Corporate venture capital “is the investment of corporate funds directly in external start-up companies” (Wikipedia). As a medtech entrepreneur raising funds, you should know about them. They are an extremely valuable source of VC funding for your company. But they do have distinct differences from VC firms (described here).
Here are 4 differences I see between corporate VCs and VC firms:
1. Source of Capital?
VC firms have external financial investors (e.g. pension funds, super high-net-worth individuals). Raising each new fund can be a herculean task. This requires dedicated effort from partners which detracts from the day-to-day activity of making investments and working with portfolio companies. (Not so dissimilar to entrepreneurial CEOs who often state they spend more than half their life raising money).
Corporate VCs have all their funding from the parent company. This is usually set up as a separate fund with ring-fencing, but the money still comes from the corporate parent. Once the strategic decision is given to resource the corporate VC fund, fundraising is probably one of the lesser tasks. This in turn relates closely to different objectives.
VC firms have the primary objective of financial returns on the fund, preferably top quartile, since this gives them credibility when raising the next fund.
Corporate VCs usually have a blended objective. This is part financial return, and part strategic – aligning with the parent co. existing business areas and often as a way to identify early potential product pipeline and technology opportunities. Depending on the firm, this objective is skewed more one way than the other, but strategic alignment with the parent is usually the bigger driver. (I’ve only ever met one corporate VC which openly stated its only purpose was to make a financial return).
3. Fund Life?
A typical VC firm has a fund life of 10 years, sometimes with 2-3 year extensions. This means investments are made in the first half of the funds’ life, while the second half is focused on ensuring portfolio companies grow, including follow-on investments, and achieve all important exits.
Corporate VCs usually operate under an “evergreen” fund life. Although there may be a notional “life of fund” for the assets already ring-fenced, the parent co. will support all future fund sources and may top-up as required. This only changes when the overall corporate strategy changes (e.g. to exit corporate VC all together – which does happen).
4. Incentives of Operatives?
VC firms usually operate on the “2 and 20” financial incentives (described here). Since the focus is entirely on returns, this creates financial discipline for partners and prevents certain luxuries of trying out ideas because they are strategically interesting.
Within corporate VCs, without knowing the details of any one outfit, the pay structure and incentives for partners is much more along the lines of a corporate environment: a good salary, with some incentives on performance. But certainly much less upside than a partner in a VC firm. And performance will not be measured in hard financial returns alone – there may well be some in meeting strategic objectives. Indeed, I don’t even know if partners within corporate VCs would get ANY carry (i.e. performance bonus based on ownership of portfolio cos). If they do, it will be much lower than in VC firms.
The upside is probably in stability – your fund has evergreen funding, without the same hard metrics on financial performance as a VC firm. Even in a worse case scenario, if the parent co. decides to shut down the VC arm, employees may end up returning into a role within the parent co. (from whence they usually came).
Why does it matter?
In a word, ALIGNMENT. Specifically, alignment between the various VC shareholders within your company.
- do your investors have the same strategic objectives for your company;
- do they have the same time horizon based upon their fund lives;
- do individuals on your board have incentives to create or realise value for themselves and their firms to the detriment of other investors (it happens);
- can all investors follow-on in subsequent rounds (this can create real disincentives if certain investors are afraid of dilution and can’t follow on)
More than once, I’ve seen opportunities (e.g. new financing rounds) killed from misaligned investors than poor science or technology. Of course, this can occur between different VC firms, even if no corporate VCs are involved. And it can just as easily occur between VCs and non-VC investors (e.g. high net-worths). In essence, different fund structures, incentives and time-horizons can all add to complications.
Once investors are in, the CEO’s job is to keep them aligned, and communicate a clear corporate strategy that everyone buys into to build long-term value. Or else each investor can play his or her hand to their incentives and objectives. This can even be to the detriment of overall company growth.
Benefits of Corporate VCs
Personally, I think corporate VCs can be a very good thing. When the various shareholders are aligned, it can be very effective and things can work really well. Specific benefits of including a corporate VC, from the entrepreneur’s point of view, include:
- Strong validation from a major market player
- Patient capital
- Can temper decisions that are driven by pure financial objectives
- Deep pockets, useful in syndicates
- Potential buyer for your company
The main downside is the flip side of the last bullet – potential buyer for your company. Everyone assumes your company just becomes a shoe-in for the parent co. of the corporate VC that has invested. This can reduce your other options (Note to entrepreneurs: include a clause in your term-sheet which allows you to freely consider other trade partners or buyers, downstream).
At the end of the day, if you’re an entrepreneur leading a cash-strapped company, money is money and you may not have the luxury to choose its source. But awareness of different shareholders, and their objectives and incentives, means you can work better with them. And you’ll have to work doubly hard to keep them aligned and happy.
Have you had experience working with corporate VCs and VC firms. What do you think about shareholder alignment?
This post is by Raman Minhas. He is a medtech enthusiast, CEO of ATPBio, and works with entrepreneurial companies, providing support with partnering, financing and exit planning. He is also an investor in medtech stocks, using a value based approach.
Raman’s next conference attendance will be at a Medtech focused event – EuroMedtech in Grenoble, France. He will be moderating a panel: Keys to emerging company commercialization. Feel free to reach out if you’re going to be there.
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