Corporate venture capital (CVC) funds are gaining in popularity as established companies seek a competitive advantage in the marketplace.
“More large public and private companies are investing in startups, frequently with an end goal of making an acquisition,” says Sara Antol, a shareholder at Babst Calland PC.
Smart Business spoke with Antol about the rewards — and challenges — of these investments.
What is the difference between a venture capital fund and a CVC fund?
With a venture capital fund, the fund is formed with the sole purpose of investment and is looking for a positive financial return within a relatively short period of time.
With a CVC fund, an operating company puts funding into a startup, generally in its market space or a space the company wants to enter. It still seeks a financial return, but the investment is more likely strategically driven. The end goal is frequently to eventually acquire the startup, but the CVC fund can hedge its bets by first making an investment.
CVC investors want to know the startup’s strategy and be involved, and they may want a bigger voice than a typical venture fund would expect. The CVC fund generally avoids legal control — it wants the ability to make a difference but not to affect the company’s overall growth curve.
Recent reports have shown that CVC funds have accounted for almost 25 percent of all venture investments in 2020. It could be because technology companies have rebounded during the pandemic, giving them more access to capital. It may be that private equity has pulled back, creating more capacity for CVC investment.
Whatever the reason, it’s becoming more common for forward-thinking companies to make these types of investments as part of their strategy.
What are the challenges of this type of investment?
There can be a struggle between operating a larger business and being a startup. The investing companies have to understand how startups operate and the risks that go with that, without the controls in place that a large corporation will have.
Because of that gap, the investing companies should work with seasoned professionals who understand the ecosystem of startup financing, who can help them navigate the playbook of what their equity investment entitles them to. Larger companies tend to be risk-averse, and they have to understand there is a greater risk of losing their investment in this context. The investment must be small enough that it’s not a game-changer and that they are willing to risk losing it.
In addition, larger companies may face strict regulations on the kinds of investments they can make, and there may be issues with board representation. If the investment is large enough that the investor wants a board seat, it runs the risk of learning something that could benefit its business. You need to be aware of your fiduciary responsibility, and it needs to be very clear what information can be used by the investing company, if any.
How important is due diligence?
It is critical. Even with a very small investment, the larger company can face risks that can seem like a minor issue to the startup but that can have big impacts on the overall compliance of the larger company. It is imperative to do adequate due diligence, and an outside professional can help before you move ahead.
What advice would you give to companies considering a CVC fund-type investment?
Really think through working with another company and what it’s going to mean for the longer term. It can get ugly when a startup fails, so understand what that would mean for the investing company.
The key is to get experienced advisers. If you decide to engage in these types of investments — and more companies are doing so as part of their day-to-day strategy — understand the process and consider what issues it could create for the overall business.
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