Should I take money from CVCs?
The challenging market is putting a spot on investors who are still active like CVCs. But, as this group differs from “regular” VCs, there are various considerations needed to be considered before adding a CVC to your cap table. Unpacking The good, the bad and the ugly of CVC.
TL;DR –
CVC (Corporate Venture Capital) can be a great source of capital in this market, and as they remain quite active it is permanent to consider them as relevant capital allocators.
In this piece we will discuss:
The different shapes and sizes of CVCs, and their effect on their approach and goals
Which things should you assess before trying to raise capital from CVCs?
What should you consider to maximize the value you get?
What should you (try) to avoid and how?
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These days, where one might be wondering how many piles of dry powder are sitting on the sidelines or when they will be back in action, one category of investors is becoming much more meaningful – corporates and their venture arms (namely, CVC – Corporate Venture Capital).
Per the structure of these entities and in many cases their more resilient budgets (will try to back this claim in a second), these guys are still very active in this slower market and it therefore might be helpful to consider when, how, and if, to work with them.
Most traditional VCs have commitments for their capital from LPs. In other words, when you hear that a certain firm raised a X Million $ fund, it doesn’t mean their LPs sent them a check for that amount but rather gave them a contractual commitment to wire funds per specific investment that meet the funds mandate (I,e when the fund “calls the money”). However, as these are contractual commitments and usually a firm hopes to have more commitments from their LPs for future funds, every once and a while (and especially in down markets), LPs would “suggest” the fund management not to call the money. Putting it differently – yes there was a lot of capital that was committed to VCs over the last few years but it is hard to say how much of it is still available.
CVCs on the other hand, are either getting a dedicated budget from the corporate (investing out of the P&L) or have the corporate as an LP. In both cases it isn’t an immune model but there are higher chances of having a more resilient checkbook.
Describing the landscape of CVCs in healthcare is out of scope for this piece (see this great post from Halle Tecco for more information). The goal here is to discuss the nuances that pertain to working with corporates as investors.
Some of the inputs below were taken from a dedicated event on CVCs we held for entrepreneurs as part of our series “Digital Health Dougri (candid in Arabic / Hebrew)”, with Lizzy Goldman, Investor at Samsung Next , Jon Galitzer, Director at Koch Disruptive Technologies, and Or Perluk, Managing Director at Essen Health Care Ventures.
Assessing whatever a CVC is good fit for you as an investor
Yes, they are called “strategic”, but like with other classes of investors, there are many shapes, colors and sizes for CVCs. Therefore, like with any other VC, you should know exactly who you are partnering with and what is the value (positive and negative) you should expect. Before trying to unpack what things to consider, two general pieces of advice are speaking directly with other companies that have partnered with these investors (i.e. doing your DD…) and making sure you interact with the CVC enough time to know them before conversations on the actual investment start.
Is there really a strategic fit? Some CVCs are very clear on the type of companies they want to work with and how they want to work with them (the general theme is companies accretive to specific business units to either augment existing products or create new offerings) and can be transparent about it, while others have broader, sometime less clear focus (either intentionally or unintentionally). For the latter, flowing into the “vision / not near future plans for the corporate” investment bucket might shrink any potential value you may receive.
Check size – some are fast movers with smaller checks (as a foot in the door or as general investment strategy) while other write larger checks and will have a longer process (and yes, some will do smaller checks but still take a lot of time to reach a decision)
Future (additional) investments – ‘traditional VCs usually reserve additional capital for follow on investments. This is not necessarily the case with CVCs. Some have clear criteria about participating in additional financing whereas others are on more of an ad-hoc basis. This is something that should be clarified as early as possible because having a strategic investor not participate in your next round can send a very bad signal, regardless of if it is purely based on the corporate / fund internal issues while the company is actually doing well. There is actually a pretty simple quick and dirty way to assess this part – just look at the CVC’s portfolio and learn what they have done so far.
What does “value add” and day-to-day work look like? One level of value that CVCs can add is industry expertise. Having an investor who can really bring the customer perspective can mean a lot in terms of improving your product and sales motion. Furthermore, some are able to help with promoting or expending the commercial work with the corporate, sometime even with designated BD teams (for example Cigna Ventures and Optum Ventures) that are usually doing both push (offer new solutions internally) and pull (teasing out challenges / unmet needs) work with the corporate business units.
Understand why the CVC interacts with startups - is it to buy later on (“disrupt their business”), is it mainly for partnering (more incremental changes) or is it for learning and perhaps mimicking this play later on (yes, that is also an option). You must be very aware which products the corporate currently has, what additional partnerships exist and if there is a substantial competitive threat from either of them.
Why not? (i.e. check these boxes before moving forward)
Above all, adding a CVC to your cap table inevitably creates a signal to future customers, investors and acquirers. This signal can be very positive but also potentially very negative. The thing is, there are ways to control, at least to some degree, the narrative.
Let’s start with the “worst case scenario(s)”:
CVC has invested in your business. On the very next day a competitor knocks on your door, interested in a wide scale partnership only until they realize their biggest foe is on your board and can (theoretically) gain valuable business intel on them. Deal canceled.
The next day another potential customer knocks on your door. This time they are actually on good terms with “your” CVC and asking for their feedback on the product (“seems like you are excited as you actually invested in the business!”) only to find out they are still not really using the product and actually still have questions. “OK, let’s wait until they use it before we move” or some version of that would probably be the next email you get.
Cash flow isn’t going so well and you need to raise more funds. New investors are doing their diligence, and learn that the strategic, who is actually one of the largest shareholders, won’t participate. “If an internal investor with clear insights as a customer isn’t participating, why should we?”.
Lastly, and even the most devastating option, there is a similar version of this last sentence for a potential acquisition by another corporate. “Corporate X (CVC) is in and not acquiring the company, why should we?”
So, few things worth considering with respect to managing this signal:
General rule of thumb is not taking strategic money if there isn’t already a commercial (i.e. vendor-client) relationship with the mothership. By all means, it doesn’t have to be nationwide deployment, but the CVC should be able to explain why the product is of value for the corporate with real life examples. You need your strategic investor to be a referenceable customer. They need to be proud of using you.
Few more suggestions:
Generally, it would be better to have more than one strategic on your cap table. That way if one of them doesn’t invest in a future round / place a bid to acquire the company it is easier to “put the blame” on their internal issues.
Understand in detail what the CVC’s view / approach is re competitors as customers or potential acquirers. Some CVCs are much more financial investors by nature and thus will be happy to hear your pipeline is expanding. Others will be less friendly.
But beyond that, think about structured ways to hedge this risk. For example, limiting information rights and rights of first refusal (for new investment / acquisition) can help in reducing concerns from potential customer / acquirers who are competitors to your investor.
Remember that if a strategic is a potential acquirer for the company, and the CVC is not / less measured by financial returns (ROI, MOIC, DPI) but on introducing new businesses to the corporate, there is actually a perverse incentive to keep your valuation as low as possible to decrease the future acquisition price. Having multiple strategics on board can mitigate that, as well as limiting the CVC’s ability to price the round.
It is worth mentioning, there is a very positive counterfactual here.
TL;DR – an excited customer turned into investor with a fast and efficient process, other investors are super encouraged, and soon after the company is acquired. Everybody happy.
OK, I’m game! How to start and manage a process?
Gather intel and build your internal network in the corporate and CVC - Behind the commercial relationship and like with other classes of investors, getting to know the corporate, the fund and the people involved is crucial. This is helpful in making a future investment easier, more efficient etc. Specific points to cover:
Understand the organizational structure and your entry point - Some CVCs are only based on referrals from the corporate business units (‘first have a commercial relationship’) while others prefer to have the CVC as their front door to the organizations (these are more the ‘innovation arms’ type of investors).
Is the CVC a financial arm (separate budget, sometimes even additional external LPs, KPI is $ ROI) or more of a corporate development arm (investing off the corporate’s balance sheet, only in potential P&L accretive acquisition, etc.). As mentioned before it will affect the CVC’s priorities and goals. Furthermore, some corporates have more than one investment arm (Optum venture and United Healthcare ventures for example) and each has a distinct goal / agenda.
Understand who the decision makers are and which stakeholders you need to engage and in which order. Some CVC teams have dual corporate roles (SVP strategy, director of corporate development, etc.), some need signoff from specific people to make sure there are no overlaps between internal initiatives and an external solution.
Figure out how does the investment committee looks like, who would need to sign off on the investment, and what can make your case more appealing.
This is a bit larger than just the CVC angle – you are not trying to work with ‘the corporate’, you are trying to work with specific people. They need to make a leap of faith, sometimes even to the extent of risking their positions. Think carefully on how you can make their decision less complicated or risky for them. How can you create clarity for them, build trust, and make them feel confident they are betting on the right horse.
In general (and already apologizing for making a general statement here), CVCs tend to move slower than other VCs. Make sure you have enough time to manage the DD process.
FOMO is a great enabler 😉
By the end of the day, CVCs can be a great addition to your cap table, and not just in this market. Hope this piece gave you some things to consider before double clicking on that angle.
Good luck in finding yours truly!
Big thanks to Katharine Gilbert for helping with this piece!
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Nadav