The value of Corporate Venture Capital (CVC) investments was around 6% of last year’s global M&A value, but minority investments are often viewed as a significant and important extension of the inorganic growth strategy and acquisition pipeline, despite the small deal value.
Minority investments, including through CVC units, are often used to fund strategic bets on new technologies, emerging markets, and talent-driven partnerships.
However, according to a survey by the Transaction Advisors Institute, most corporate venture teams (85%) are managed separately from M&A teams.
The Institute’s members also reported that most (62%) have the CVC reporting to multiple executives, which makes them subject to a range of interests that tend to shift over time.
The academic paper, “Organizational Structure and Decision-Making in Corporate Venture Capital” by Ilya A. Strebulaev & Amanda Wang from Stanford University’s Graduate School of Business, found that in almost half of the CVC units studied, the parent company did not acquire a single portfolio company.
The paper also reported that very few CVCs negotiate for the right of first refusal (ROFR) to acquire portfolio companies at equivalent value to another acquisition offer, a practice that is viewed as out-of-step with current venture practice.
The standard terms that are used in most investments do not include a right of first refusal (ROFR) to acquire a portfolio company.
According to the study Standardization and Innovation in Venture Capital Contracting by Robert Bartlett, Professor of Finance (by courtesy) at Stanford Graduate School of Business and Professor at Stanford Law School, the model contracts provided by the National Venture Capital Association (NVCA), which are used in nearly 85% of early-stage investments, do not include ROFR provisions.
In fact, CVC investors are present in less than a quarter of all VC deals, according to Venture Monitor, published by the National Venture Capital Association and Pitchbook.
CVC investments can be engineered to play a strategic role in the corporate strategy, supporting the development of a critical adjacent market, providing insights into the direction of innovation, and enhancing existing or future commercial strategic partnerships, among other purposes.
At the M&A Conference at Wharton San Francisco, hosted by the Transaction Advisors Institute, the discussion on minority investments outlined a range of early-stage “sensing” benefits that complement the corporate development team’s market mapping and M&A roadmap.
While financial returns are expected, the primary drivers are ecosystem development, technology testing ("try before you buy"), and strategic alignment.
A related paper from McKinsey & Co., “How to make investments in start-ups pay off,” reported start-ups that receive CVC funding are more likely to grow, have a successful exit, and avoid failure -- suggesting a broader lens and more favorable view should be taken on the impact from corporate investors.
In the paper "Steer Clear of Corporate Venture Capital Pitfalls," published by MIT Sloan Management Review, the authors note that CVCs do not have an obvious home in the parent company because they can "report to a startling variety of bosses."
As discussed at the recent M&A Conference at Wharton San Francisco, CVCs also suffer from ‘moving sponsors’ when the deal lead changes roles.
This led to a deeper look at approaches for financial accountability and P&L attribution.
To ensure business units remain committed to investments, some companies are using internal accounting mechanisms, including (1) attributing a portion of the investment cost or operating expenses (OpEx) to a specific product P&L, and / or (2) forcing sponsors to "underwrite" the FTEs and resources required for the investment over several years.
The quarterly data on CVC deal counts shows the decline since late 2021, which was attributed to more cautious corporate actions and concern over limited exit opportunities, has started to reverse according to the Global Venture Capital Outlook by Bain & Co.
It’s also interesting to note that more (67%) CVC-backed investments are being made in the early stage, before any financial return can be evaluated, according to the State of Corporate Venture Capital Report from Silicon Valley Bank and Counterpoint.
This may be a sign that the environment is shifting from the prevalence of financial funds to strategic funds that invest for insight or synergy with the corporate parent’s objectives - whether or not there is coordination and alignment with the M&A strategy.