Kashyap confirmed that he would bring a similar philosophy to Microsoft, “We don’t see the distinction between financial and strategic [goals]. The best financial companies make for the best strategic returns.”
That does not mean, of course, that Microsoft Ventures will be investing in coffee startups or lifestyle brands. On the contrary, it is focused on enterprise startups providing business-to-business services, such as companies building next-generation cloud infrastructure, companies that help enterprises migrate to the cloud, and all sorts of business-oriented SaaS; thus far, enterprise startups account for approximately 90% of Microsoft Ventures’ investments.
Why these companies? The answer is simple: These are the companies where Microsoft can provide the most help and technical support post-investment. Microsoft’s investment philosophy does not mean the venture arm is indifferent to strategic concerns, but rather that they have set investment parameters that fit their strategic interests and then focus on financial returns within those parameters. “If I spend an enormous amount of time engaging a company with Microsoft and it fails,” said Kashyap, “that is basically a waste of time for everybody.”
Microsoft Ventures’ portfolio companies are under no obligation to work with Microsoft post-investment and vice-versa, and many of the startups have not even met with the company at the time of investment (excluding the investment team, of course). Nonetheless, the CVC offers these companies three services, should they accept an investment:
- Technical integration with one of Microsoft’s products, such as Azure or Office 365, if it is beneficial to the portfolio company’s product
- Go-to-market help, using Microsoft’s large and robust enterprise sales team; and
- Promotional services, such as featuring a portfolio company at a Microsoft-held conference
Microsoft Ventures makes the necessary introduction and then an internal business development team, staffed by Microsoft employees, manages its portfolio companies’ interactions with Microsoft.
The investment team, however, is staffed by investment professionals, some of whom previously worked at other CVCs, like Intel Capital, or for independent VC firms, and they are expected to evaluate startups as any other VC would, without regard to a startup’s potential strategic advantages.
Microsoft Ventures has no set investment budget, no limiting fund size, and no minimum or maximum required investments per year. In some regards, this means its investors have an even greater level of flexibility than their counterparts at independent VCs, highlighting a potential advantage of CVC. It has the autonomy to invest more or less in a company, take a large or small ownership stake, and invest in as many good opportunities as it can find.
Kashyap sees the group’s focus on financial returns as key to maintaining its unusual degree of independence and flexibility, “As long as you’re making good investments, a corporate parent will typically not have problems with you spending more or less.”
They have made good use of the flexibility thus far. Microsoft’s 18 deals in 2016 are more than many robust independent VCs typically make per year — and the group was only founded towards the end of January. Kashyap says that the market has gradually improved over the course of the year as valuations have become more rational than in recent years and entrepreneurs have accordingly lowered their expectations.
As can be seen from the snapshot from CB Insights’ Investor Analytics tool below, Microsoft often invests after top VCs such as Bessemer and Data Collective, and also sees VCs and CVCs like Trinity Ventures, Intel Capital, and Accel invest in its portfolio companies.
Kashyap believes that market conditions have fundamentally changed since the end of the last tech boom and there is unlikely to be a shakeout as brutal, despite concern over a unicorn-era bubble.
Many CVC investors back then were looking for quick returns from portfolio companies’ IPOs — the criticism that they were short-term players was largely true, he says. Today, however, the IPO market is much less robust, meaning CVC investors can no longer expect an instant return on investment, and corporations’ balance sheets are generally much stronger — corporations are sitting on record levels of cash in a historically low interest rate environment — meaning that they can afford to focus on longer-term goals and let the companies they’ve invested in mature over time.
Critics aside, CVC grows up
CVC investors have changed as well. There are enough established investors with strong track records that independent VCs and entrepreneurs are less wary of partnering with CVCs than they once were. Nonetheless, Kashyap warns, “There’s always going to be immature actors — not bad actors but immature actors, because they [started investing] from the wrong perspective and for the wrong goals.”
Skepticism on the part of entrepreneurs and other VCs is justified, because not all CVC investors share their principles. While some of these immature investors will undoubtedly disappear as the market cools and others will pull back, it is unlikely that we will see the sort of enormous drop-off in CVC investing that occurred in the early 2000s.
Meanwhile, the music has not yet stopped playing, despite the downturn in VC activity in 2016. More than fifty new CVC units were started in the first half of 2016 alone. The number of active CVC investors per quarter more than doubled between 2012 and 2016, according to CB Insights.
However, despite assurances from CVC investors that they are pursuing smaller, more nimble investments than during the tech boom, CVCs on average actually invest in larger deals. In the second quarter of 2016, CVC units participated in 19% of VC deals, but those deals represented 27% of VC investment dollars.
CVC has, however, grown up in the meantime, meaning that there is more institutional knowledge and more resources for companies just starting out. According to a survey of CVC investors, about half have processes in place to solicit and incorporate feedback from other stakeholders at their parent corporations. Two-thirds have a dedicated budget, and 80% complete more than five deals a year. CVC has, to some extent, standardized.
The mix of strategic and financial objectives continues. Four-fifths say they are primarily looking for strategic alignment in their startup investments, but three quarters also list financial considerations as a core objective.
Some companies, it should be noted, employ multiple types of funds and investment strategies. Cisco Investments, for example, makes direct investments and acts as a limited partner in a number of independent venture capital funds. Microsoft Ventures, referenced above, is an internal dedicated fund.
Others are like more elaborate iterations of the “client-based” funds first pioneered in the 1980s, i.e. external funds which may be managed by an independent investment team, but that are wholly funded by a specific corporate or group of corporates.
Unilever and Pepsi, for example, are limited partners in Physic Ventures, a firm whose stated mission is “investing in keeping people healthy” and which is designed to let corporate investors forge commercial partnerships with portfolio companies. Both companies reportedly have full-time employees working out of Physic Ventures’ offices.
Kleiner Perkins similarly teamed up with Apple to create the iFund in 2008 in order to stimulate development for the app store and potentially create more companies that would funnel through KPCB, similar to the fund to spur Java development in the 1990s.
Bumps in the road
Despite the generally positive atmosphere surrounding CVC investment of late, there have been setbacks. OnLive, an online gaming startup backed by Time Warner Investments, AutoDesk, HTC, and AT&T, crashed and burned in 2012 after achieving a $1B valuation. Walgreens and BlueCross BlueShield Venture Partners were investors in Theranos, the highly touted blood testing company that spectacularly blew up last year after a scandal. Other corporate-backed startups have seen steep drops in their valuations lately, including Jawbone, Zenefits, and Dropbox.
This could signal the beginning of a broader chill in the market. If and when this happens, many CVC investors will have to write down significant losses — 76% of CVC investment is funded through the balance sheet, meaning that the market value of these investments must be reflected in company filings.
Even if these do not necessarily reflect real losses, the numbers will raise eyebrows and fresh questions about how worthwhile CVC really is to the corporation. Some companies have publicly stated that they will continue investing even if there is a downturn — but that is, of course, easier said than done. Nonetheless, some are putting their money where their mouth is.
Sapphire Ventures, formerly SAP’s CVC arm, and still solely backed by SAP, recently raised a $1B fund.
There are also important structural differences in CVC between the dot com era and the current tech boom. Many of the largest CVC investors in the past few years are not upstart units blundering into the market, but rather the CVC arms of blue chip tech companies, many of which rode out the last downturn and kept on investing, like Intel Capital and Cisco Investments. This makes them well positioned to capitalize on the current upswing. Other large CVC tech investors, like Google and Salesforce, started their funds more recently, in 2008 and 2009, respectively, but were already investing heavily in the market before it really heated up.
Salesforce has substantially increased its investments to more than $500M, from $27M in 2011. Many of the large investors subscribe to some variant of Intel Capital’s approach to corporate venture capital. Salesforce, for example, has been funding enterprise companies in order to stimulate the ecosystem of its core product. Comcast invests in a variety of content companies that complement and could possibly be incorporated into its core offerings, as well as technical companies that augment its core competencies.
Everyone’s a VC
It is true that there have been new CVC units from companies far from the Silicon Valley ethos, such as 7-Eleven, Campbell Soups, and General Mills, and this has raised some eyebrows. However, the success of a CVC program is not contingent on its proximity, geographically or spiritually, to San Francisco.
Companies across numerous industries face fresh challenges from a rapidly changing world, much of which, indeed, is rooted in Silicon Valley, but not exclusively so. American consumers, for example, have recently shown an inclination towards healthier foods, embracing some ingredients — kale, quinoa, acai berries, etc. — and rejecting others — gluten, some dairy and meat products — in a way that would have been nearly impossible to predict a decade ago.
This is obviously a concern for a food company like General Mills. Rather than exclusively relying on internally generating new product lines to meet these changes — a long and time-consuming process with no assurance of success — General Mills is using its new venture arm, 301 INC, to invest in food startups like Kite Hill and Rhythm Superfoods that already have a foothold in the market.
Given its expertise in marketing and distribution, this is a natural extension of General Mills’ institutional knowledge, much more so than Sand Hill Road stalwarts investing in coffee companies and grilled cheese startups — which is not to say that it will succeed.
Corporate venture capital is, in a sense, getting back to roots, moving beyond its strong association with the technology industry that has come to predominate in recent decades. In doing so it has underlined what corporate venture capital actually is, at its essence: a tool for augmenting a company’s products and strategies, present and future. For many reasons, that often includes Silicon Valley, but it does not mean that CVC is an easy way to access its buzziest technologies.
CVC must be informed by an underlying strategy or differentiator. Have corporate venture capital firms learned the lessons of the tech boom, when they piled in simply because the internet was the shiny new thing? Over time, we’ll learn what companies really had a strategy — and which were merely victims of FOMO.
Source: CB Insights
Article Link: https://www.cbinsights.com/research/report/corporate-venture-capital-history/#origin
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