Updated: Jan 24, 2019
The number of active Corporate Venture Capital (CVC) unit’s in South East Asia has increased a lot in the past few years. Not only has the number grown but the new CVC units are more active so there are a lot more deals done where CVC’s are involved. This is in line with a global trend where big companies actively engage with startups as a strategy to stay competitive. As the pace of innovation increases and industry after industry is disrupted this strategy becomes more and more relevant.
For regional startups this means that Corporate Venture Capital is becoming a much more available source of capital. So any startups currently fundraising should take this into consideration.
Given that the growth of Corporate Venture Capital in South East Asia is a relative new phenomenon many times there is a lack of experience on both sides of the table. This could lead to misunderstandings. In order to be prepared and increase the likelihood of success here are five things all startups should know about Corporate Venture Capital.
1 Understand the motivation of Corporate Venture units Financial VCs motivation for investing in startups is pretty straight forward – they are looking for financial return. Negotiating with financial VCs can still be challenging but at least when startups know their objective it is easier to find compromises and drive negotiations forward. With Corporate Venture Capital identifying their objective can be a bit more challenging.
At one end of the scale you have Corporate Venture unit’s that operate almost entirely as financial VC’s and have financial returns as their main goal. On the other end of the scale you have CVC units that aim to produce strategic value for the parent company. Their measure of success is how well their investments help to improve business in the parent company. Most CVC funds have a mandate that incorporate both financial and strategic goals but it may be tricky to identify just how much weight they place on each of these goals.
To make things even trickier a CVC unit can have a portfolio consisting of both strategic and financial investments. An investment can even start out as a strategic investment but shift to a financial investment if it turns out the fit with the parent company is not as good as initially anticipated.
This can makes it challenging for startups to know exactly what objective the CVC unit has. So it is important to spend some time initially to learn more about the CVC unit’s position and mandate from the parent company and how they view this particular investment.
2 Financial vs Strategic investor
A financial investor, whether it is a financial VC or a CVC, have no desire to run the companies they invest in. They may sit on the board and help with strategic decisions. Some may even offer help with things like recruitment, legal or accounting. However the day-to-day running of the company is left to the founder(s).
This is different for strategic investors. They invest in companies where they see synergies with their parent company. So they may want a say in how to develop the product, which customers to target, which geographies to target and so on. Some entrepreneurs may get surprised and suspicious when a potential investor has very specific opinions about things like this. However they should keep in mind that a strategic investor does this in order to make it easier for the startup to be integrated with the parent company through a partnership or acquisition later. In other words; they are guiding the startup to build the product or service that has the most value to their parent company.
There is nothing wrong with this, however the startup has to carefully manage this relationship so that they listen to the input but at the same time don’t build something that is so specialized there is only one potential acquirer. If the startup manages to balance the requests from the CVC with their over all strategy this will be a win-win for both parties.
3 Align business collaboration goals
In addition to funding many CVC’s provide their investments the opportunity to partner with their parent company. The parent company could become a pilot customer or they could enter into a partnership on sales or marketing or some other form of collaboration. Partnering with a large company is a big validation for the startup so this can be a major part of their consideration when taking an investment from a CVC.
Misalignment of expectations around how quickly and how comprehensive a partnership will be is one of the most frequent issues that surface in the relationship between startups, CVC’s and their parent company. Many startups make the assumption that because the CVC is willing to invest a lot of money into their company then surely they will also provide the other help the startup needs. It is also natural to leave most of this discussion until after the parties have agreed on the investment. As a result the parties might have very different expectations on how the business partnership should play out when they agree on the investment.
Startups are used to getting things done really quickly. A lot of startups subscribe to the popular idea of lean startup. A bit simplified this idea states that you should get your product in front of customers as early as possible so that you can learn what customers think and start improving. For a startup this approach makes sense. Startups have limited funds and they have to make as much of an impact as they can quickly in order to make money or raise the next round of funding. Failing to do so means they go out of business. Basically a startup has everything to gain and very little to lose by launching early. A big company has a different approach to this. They already have customers and revenues. As a result one of their main priorities is to keep these customers happy. Launching a new products or services too early will almost certainly result in more frustrated customers and more complaints thus it runs contrary to their goal of keeping their customers happy. Because of this, big companies usually require rigorous testing and planning before anything new is introduced to their customers. This is almost the exact opposite approach to what startups have. In order to bridge this gap and give the partnership the best possible chances of success both sides should come together to outline their shared expectations. This should happen in parallel with investment discussions.
4 Understand the CVCs investment process
Ideally the investment process for a CVC should not take more time than a financial VC. Given that CVC’s compete with financial VC’s for deals they really can’t afford to linger on important things. CVC units often rely on the parent company for support in various non-core areas like legal or finance. Unfortunately this sometimes means that things take more time.
For example the CVC's finances could be handled by the parent company’s finance department. These are the people that have a 60-90 days processing time on a regular invoice. An investment is a non-standard transfer of a significant amount so this might even trigger additional safety procedures like the personal signature of the finance manager or CEO (which happen be on a two week holiday when your investment is being processed). This kinds of delays can cause a lot of frustration with startups that are in a hurry to complete the investment and can't understand why things are taking so long.
To avoid this kind of delays, or at least prepare for it, startups should ask the CVC about their investment process. They should clarify the internal steps the CVC needs to take in order to decide on the investment, complete the paperwork and transfer funds. If any one of these steps seem to take unnecessarily long startups should raise the issue early and ask if there is any way the CVC can expedite this.
5. End game scenarios So a CVC invested in your startup because it had strategic interest for the parent company. The intentions on both sides were for the parent company to acquire your startup when the product and market matured in a couple of years’ time. Everything looked good. But then something changed. Perhaps your product didn’t perform as well as they had hoped. Perhaps the parent company changed focus and is no longer interested in the market your startup serve. For some reason the acquisition is not happening. Now what?
For a CVC with a financial focus one potential acquirer falling away should just be a bump in the road, even if it happens to be their parent company. They would still want to assist you to find other potential acquirers so that they can maximize their return. For a strategic CVC it might be a bit different. If their overwriting goal is to provide value for the parent company and your company no longer does that than your startup can't help them reach their goal. So where does that leave you?
It is important to understand what the CVC will do in a situation where things do not go according to plan. Ideally they should be able to give you examples of investments where the collaboration with the parent company didn’t go as planned but where they helped the startup to find good solution anyway.
Final thoughts When reading this it may be easy to think that raising funds from a CVC unit is a lot more hassle than a financial VC. It is true that you have to put in more effort during the negotiation phase to get to know your CVC investor but this is because a CVC may bring a lot more value to the table than a financial VC. So to wrap this up I would just like to quickly mention five reasons why you might want to invest that extra time to get a CVC investor: - CVC’s and their parent company probably understand your business and industry better than any financial VC. - In addition to the investment CVC’s and their parent company can offer access to network and resources that can be more valuable than the investment itself. - CVC’s may see synergies with the parent company’s business which can lead them to see less risk and more value in your company thus they might agree to a higher valuation. - CVC’s are usually more patient than financial VCs because they don’t have LP and a fixed fund life. - CVC’s can offer a route to acquisition so that founders have to worry less about fundraising and can focus more on building their business. Looking at some of the advantages CVC's offer and it is clear that the resent emergence of more CVC units in South East Asia represents exciting new opportunities for regional startups. CVC might not be the right path for all startups but for many it is definitely something to consider. Founders who understand how CVCs operate will be much more likely identify the right CVC partner and have a successful collaboration. Next week I will dive deeper into other aspects of CVC in South East Asia. Stay tuned! Have a great weekend! Cato