3 questions to smart minds
Photo: J. Balssen | Gleiss Lutz

Corporates act as VCs in search of new business areas

For this 3 questions to Dr. Jan Balssen

Gleiss Lutz
Photo: J. Bals­sen | Gleiss Lutz
11. Febru­ary 2015

There are a few dozen ‘corpo­rate VCs’ in Germany. Corpo­rate venture capi­tal compa­nies’ are subsi­dia­ries of large compa­nies that make stra­te­gic invest­ments for the parent company — usually in line with its core busi­ness. In contrast to other venture capi­tal (VC) compa­nies, they target both the return on the funds inves­ted and the added value that can be gene­ra­ted from syner­gies between the parent company and the finan­ced part­ner company. — Why are more and more large compa­nies setting up their own VC units and what do they expect from them?

For this 3 ques­ti­ons to Part­ner at Gleiss Lutz in Munich (Co-Head of Private Equity / Venture Capital)

1. Why are so many corpo­ra­tes suddenly inte­res­ted in inves­t­ing in start­ups or have set up their own venture unit?

Venture capi­tal invest­ments by compa­nies, so-called corpo­rate venture capi­tal, offer multi­ple bene­fits to the compa­nies concer­ned. On the one hand, with their early invest­ments in start­ups, compa­nies are natu­rally aiming for the (some­ti­mes substan­tial) finan­cial returns. On the other hand, the compa­nies also pursue stra­te­gic goals, in parti­cu­lar the deve­lo­p­ment of new know-how and new busi­ness models as well as the early iden­ti­fi­ca­tion of market trends that may be important for their core busi­ness and its further deve­lo­p­ment. In many large compa­nies today, struc­tures are too rigid to imple­ment new ideas at short notice or to simply “try out” new tech­no­lo­gies on the market. Here, start­ups with their dyna­mic, infor­mal struc­tures foster inno­va­tion. Large compa­nies take advan­tage of this; via their invest­ments in start­ups, they gain access to these inno­va­tions and thus streng­then their rese­arch and deve­lo­p­ment acti­vi­ties or the further deve­lo­p­ment of their core busi­ness. Of course, the stra­te­gic bene­fit is not one-sided, the start­ups receive via a corpo­rate venture capi­tal inves­tor, in addi­tion to the finan­cial endow­ment with venture capi­tal, also, often very valuable, access to the orga­niza­tio­nal and tech­no­lo­gi­cal know-how of the company, its produc­tion, distri­bu­tion chan­nels or coope­ra­tion partners.

2. What approach do the corpo­ra­tes use? Do you have your own teams?

Large corpo­ra­ti­ons regu­larly create their own subsi­dia­ries for corpo­rate venture capi­tal, which moni­tor the rele­vant markets and the start­ups opera­ting there for the parent company and make stra­te­gic invest­ments. In some cases, simply revie­w­ing invest­ment offers from various start­ups seeking inves­tors provi­des valuable insights into new (market) developments.

Ideally, the corpo­rate venture capi­tal invest­ment compa­nies are not too closely inte­gra­ted into the parent company and its struc­tures and proces­ses. In parti­cu­lar, the decis­ion-making proces­ses for venture capi­tal invest­ments are inevi­ta­bly quite diffe­rent from those for tradi­tio­nal invest­ment decis­i­ons within a group. The invest­ment decis­ion of an early venture capi­tal inves­tor is based prima­rily on the belief in the econo­mic poten­tial of a busi­ness idea and in the abili­ties of the startup foun­ders to imple­ment this idea. Relia­ble key econo­mic figu­res that can be compre­hen­si­vely audi­ted within the scope of due dili­gence in accordance with group requi­re­ments will only rarely be available here. Without corre­spon­din­gly flexi­ble struc­tures, howe­ver, copo­rate venture capi­tal inves­tors will often find it diffi­cult to find inte­res­t­ing target compa­nies for invest­ment and also to attract or retain talen­ted invest­ment mana­gers. In addi­tion, an inde­pen­dent invest­ment company with flexi­ble struc­tures and proces­ses is regu­larly more attrac­tive to start­ups and their foun­ders, who are only used to infor­mal, dyna­mic proces­ses, than the rather infle­xi­ble, partly bureau­cra­tic world of the large company.

3. At what stages of the start­ups’ deve­lo­p­ment do corpo­ra­tes get involved?

As a rule, large compa­nies parti­ci­pate in start­ups in the early deve­lo­p­ment phase in their corpo­rate venture capi­tal invest­ments. At this point, the price of an invest­ment is rela­tively low and the company gains suffi­ci­ent insight into the respec­tive busi­ness idea. The acqui­red inte­rest secu­res the oppor­tu­nity to parti­ci­pate in a subse­quent sales process as an inte­res­ted party. At this early stage of deve­lo­p­ment, the poten­tial syner­gies of a large company’s invol­vement are also parti­cu­larly valuable for the startup and its foun­ders in many cases. In a later deve­lo­p­ment phase, the foun­ders may be reluc­tant to involve a corpo­rate venture capi­tal inves­tor. By then, foun­ders often alre­ady have the goal of an opti­mal exit in mind. They fear that the parti­ci­pa­tion of a stra­te­gic inves­tor in the startup could possi­bly have a nega­tive impact on the purchase price that can later be achie­ved at the exit. For exam­ple, a poten­tial acqui­rer might be concer­ned that the corpo­rate venture capi­tal inves­tor, as a signi­fi­cant compe­ti­tor, knows all the company details and rele­vant know-how through its stake in the startup. In addi­tion, a corpo­rate venture capi­tal inves­tor who may want to acquire the startup itself as part of the sales process natu­rally has no inte­rest in the foun­ders achie­ving the highest possi­ble sales price. He will ther­e­fore seek ways to bring forward any problems the startup may have, which he is well aware of, to reduce the purchase price. In the late deve­lo­p­ment phase of start­ups, one curr­ently sees more typi­cal private equity inves­tors tapping into invest­ments in this area — often with smal­ler invest­ment sums than usual. The reason for this is proba­bly the lack of good targets in the tradi­tio­nal private equity segments on the one hand, and on the other hand, of course, the hope of a successful exit with (at least in abso­lute figu­res) considera­ble increa­ses in value, espe­ci­ally in the case of an IPO.

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