As traditional venture capital funding dries up, should your startup consider corporate VC?

Startups have long relied on three primary funding sources: venture capital, angel investors and the family office. But in recent times, corporate venture capital, whose roots can be traced to the early 20th century in the U.S., have taken hold as a popular fourth funding option.

Corporate venture capital-backed investments have swelled to represent over 20% of total venture capital value, a February 2022 Bain & Company analysis found. And as talk of a global recession grew louder in the second quarter, while the market dropped, CVCs were still investing at levels that were higher than any quarter before 2021, according to CB Insights. 

“The natural instinct when the economy becomes more challenging is to become more defensive, but investing in innovation can give corporations an advantage during a crisis,” BDO Corporate Finance Manager Matthew Gilmour told Pitchbook.

Making sense of CVC: the parent company’s side

Corporate venture capital, which is sometimes also referred to as corporate venturing, refers to the practice of larger, more established companies directly investing funds into external startups. Teaming up with small, innovative startups on a project allows the venturing company to create value through synergy.

For example, the CVC may aim to boost sales and profits for the larger company, or it may enable them to access new technologies, skills and resources, or to enter new markets. The venturing company may be in pursuit of a strategic advantage or early involvement in promising, cutting-edge businesses that may one day pose a threat to established market leaders.

As opposed to traditional VC investments, CVC deals directly with entrepreneurs and does not involve outside investment firms. Google Ventures, Qualcomm Ventures and Intel Capital are among the most prominent CVC funds today.

Making sense of CVC: the startup side

For startups, there are three primary benefits of receiving a CVC fund investment. First, they attain the potential for acquisition by the venturing company in the future. Second, their credibility with other investment sources is boosted for future capital raises. Third, they receive access to the parent company’s assets, such as advice and infrastructure.

Looking at it from the startup’s perspective, the company gets a chance to launch through a partnership with a larger company coupled with a funding infusion. The arrangement can also help the startup with expansion, to move into broader markets and to manufacture at scale. 

There is no doubt that CVC is a particularly reassuring proposition for startups at a time when the media is abuzz with speculation over a potential collapse of the economy. 

CVCs may focus on different startup phases

Rather than a one-size-fits-all approach, CVCs may invest on startups at varying stages of growth. 

Early-stage funding:

Refers to funding for new businesses that are ready to start up, but that are not yet ready to produce and sell on a large scale.

Seed funding:

Refers to the initial money used to cover the costs of starting up and to attract venture capitalists. Small amounts of financing are typically provided in exchange for a partial ownership position in the company.

Expansion financing:

Refers to capital offered to startups expanding via the introduction of new items, expansion of their physical facility, enhancement of products, or marketing.

IPO:

The coveted stage that most CVCs aspire to reach over time. The parent company stands to earn sizable returns by selling their investments when the startup’s stocks are open to the public. Earnings are then earmarked for new ventures.

Mergers and acquisitions:

Refers to financing a startup’s company’s acquisitions via an investment fund and aligning the startup and a complementary business to try and achieve synergy, where the new company is greater than the sum of the two previously separate entities.

Types of CVC by investment goal

CVCs can also be segmented into four categories based on how they prioritize their investments. Startups should consider which type would best fit their needs.

• Strategic CVCs —

Prioritize investments that augment growth for the parent company; best suited for startups needing long-term strategy support.

• Financial CVCs —

Prioritize maximizing their return on investment; best suited for startups mostly in need of financial resources and with potentially little in common with the parent company.

• Hybrid CVCs —

Simultaneously prioritize return on investment and bringing strategic value to the startup; generally, the most desirable category of CVC to startups as they provide resources and support without the demand for a short-term return for the parent company.

• Transitional CVCs —

This category refers to CVCs shifting among the previous three categories; startups considering this category of investment must be mindful that the investor with whom they are communicating now could change quickly.

How startups can assess whether a CVC is the right fit

Most corporate venture capital arms rely on evergreen funds that receive a designated sum at regular intervals. Because their budgets have mostly been established before the economic downturn, CVCs still have ample unallocated capital on hand. 

However, not every CVC will be a good fit for every startup. So, how can entrepreneurs select the best match?

1. Analyze whether the CVC’s investment goal is congruent with your startup’s requirements.

Do you need long-term support, or are you looking primarily for financial support?

2. Assess the relationship between the CVC and its parent firm.

Will it offer the internal resources your startup needs, how will the parent company measure your success, and how well has the CVC communicated its vision throughout the parent?

3. Ascertain the CVC’s expectations and fit in the larger company.

Does the CVC make decisions independently from the parent; how are decisions made in terms of resource allocations for portfolio companies; how long does it hang onto portfolio companies; and what are expectations for exits and outcomes?

4. Talk to multiple people from the CVC and parent company.

Have you talked to key leaders from the CVC and parent company to understand their vision? Can you speak with CEOs from the CVC’s other portfolio firms to identify any hidden issues?

Takeaway

CVCs provide more than funds and advice to startups. They can offer resources beyond the domain of traditional VCs, such as industry expertise, access to potential customers, an ecosystem of products and a stable financial standing. These resources are effectively a type of non-dilutive capital that confers an important competitive advantage for entrepreneurs in an economic downturn.

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