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Investors with benefits

I have in the past wondered why “corporate venturing” has never appeared to be as prevalent in the UK as it might be. One might expect equity investment by corporate trading businesses for financial returns and strategic benefits to be a core part of the investment ecology but this hasn’t seemed to be the case.

Looking at the impact of corporate venturing historically, some detractors may have grounds for scepticism and can point to mixed, if not volatile, results. 

Some may also consider corporate investors to be risk adverse and intolerant of failure but there is an emerging generation of corporates who understand growth company dynamics and can make it work, perhaps Google Ventures being the best current example.

Nevertheless, if you were to aggregate some high profile historic corporate venture plays you could identify billions that have been wasted. But has that been to detriment of investee companies? The answer appears to be “sometimes, if you don’t get the terms right”.

While there are good reasons for early stage companies to tread carefully, according to the well regarded “Global Corporate Venturing”, there are now more corporate VCs in the market place than traditional venture firms. These “corporate VCs” adopt key elements of a traditional VC fund but with the additional strategic incentives of a global corporate brand.

Leading corporate VCs are now concentrating on price and deal structure and are increasingly sophisticated. They are also now investing earlier with increased syndication with traditional VCs.

Whether it’s a corporate VC or a corporate investing off its balance sheet in another company in its sector or supply chain, from the investee company’s perspective, there are a number of dynamics to take into account. Accordingly, relatively detailed negotiations at the Term Sheet stage may be invaluable in allowing the parties to manage mutual expectations and recognise the potential areas of conflict and tension.

Even if the potential benefits to both the investor and the investee company are obvious to all, the potential future flashpoints might include some of the following:

  1. Being too closely connected with one large corporate could cause other customers or suppliers to rule out the trading and acquisition possibilities;
  2. A concern that corporates may have a reason to supress new replacement technology and frustrate growth plans;
  3. A risk of becoming a cheap outsourced R&D division, restricted or distracted from pursuing its own objectives;
  4. Conflicts can and do rise at board level and an incumbent investor director may be difficult to remove;
  5. Any desire for preferential rights over any new technology licencing or company ownership could result in harmful restrictions or cumbersome processes ;
  6. Exposure of company’s pricing policies, profit margins and negotiation position to an investor who may be a customer in subsequent commercial negotiations.
  7. Risk of negative impact if a recognised corporate investor is not seen to follow their investment;
  8. Corporate’s ability to truly engage and provide the promised “value add” may be limited;
  9. Internal processes can result in slow decision making and action taking.

While all of this may paint a rather negative picture, it shouldn’t. An awareness of such issues should allow growth companies to pre-empt such issues and as part of the investment structuring they should have an opportunity to:

  1. Use robust confidentiality provisions and control the flow of technical information to avoid IP leakage;
  2. Ensure a sufficient autonomy is retained;
  3. Adopt clear rules on conflicts of interest;
  4. Instil clear rules on ownership of background IP and ownership of new foreground IP that is created;
  5. Ensure it is not unduly restricted from exploiting new IP with third parties ;
  6. Tailor usual investor controls and information rights;
  7. Set drag along percentages at an appropriate level to avoid withering on vine;
  8. Agree a threshold of equity below which the corporate’s investor director rights fall away.

At a general level, in order to optimising the outcome, investee companies need to go in with their eyes open to the more complicated dynamics and understand the corporate’s motivation. Exit must be a priority.

At a human level there may also be a need to create shared excitement between the technical teams, recognising that interaction may not happen naturally.

Even if corporate venturing has learnt some lessons from the past, we do still hear of companies that have not retained sufficient autonomy and have lost direction and opportunity.

Taking all of this together, the need for a genuinely thoughtful approach to any Term Sheet is clear, with there being less scope for using a standard form Term Sheet.

Indeed, “investors with benefits” can lead on to a flourishing relationship or one or both parties feeling slightly used.

If the above issues can be adequately addressed then there must be scope for corporate venturing to further establish itself at the heart of the UK investment ecology.

Kenny Mumford

Partner

Head of Corporate

Email: kenny.mumford@mbmcommercial.co.uk

Munich comes to Edinburgh
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