The Art of the Corporate VC Divestiture
Corporate venturing dates back to the 1930s and is one of the oldest forms of venture capital. In those years, other than wealthy families, corporations were the only entities with deep enough pockets to fund new ventures. Today, while there are many other types of investors, corporate venturing continues to be one of the most important sources of venture capital. According to Global Corporate Venturing, corporations account for approximately 20% of all venture capital invested today. In the last few years, there has been a renewed focus by Fortune 500 companies on external innovation not seen since the late 1990s. There are more than 1,200 active corporate venture units worldwide tracked by Global Corporate Venturing, almost double the 625 active corporate venture units just five years ago. The NVCA reported a record high of $5.4B of corporate venture capital investment in 2014, representing growth of 69% over 2013. Some of the most active groups were Intel, Google and Tencent.
Corporate Venture activity tends to mirror the macroeconomic cycle. Following the internet bubble, Global Corporate Venturing estimates that 64% of the 500+ active corporate venture units in 1999 were inactive by 2004. According to Josh Lerner, Jacob H. Schiff Professor of Investment Banking at Harvard Business School, the median life span of corporate venturing programs has historically been approximately one year. To withstand the test of time, corporate venture units may have to navigate any number of challenges, including shifts in company strategy, changes in management, failed investments and macroeconomic challenges.
Active portfolio management and careful planning is very important for corporate investors. Given the historically high attrition rate of corporate venture units, it is surprising that few active corporate investors today are prepared for divestiture. We’ve seen many investment cycles over our fifteen year history and worked as a trusted partner on over 25 corporate venture transactions including asset sales, restructurings and spin-out funds. In our experience, there are three main types of divestiture for corporate VCs to consider. Since there is no “one-size-fits-all” approach, choosing the right path will depend on the goals and objectives of the corporate parent and the needs of the portfolio companies.
Option 1. Spin-out team and portfolio to raise new capital:
Running a successful Fortune 500 corporate venture capital unit requires executive management oversight, a dedicated team and support resources. If a venture capital divisions outgrows the needs and resources of the corporate parent, it is worth considering a spin-out to become a standalone venture capital group. In a properly executed spin-out, the team, relationships and value are transferred in a way that does not disrupt the portfolio companies and attracts new investors. We have seen many successful corporate venture spin-outs and found that the process is most expedient when new LPs can acquire part of an existing portfolio as well as fund new capital commitments (so called “blind pool” investments). According to Stephen Socolof, Managing Partner at New Ventures Partners (formerly the venture arm of Lucent Technologies), “a successful spin-out has to have a buyer, seller and a spin-out team willing to deal with a three way negotiation. The buyer needs to able to conduct due diligence on the portfolio, structure an appropriate transaction and come up with capital to support the team’s operating budget and reserves for follow on investments.” Secondary funds are uniquely set up to help with corporate spin-outs as they not only have transaction structuring expertise but can also help spin-out funds earn credibility with new LPs to help the newly independent VC raise a third party fund.
Option 2. Sale of assets on a “one-off” basis:
Corporate venture units such as Google, Salesforce and GE tend to invest for strategic rationale as well as for financial gain. They may want to understand a recent technological innovation, a preview of a technology that could be acquired or a partner that increases demand for an existing product. Over time, however, corporate investments run the risk of diverging from the strategy of the corporation or becoming head-on competition. A corporation may ultimately try to acquire a portfolio company. But finding an agreeable price and structure in an M&A may not be possible. As an alternative, selling an investment can be a viable solution to manage the portfolio in a way that focuses the corporation’s effort and capital on the most promising portfolio companies. According to Rich Grant, Managing Director at Touchdown VC, “Companies change direction and strategic approach. A startup may have been relevant upon investment, but may not be five years later. If that is the case, a corporate venture capital firm should consider focusing on the financial outcome of the deal, taking liquidity when it is best for all shareholders, and prioritizing strategic efforts on other portfolio companies that are more relevant.”
Option 3. Sale of entire portfolio:
Why would a corporate parent dispose of an entire venture portfolio? It can be the result of a change in priority following an M&A, the departure of management internally sponsoring the effort, or a corporate parent who can no longer fund the effort. In prior recessions, corporate venture units were one of the first divisions to be downsized due to 1) their negative cash flow characteristics (disbursements during a recession tend to outpace exits); 2) general perception of corporate venture capital as a “non-core” business unit and 3) the illiquid nature of venture investments. When this happens, a sale to a reputable third party can help the portfolio companies find a new home while keeping underlying relationships and reputation intact. It is important to find a partner that has the capital to fund follow-on investments and can earn trust among portfolio company management as well as other existing shareholders. Over the years we have helped dozens of corporate venture funds sell venture portfolios and wind-down operations, including EDS Ventures, Enron Broadband Ventures, Washington Mutual and Hollinger International.
Among the corporate VC community, divestment is a subject that is often ignored until it is too late. However, whether pruning the portfolio or executing a spin-out, corporate divestment has been an important part of the venture capital lifecycle for many years. It is important for both newly established and experienced corporate venture units to regularly revisit exit scenarios and contingency plans to ensure that relationships, value and reputation are preserved if a divestment is necessary. Since every situation is unique, we urge corporate venture units to consider many alternatives and seek an experienced and flexible partner.