Corporate venture capital (CVC) units have become an important factor for the financing of start-ups – not only in Germany, but also in Europe and around the world. According to data service provider CB Insights, CVC’s investment volume in Europe last year was around USD 5.5 billion. And even if the investment branches of the corporate groups increasingly act like classic venture capital companies, there are a few special features which need to be taken into account when it comes to investments.
Which legal concerns do start-ups, but also established companies, have when it comes to a cooperation structured as a CVC?
During almost the last 20 years, in which corporate venture capital (CVC) has been on the market, the concerns have been the same one, but there is a more practical perception of CVC today. On the part of start-ups, other venture capitalists are usually already shareholders when a corporate investor joins the company. Often there is a concern that a deep-pocketed corporate investor joins the start-up with exclusively strategic interests while not being interested in making profits within a limited timeframe, i.e. seeking an exit at the highest possible valuation. The question is then: Am I, as a founder or shareholder, still able to profitably sell the company to a third party in the future upon the entry of a CVC? The question as to whether the strategist could block a possible future Financing round without prior approval also comes up repeatedly. Another concern is whether the investment will enable the CVC to access to the start-up’s technology and whether it will then be able to use it itself.
In your experience, how well are start-ups positioned when it comes to protecting their know-how from a possible outflow to invested companies?
Generally not well positioned. This is because approximately 90% of all the start-ups in Germany are structured as companies with limited liability (GmbH). If a CVC now joins the company, it usually does so by acquiring shareholdings under the law on limited companies (GmbH Gesetz) and thus has a full statutory information Right vis-à-vis the company. Therefore, as a start-up company one should make accommodations, as far as possible, to restrict information access by means of contractual regulations. In many cases, start-ups do not even perceive this as a possible threat, instead they are mainly concerned about exploiting synergies with the group and about further developments of their own product.
Are the aforementioned concerns shared or dispelled by the classic venture capital companies?
Things have changed a little bit over time. My first experience in this context was made during a very exciting case almost eleven years ago. At this time, there were already major concerns about the strategies of classic venture capital investors. The consistently positive experiences of recent years have almost completely dispelled These reservations. However, financial investors are very careful to ensure that their own freedom of movement is guaranteed at the relevant points.
Which legal structures of cooperation do you currently see in addition to participation?
At the end of the day, about 80% of the legal structures consist of the subscription for a shareholding under German company law. In this context, direct equity participation, debt financing – usually linked to a cooperation or Joint venture agreement – as well as incubator or accelerator programs are often used structures. The latter two, of course, start very early, even before a real business model has been tested. A further model that is still frequently used today is equity investments via Service for Equity or Media for Equity. Here, the CVC provides the start-up company with a service that it offers on the market anyway, instead of merely financing the start-up. In this case, sufficient care must be taken to ensure that both the start-up and the CVC properly book these services for tax and accounting purposes.
A few years ago, there was a real hype about incubators in particular, which has since subsided considerably. In your opinion, how professional are corporate groups today with regard to their investment decisions?
Of course, there is a wide range here. Many decisions are undoubtedly influenced by trends or fears of missing out on something. However, my impression, is that those who have constantly invested in start-ups over the course of the years have now a very professional set-up. These companies don’t see their investments through the lense of giving support but pursue a very concrete agenda based on self-interest. Personally, I also don’t see any real added value for the corporations regarding the incubator and accelerator programs unless a real business model is financed from the outset. If this is not the case, the economic output for corporates will not be particularly yielding. In my opinion, the groups, which have set up their own investment company including investment team and which scrutinize individual investments case by case are highly professional and are perceived in the market as complementary offerings.
Could these professional structures lead to the CVC activities being continued even in the event of an economic downturn or a financial crisis – in other words, could they be saved from the fate which start-ups suffered in the beginning of the 2000s?
Many of the groups which sold their portfolios 10 to 15 years ago are now active again in the corporate venture capital field. I believe that hardly any large company will commit again the mistake of divesting its start-up Portfolio on the basis of a strategy shift or something similar. How seriously the matter of corporate venture capital is taken can also be proven in the professionals employed with CVCs. It is by no means the case that only employees from the parent company work for the CVC units. Many investment professionals regularly work for CVCs, who are usually incentivised in line with market practice and they are thus naturally also motivated to make good and profitable investments.
Change of topic – takeovers: How should start-ups and established companies “position” themselves in order to avoid any complications when affiliating with the group?
This is a quite critical point, since entrepreneurial freedom is very important for start-ups so that they can develop dynamically. In my opinion, however, this usually works quite well in practice, as the start-ups are generally not integrated into the group – even if certain compliance issues cannot be completely ignored. However, start-ups usually get acquainted with certain “hygienic regulations” during the investment period of a corporate venture capital investor. CVCs expect decent reporting, a reasonable annual financial statement and proper accounting. In many cases, the CVC effects with its investment a certain new kind of discipline in these young companies, which have often primarily focused on promoting their business idea or product.
Classic venture capital investors also demand reporting from their start-ups. What are the differences between the classic venture capital investors and CVCs?
There is hardly any difference between them with regard to reporting. The classic venture capital investor demands reporting based on a different interest, i.e. being able to consistently evaluate its portfolio and report it himself to ist limited partners. Where I see quite some differences is in the hard enforcement of this issue. A CVC insists very formally on reporting, whereas a classic venture capital investor has a little more headroom for manoeuvres. CVC units are forced by their group controlling to make certain disclosures – they pass this pressure straight on downwards.
This article was first published in: VentureCapitalMagazin, Corporates & Start-ups 2019, p. 14/15
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