Corporations continue to look to innovation to increase value and expand capabilities. Traditionally, corporations focused on internal research and development (“R&D”) and acquisitions of strategic targets. Yet, innovation through R&D can have its limitations as it is funded internally and can be restricted by internal policies and procedures that may hinder innovation. Innovation through acquisition also has its risks, as the purchaser may not identify all of the potential issues of the target when conducting its due diligence. A purchaser may also face issues when attempting to integrate the target into its existing business—particularly when the purchaser is a multinational corporation and the target is an emerging company.
To address these concerns, corporations have increasingly looked to establish a corporate venture capital (“CVC”) program to support and complement their innovation strategies and outsource strategic alignments to stay competitive. Corporations that have established a CVC program can gain invaluable market intelligence, as well as invest in and understand future acquisition targets. For emerging companies and start-ups, CVC programs offer funding as with traditional venture capital funds but can also provide such companies with market and development support. CVC programs can also form alliances with emerging companies that may be potential customers or strategic partners.
Corporate Venture Capital Programs Defined
CVC, a subset of and different from traditional venture capital, is the investment of corporate funds directly into emerging companies. CVC programs allow companies to gain insight and access to new markets, trends, and technologies.
The term CVC both broadly captures strategic investments made by large and established corporations in emerging companies and also more narrowly refers to investments that a corporation makes through a related CVC arm dedicated to sourcing and making investments in start-ups, rather than through direct strategic investments.
Objectives of a CVC Program
CVC programs are similar to traditional venture capital funds in that the goal is to invest in emerging high-growth companies that drive value back to the company. Both CVC programs and traditional venture capital funds are driven by financial returns.
However, CVC programs, once known as strategic investments, also strive to advance the company’s strategic objectives. In addition to financial returns, the other goals of a CVC program could be to (i) identify and capitalize on synergies between the corporation and emerging company, (ii) develop the corporation’s technology, (iii) acquire the emerging company’s technology, and/or (iv) create commercial partnerships.
For the emerging company, and in addition to funding, a CVC program can offer (i) access to resources, (ii) access to customers, (iii) market knowledge, (iv) brand validation, and (v) wider networks.
As such, CVC programs may look to invest in emerging companies that operate in the same or complementary industries.
Choosing a Legal Structure
A CVC program’s strategic and financial objectives will inform how closely the program will coordinate with the corporation’s current operations—that is, its legal structure. There are three main types of legal structures for CVC programs: limited partnerships, investment via an affiliate, and fully integrated programs. Many factors should be considered when establishing the appropriate structure for a CVC program, including tax considerations. These considerations are beyond the scope of this article.
1. Limited Partnerships
A CVC program can be structured as a limited partnership operating as a separate legal entity from the parent company. A limited partnership is made up of at least one general partner (“GP”) and one limited partner (“LP”). In any partnership, the GP or GPs manage the partnership. CVC programs may utilize this model of investment in two ways. First, they may look to form an independent limited partnership. Second, they may invest in a venture capital fund as a limited partner.
(a) Formation of a Limited Partnership
A corporation may look to form an independent limited partnership in which the parent company is the sole LP and a separate entity is incorporated that is the GP. Under this approach, the corporation can set the investment criteria and strategic direction of the limited partnership. This means that the CVC program can be focused on investing in portfolio companies that directly benefit the corporation. This approach can offer tax advantages, but these are beyond the scope of this article. The disadvantage is that this approach requires substantial capital investment for the corporation, and conflicts may still exist between the parent company and the investment arm.
(b) Investment as a Limited Partner
Alternatively, the corporation can invest as a limited partner in one or more independent venture capital funds. By joining as a limited partner, the corporation has quick and easy access to deal flow, invests in areas farther away from the corporation’s core business, and relies on the venture capital fund to make investment decisions. However, this structure also means limited influence and autonomy on the investments and fewer strategic incentives for the corporation. In addition, the CVC program will have limited access to information relating to the day-to-day operations of the portfolio companies.
2. Investment via an Affiliate
A CVC program may also be structured as an affiliated legal entity of the corporation or a separate business unit within the corporation. Under this approach, the day-to-day management of the CVC program can be separated from the other aspects of the corporation as the CVC program can be managed independently from the rest of the operations of the business. As such, the investment selection and decisions can be separated from the parent company. Typically, the parent company will have oversight over certain decisions by way of an executive committee.
3. Fully Integrated CVC Programs
A corporation can also form a CVC program internally, where the investment team consists of company employees. Under this structure, a specific investment department or business unit oversees and approves each investment. As this is an in-house CVC program, investments made are generally closely related to the business divisions of the parent company.