The New Venture Capitalists -- from Corporate America
About 38% of all VC funding now comes from big companies, signaling a sea
change in strategic thinking
By Margaret Popper [email protected]
Businessweek on-line, 14 October 1999
© Copyright 1999 The McGraw-Hill Companies
Inc. -------------------------------------------------
Dick Bodman is proud as can be of his venture-capital record. He has 14
companies in the lock-up period before they go public -- which will bring
his total IPOs for this year to 15. "Fifteen in one year!" he crows. "I
don't think there's another venture capital firm that can say that." Oddly,
for a managing general partner with a great record, Bodman is reluctant to
brag about his exploits in much greater detail. That's because he doesn't
run a top-dog VC firm such as Brentwood or Kleiner Perkins, but rather he
heads AT&T Ventures, a former subsidiary of AT&T. Which means that he has to
follow corporate rules of discretion.
Buoyed by the bull run in the stock market plus surging interest in
e-commerce and the Internet, venture capital disbursements hit a record $13
billion last year. According to statistics from industry tracker VentureOne,
roughly $5 billion of that -- or 38% -- was kicked in by corporations in
search of successes such as Bodman's. Compare that total to the $1.2 billion
corporations invested in 1994, and you have evidence of a sea change in the
way big companies view risk capital. What's driving this trend is the
realization that product innovation and technological savvy aren't just
important in the Internet Age: They're the key to corporate survival. Big
companies want to control the technologies that affect their businesses, but
they're disenchanted with the idea of sinking huge amounts into research and
development that may never see the light of day. It's far better, they seem
to be saying, to turn the R&D effort into a profit center. "We can't invent
everything," says Fernand Kaufman, vice-president for strategic development
and new business at Dow Chemical, a general partner in four venture funds
totaling $100 million. "And [the venture-capital model] has both strategic
benefits and financial rewards."
THREE METHODS. So it is that Intel Corp. creates its Intel 64 fund to invest
in new technologies that will eventually use more Intel next-generation
64-bit chips. Or that Allstate Insurance invests in Apropos Technologies, a
company whose software products can enhance Allstate's customer-service call
center. Or that Dow Chemical's fund invests in Illumina, which makes a
fiber-optic sensor that's good for testing chemical products. While the
rewards of corporate venture investing are enticing, choosing the best
approach can be a black art. Some corporations do it ad hoc, through
operating divisions, the finance department, the mergers and acquisitions
group, the business development function, or some other business unit that
happens to come up with a bright idea. Other companies create a business
development group with a specified venture-capital budget. Created as one of
Lucent's 11 business units two years ago, Lucent Technologies New Venture
Group (NVG) uses a venture-capital model to develop ideas that come out of
Bell Labs. Still other companies have spun off the ventures piece of their
budgets into separate funds that have a strategic investment mandate but
aren't consolidated on the balance sheet. A corporation that spawns such a
fund may have an investment in the fund's stock or may invest in one of the
funds the venture company manages. AT&T Ventures falls into this category,
as does Lucent Ventures -- a venture-capital arm that funds ideas from
outsiders but is separate from the Lucent Technologies New Ventures Group.
Other major companies with separate funds include Dow Chemical and
SmithKline Beecham.
A ONE-IN-TEN JACKPOT. As of last year, 67% of corporate venture-capital
groups were organized in one of the first two ways, according to
VentureOne's statistics. But as corporations get used to the idea of profits
from venture investments and tire of the political and accounting hassles of
keeping such operations in-house, they are increasingly trying the separate
fund model. This evolution indicates a change in the way corporations view
business development. No longer a defensive strategy, R&D is a potential
money-maker. But for it to achieve its potential, it has to be outside a
company's normal reporting structure. That's because most public companies
can't stomach the roller-coaster nature of earnings from venture
investments. Consider an average VC's record across all stages from seed
money to mezzanine investments. Typically, 1 of every 10 deals hits a home
run, defined as a return in excess of 50%. Another two or three pay back the
principal investment. And the rest tank. Tank means losing billions over the
life of a fund. If you're a corporate chieftain, try telling that to a bunch
of analysts when you announce your quarterly results. As stakeholders in
independent funds, though, corporations demand and generally get the same
annual returns as traditional VCs: 25% to 30%. And the company rakes in this
profit without having to declare the in-between losses from the bum
investments.
BUDGET BLIP. Even in arms-length venture funds, corporations tend to be more
cautious than VCs, going for doubles and triples rather than for home runs.
It's a strategy that keeps the corporate brand name sparkling. "If a
traditional VC has a 1 in 10 hit rate [for seed capital investments], ours
is probably the reverse," says Michael Pralle, president and CEO of GE
Equity. The $1.3 billion fund has just announced that it'll throw $50
million into seed capital in Europe. Avoiding conflicts over strategic fits
is another reason to spin off a venture subsidiary. AT&T Ventures started in
1991 as a blip in the budget. "We put money in small companies that we
thought might be important to us in the future," says Bodman. As time went
on, it became apparent that the fund was at a disadvantage as a department
of AT&T. Entrepreneurs and independent VCs weren't thrilled about having
AT&T in their deal. "If your motive is not simply greed, nobody trusts you,"
Bodman adds. "People want to know that if I'm on the board of a company, the
only way I'll get rich is if they get rich. They don't want me pushing some
AT&T agenda."
Conflicts over pay for fund managers is another reason to create a separate
venture unit. A corporate venture-fund manager might earn $400,000 a year
with bonuses. Partners in independent VC firms make three times as much
because they can keep a carried interest in deals -- options on the future
equity of the venture.
MANAGEMENT BUY-IN. At GE Equity, this gave rise to a battle between the
venture guys and Chairman Jack Welch. While Welch had no problem cashing in
$31 million worth of GE stock options last year, there's a perception among
some within GE that he's less keen on venture managers making really big
money. GE declines to comment on the subject. At least Welch believes in GE
Equity. Top management buy-in is crucial to any corporate venture-capital
effort. Getting and keeping such a commitment can be a big question mark for
corporate venture funds, which understand that if the economy sours and
management starts looking for things to dump they can disappear. "We
believe we've found a solution that works, but AT&T might have a shift in
strategy," notes Bodman. "A corporate venture-capital program that has
lasted more than 10 years is hard to find." The best plan, it seems, is to
produce a superb track record -- and put faith in the idea that the fit will
survive.