As the recovery of the economy has progressed, we have seen an increase in corporate activity, both through outright acquisitions and through a rise in the number of corporate investments or corporate venturing. Recently, tech giants including Google, Yahoo! and Facebook have all acquired innovative start-ups and this trend was further demonstrated by research from CBI last week, which predicted that business investment for 2013 is set to rise by 7.3%.
There has also been a significant increase in the number of companies setting up corporate venture departments that aim to make strategic investments in innovative early stage businesses to support their own corporate development.
For entrepreneurs, the attraction of corporate investors can be both appealing and, at times, somewhat daunting. So how do you get the right balance and ensure this is a mutually beneficial relationship?
The benefits for start-ups can be significant - access to technology, customer bases, joint development projects, co-marketing opportunities, as well as the additional resources that corporates can also deliver. It is easy to see some of the huge potential benefit that a mobile technology business would receive from an investment by a handset manufacturer, for example Samsung Ventures, or a mobile operator like Vodafone Ventures. This applies across many of the industrial spaces, particularly in technology, media and engineering.
In Europe, for example, we have seen Telefónica building on its success in South America, setting up its Wayra Incubator programme across six European cities over the last couple of years. This programme welcomes start-ups, providing a €50,000 investment into office space, tech support and mentoring.
Such programmes are at the heart of the London start-up scene as not only do they provide practical support and help, but importantly they also offer access and contacts to investors who can continue to back the businesses and see them develop further.
As with any investment, entrepreneurs should understand clearly and exactly what the corporate investor will bring to the table beyond just the financial capital. Will they be active participants in the business? And is their objective aligned with the entrepreneurial high growth business? Building a big business is hard, and securing funding is only one of the elements that the entrepreneur should consider.
The downsides of corporate partners must also be considered. Corporate investors actually rarely have a financial return from their investment as a primary criteria for their investment. (There are, of course, exceptions, particularly in those firms with dedicated investment teams rewarded directly from the capital appreciation of the investment they make.) So it is important to assess the rationale for their investment, especially if they may be a potential acquirer at some point in the future.
While terms can be inserted in the legal documentation if required, it is worth considering how potential acquirers might view the fact that any offer they make for your business will be known to the corporate investor who may essentially be their competitor.
It is also imperative to look at where the decision making lies within the corporate investor. Is there a risk that poor quarterly results could lead to an arbitrary decision by the financial director to implement a change of strategy? The sudden closure of the corporate venture arm could cut off both essential funding and valuable access that the investee company was relying on. The impact of the economics highlight this: a £3m investment in an early stage business that makes a ten-fold return to investors is likely to make a life changing difference to the entrepreneur and a significant return to an early stage financial investor. But what is the true impact felt by the corporate who is already measuring its annual profits in hundreds of millions?
All that said and done, there is no denying that the increase in corporate investment and corporate venturing is adding to the current favourable climate for entrepreneurs and enterprise in the UK. It is great news that corporates are recognising the value that can be found and realised through investing in smaller businesses that are developing innovative solutions for their market.
While it is important to be aware of the impact of the corporates as investors in UK early stage companies, we definitely see the benefits outweighing the potential pitfalls and there is no doubt that with the right corporate partner, the ability to scale a high growth opportunity is greatly enhanced. Speed and scale generates winning businesses that can change the way in which an industry operates and generates returns to investors. However, it is important to go into any investment relationship with eyes wide open if you are to avoid potential disappointments in the future.
Alex Macpherson, head of the Ventures team at Octopus Investments