Corporate venture capital: Chapter 2 (Corporate Dealmaker)

Corporate venture capital: Chapter 2

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It wouldn't have seemed so surprising if Motorola Inc. had lost interest in venture capital investing in 2001. That was the year the mobile communications company reported a $3.9 billion net loss and reduced its work force of 150,000 by nearly a third. Plenty of big companies were beating an ignominious retreat from corporate VC amidst the great tech bust. But at Motorola, which formed its venture unit in 1999, that wasn't what happened. "Motorola has never pulled the checkbook back from us, despite some of the challenging years we've faced here," says Warren Holtsberg, co-founder of Motorola Ventures and corporate vice president for equity investing.

On the contrary: The only reason Holtsberg's team slowed its $100 million-a-year investment pace was a temporary dearth of compelling strategic investments. The market had slowed, but Motorola's conviction that it needed to tap external sources of innovation to keep pace hadn't wavered. That conviction strengthened in early 2004 when Motorola got a new CEO in the person of Ed Zander, whose résumé includes five years as president of venture-backed Sun Microsystems Inc. and a stint at private equity firm Silver Lake Partners. "Ed has a deep appreciation of the value of VC," Holtsberg says. The result, he says, is a re-energized VC program that will likely invest more than $100 million this year amidst a strong turnaround for Motorola. "We have a very clear purpose to be even more aggressive going forward," Holtsberg says.

Motorola isn't the only company thinking that way. Corporate venture capital investing actually showed an uptick last year, the first such increase in three years, and there's also some evidence that the number of dollars invested is no longer the only way to gauge corporate engagement with the venture world. Meanwhile, as some companies continue to pull back from corporate VC (Dell Inc., for example, recently sold off most of its venture portfolio) others, such as chipmaker Xilinx Inc. and biotech giant Amgen Inc., are getting in. There are other signs of interest as well. Last year the National Venture Capital Association formed a corporate venture capital group that now has around 50 members, including IBM Corp., Eastman Chemical Co., Procter & Gamble Co., United Parcel Service Inc., Visa International, Microsoft Corp. and many other familiar names. In Silicon Valley, another group of 59 corporate venturers have turned the best-practice-sharing and networking meetings they've been holding for the past year and a half into a formal group called the Strategic Venture Association. Members include Honda Motor Co. Ltd., Applied Materials Inc. and BT Group plc.

So are these the beginnings of another great wave of corporate VC, like the one that saw corporate venturers invest - OK, maybe "spend" is a better word - nearly $17 billion in 2000? Unlikely. It's true that venture capital activity runs in cycles. But the signs are that this cycle of corporate venture capital will have some important differences from the last one. You might call it Corporate Venture Capital, Chapter 2.

Not that everybody is on exactly the same page. Every corporate venturer (there may be 400 in the world, according to one informed estimate) has its own story. There are the deans of the discipline, most notably Intel Capital, the powerhouse that has invested billions in companies that increase demand for Intel Corp.'s products since 1991; Johnson & Johnson Development Corp., serving as the healthcare giant's window on biotech and other fields since 1973; and Cisco Systems Inc.'s VC arm, known for linking its work with the company's acquisition strategy. There are the many corporate venturers who entered the field in the late 1990s and have since changed their focus, such as Cargill Ventures, VC unit of the privately held food ingredients giant. That operation started life in 1999 as Cargill e-Ventures, with 25 employees and plans for half a dozen vertical business-to-business plays; it subsequently dropped the "e," reduced staff and broadened its investment scope. There are lower-key groups, such as the 2-year-old, three-person shop at Honda Research Institute USA Inc., based in Silicon Valley and closely linked to the company's R&D operation. And then there's mammoth IBM, which arrived on the venture scene in a major way only last year, with its own distinct ideas about strategic interactions with the VC community.

But some trends are coming into view. The most fundamental is a tighter coupling of venture activities with research and development and strategy, as companies in multiple industries migrate toward a so-called open-innovation model (see Corporate Dealmaker, winter 2005). Motorola is a case in point. Known for pioneering mobile communications but also for losing its lead by being too internally focused, the company still has an internal R&D budget that tops $3 billion a year. But it also has a better appreciation of the help that outsiders can provide in getting products to market faster and more cheaply. "It's not a matter of doing everything yourself," Holtsberg says. "You don't have to do that anymore." Monitoring technological developments outside the company walls has always been a key rationale for corporate venturing. Now, however, participating in and even influencing those developments is more often the main motivation, even as more financially oriented CVCs (Dell was one) end or reorient their programs.

Corporate-startup links strengthen
The proportion of venture-funded startups receiving some corporate investment is back above the 1998 level.
Year	Total companies funded by VC industry	Number of companies receiveing an investment from CVC
1998	3,000	495
1999	4,469	1,164
2000	6,410	1,969
2001	3,840	957
2002	2,579	533
2003	2,359	425
2004	2,403	472

Smaller investments, but more investing
The average amount invested by CVC groups has continued to fall - even as the overall number of CVC deals inches back up.
Year	Average amount invested by CVC groups ($mill.)	Number of CVC deals
1998	$3.2	535
1999	6.3	1,327
2000	7.9	2,155
2001	4.9	1,015
2002	3.4	570
2003	2.8	449
2004	2.6	518
Source: PricewaterhouseCoopers/ Thomson Venture Economics/ National Venture Capital Association MoneyTree Survey

Also coming into sharper focus, though, are many of the same issues that have made corporate venturing a challenge all along. How do you manage the inherent tension between financial and strategic goals? How do you show the CEO that those strategic benefits you're touting are real? How do you connect with your company colleagues in such a way that business units and researchers stop rejecting outside ideas and start helping you find them? How do you compensate your corporate venture team in such a way that they don't decamp for a VC firm but also don't out-earn the CEO?

Last and surely not least there's the cultural chasm between corporates and the venture community - bridged in places, but still present, thanks in part to the lack of staying power shown by so many CVCs. "Today there's a bias against working with corporates," says Bob Ackerman, managing director and co-founder of VC firm Allegis Capital, who argues that a good way for a company to access the clubby VC world is by investing in his funds, as indeed many blue-chip companies do.

There is, come to think of it, something slightly paradoxical about the very premise of corporate venture capital - big, established companies making common cause with small, disruptive ones and their backers. Tensions over conflicting interests are never entirely absent. At the same time, however, there are forces pulling the two sides together.

On the corporate side there's that hunger for innovation. On the venture side, a rational initial public offering market means that VCs are more likely to cash out of their investments by selling to a strategic buyer than to the public; M&A accounted for more than half of the $26 billion exiting venture investors took in last year, the NVCA reports. Another factor, regularly stressed by corporate venturers eager for partners, is the access to global distribution channels and far-flung customers that many startups now must think about almost from their inception. And it might even be the case that both sides have learned something since those few crazy years when VCs sometimes got too greedy even to partner with each other. "During the heyday, people on both sides were arrogant and doing stupid things. Syndication was kind of a dirty word," says Alex Komoroske, principal-strategic venturing at Honda Research Institute and a board member of the new Strategic Venture Association. "Now very few people would think about going it alone. And syndication very often involves corporate."

So how are the paradoxes being sorted out? As you'd expect: company by company and situation by situation. Start with the reconciliation of financial and strategic goals. The majority of corporate venturers take direct stakes in startups (participating in VC-managed funds only selectively) and expect to make money doing so. "The corporate venture capital program is vulnerable if it's losing money," says Mark Klopp, until recently head of the VC unit at Eastman Chemical and now a partner with Bell-Mason Group as well as chairman of the NVCA corporate venture group. "The venture that you're partnering with and have invested in won't be able to help you strategically if it's struggling or shutting down." Jim Sayre, president of Cargill Ventures, points out that the reverse is also true. "We're not going to be financially successful if we make investments in things we don't have insights on," he says.

But here comes IBM with a different view. "The corporation does not look at the financial return as a critical measurement for the venture team," says Claudia Fan Munce, who has managed IBM Venture Capital Group since last year. In fact, after testing the VC waters for some time, IBM moved decisively last year to position venturing as part of its strategy organization. Fan Munce, who was previously head of business development for IBM Research, reports to senior vice president J. Bruce Harreld, the corporate strategy chief.

Fan Munce notes that the financial return obviously needs to be "somewhat positive." But the point is that IBM has chosen to downplay its financial relationship with the venture world while at the same time promoting the other things it can offer a startup - starting with a view of its own strategies and how a young company might prosper by working with them. The investing it does is mainly through VC funds; Fan Munce says the company has relationships with about 50 but hasn't invested in all of those. "Helping venture capitalists build tomorrow's market leaders" is the slogan.

Much of the work is focused inward at IBM and aimed at answering the question: What do we need to go outside for? The company's on-demand strategy is predicated on open systems and integration, on a consulting business that helps customers solve specific business problems rather than just selling them technology. Yet IBM itself is no longer in the application business. "We have a very large need for business partners," Fan Munce says. With the partnership needs identified, the process is one of working through the venture community to identify and ultimately partner with candidates within a given field - anything from fleet management in the transportation industry, say, to high-content screening in life sciences. Thus a couple of strategic relationships that IBM likes to cite are with Beijing Lingtu Software Co. Ltd., which does the former, and Cellomics Inc., which does the latter - both, needless to say, on IBM platforms.

Does IBM's great size and sweeping strategy mean that its approach to VC is suitable mainly for itself? Fan Munce doesn't think so. "I think there definitely is a trend for corporate venture capital to migrate towards our model," she says. It's worth noting that Hewlett-Packard Co., for one, has reportedly moved in a similar direction. In an interview with Dow Jones News published in late February, George Dies, HP's director of strategy and corporate development, said that the company had stopped making VC investments about a year and a half ago, choosing instead to emphasize interaction with venture capitalists and outright acquisitions of startups (another tactic favored by IBM).

And in fact, the strategic emphasis at IBM may be more a difference of degree than of kind. Motorola's Holtsberg says his venture portfolio, which currently contains stakes in about 70 companies (he uses venture funds mainly for areas his team can't cover) has been profitable almost from day one: "I say if it's not financially attractive it's ultimately not very strategic." But he's also quick to stress the strategic benefits Motorola has reaped from investments such as the one his team made in MeshNetworks Inc., an ad hoc networking company Motorola subsequently acquired. Given Motorola's strategy of promoting "seamless mobility," the deal was an important one.

Of course, the riddle of how to help outsiders forge those strategic connections with the relevant part of a large company is another of the great, semi-answered questions of corporate venturing. Forget about the not-invented-here syndrome. CVC folks are more likely to gripe about "corporate antibodies" - indicating, maybe, a more active opposition to all those great new ideas and partners they're charged with bringing into their companies.

The good news is that at the companies that have been venturing for a while, the antibodies abate. That has been the case at Motorola. "The concept at the outset of bringing a small startup and its technology inside a powerhouse like Motorola was not openly embraced by everyone," Holtsberg says. "But as the capability to add value has been proven over six years, the relationships have become more broad and embraced by all the businesses."

Cargill Ventures

Launched: 1999

Led by: Jim Sayre, president, Cargill Ventures

Team and locations: Eight professionals in Minneapolis and San Mateo, Calif.

Investment program: Expects to invest about $30 million this year in early-stage companies in two categories: IT and emerging technologies in healthcare and nutrition, biotechnology and industry. A portfolio company in IT is Outsource Partners International Inc., now becoming a service provider to Cargill business units. In emerging technologies, EcoSynthetix Inc. turns cornstarch (which Cargill produces) into high-performance adhesives and resins.

The new leadership at Motorola has certainly encouraged the embrace. Along with CEO Zander, the top team includes chief strategy officer Richard Nottenburg, a Ph.D. electrical engineer turned entrepreneur (he started and sold Multilink Technology Corp.) who is Holtsberg's boss. Like Zander, who placed him in the strategy job in September, Nottenburg believes in corporate venture capital. So do the chiefs of the four business units (personal devices; networks; government and enterprise; and connected home) into which Zander reorganized the company in December. "We have four very aggressive individuals who have a strong appreciation for speed to market and the importance of meeting customer demand as rapidly as possible," Holtsberg says. "And if we can do that with internal technology and research, then that's great. But if we can't, then there should be no hesitancy to seek smart outside investments and partnerships."

Coordinating all that collaboration at a company of Motorola's size ($31.3 billion in 2004 revenue and, in a sign of restored vigor, $1.5 billion in net profit) requires special structures. One of these is the Equity Investment Board, chaired by Holtsberg, who as the company's head of equity investing oversees not just venture investments but the stakes taken by business units in years past, which currently number about 135 and are being sold off at a rate of 30 or so a year. Joining Holtsberg at the monthly meetings of the board are CSO Nottenburg, corporate development chief Donald McLellan, chief technology officer Padmasree Warrior and chief financial officer David Devonshire.

Holtsberg also sits on the Motorola Innovation Board. That one is led by CTO Warrior, includes the business unit leaders and spends its time reviewing internal investment opportunities identified by an early-stage accelerator program started a year ago to build businesses from inside technology.

Motorola's boards are working well so far, but that's not to say they'd work everywhere. The problem of linking a central venturing operation with the other parts of an organization is one that each company has to solve for itself. At Wayzata, Minn.-based Cargill, for example, a different set of issues comes into play.

Though larger than Motorola at $60 billion in revenue, Cargill has a smaller venture unit, one that will have made about eight investments, totaling about $30 million, in the year ending in May. With deep roots in agribusiness and a culture shaped by its 140-year history as a privately owned company, Cargill has more than 90 business units, organized into a dozen platforms. Where does the venture unit fit in? "We used to be more closely associated with the more straight-up financial units," venture chief Sayre explains. But most of the financial activities were spun out in 2003 as a firm called Black River Asset Management LLC. "As a result," he says, "we are now clustered in a group of technology-oriented earlier-stage business units."

That reorganization has broadened the venture group's base in the far-flung company. So did the earlier expansion of its mission, from investing in information technology (where the company has expertise as a global organization) into emerging technologies in healthcare, nutrition and other fields. "It's been an evolution," Sayre says. "I think our linkage has worked well because of a couple of things. We've been very explicit about how the ventures activity is a business, making investments and getting attractive returns. We're very clear about that, so we don't become the business development arm of different business units."

But at Cargill, too, the strategic ties are important. "We're trying to make what I call second order of relevance investments," Sayre says. These are technologies that are very interesting to Cargill. "But they're not on the business unit 24-month development track," Sayre says. "And they have a higher risk profile than what a core business unit would have an appetite for."

Different companies, different kinds of links between startups and business units. But here's a problem that all the corporate venturers share to some degree: How do you demonstrate that those strategic links are actually helping the company execute its strategy? Honda's Komoroske says the subject is one of enduring interest at meetings of the Strategic Venture Association. "What you'd really like to show is that you developed a product through a venturing relationship that allowed you to take a big market share that you wouldn't have had otherwise," he says. "But it's awfully hard to measure those things. And they generally don't happen in short time frames."

The wacky idea that new companies can be grown (and sold) quickly was, of course, the delusion that led to the boom and bust in all kinds of venture capital just a few years ago. Holtsberg, for one, thinks the VC community has rediscovered its patience. "I think there's a new sobriety in terms of doing this the right way and taking time to build companies that can stand on their own," he says. Assuming the sobriety lasts, it is all to the good. But for corporate venturers wanting to demonstrate the strategic impact of their work it raises some key questions: How patient is the CEO willing to be? How engaged are the organization's top managers in the partnerships the CVC team puts in place?

At IBM, Fan Munce describes a huge cultural shift, years in the making, away from exclusive reliance on an R&D organization whose budget now totals $5 billion a year. IBM wants to work with the VC community to continue that shift, and as a mark of its commitment cites CEO Sam Palmisano's willingness to meet with the VCs. She also describes a recent meeting in Shanghai where the global heads of IBM's digital media and pervasive computing businesses got together with her, IBM's general manager for China and 40 Asian venture capitalists. "They all sat down for a day and talked about the spaces where we need partners," she says. "We want to engage as early as we can, because that's when the better integrations happen."

If those meetings bear fruit, the business managers presumably won't need to be persuaded of the strategic value of the relationships. Similarly, Holtsberg (who not coincidentally is also on the move in China, shifting his regional office from Hong Kong to Beijing) has as his ultimate metric not the financial returns but the judgment of top management and the business unit leaders that his team's strategic contribution is real.

At both these organizations, and also at Cargill and at nearly every other company that has decided that it has to find a way to make corporate venturing work, the changes involved are very large. So much happened so fast in corporate venture capital that it's sometimes easy to forget how young the field really is. CD

IBM Venture Capital Group

Launched: Current setup created 2004

Led by: Claudia Fan Munce, managing director and vice president

Team and locations: Core group of seven in Menlo Park, Calif., and New York. Other IBM execs around world devote part of their time to VC work as well.

Investment program: Direct investments in startups largely ceased with reorganization last year. Works through some 50 VC firms to promote the growth of startups that will further the acceptance of IBM's standards and architectures. For example, in 2001, IBM helped VCs to hone business plan of SuSE Linux AG, a Linux software and services company, before a round of funding.

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