Corporate Venture Capital

The news this morning is that Google is seriously considering entering the venture capital business. They bring a lot to the table for sure.

But as Jessica Vascellaro points out in here WSJ piece (which is what I linked to):

Their [corporations who invest directly in venture deals] track records have been mixed. Corporate
venture-capital arms have been hampered by challenges that traditional
venture-capital businesses don’t face. Venture capitalists invest in
private start-ups at an early stage, usually in hopes of a big payout
if the company is sold or if its stock goes public.

Many start-ups fear that taking corporate money limits
their options and comes with strings that could turn away other
potential investors — such as a right to buy the company at a later
date. Some funds with less competitive compensation have struggled to
retain managers, and corporate venture funds often don’t allow senior
employees to invest personal money in their funds, while other venture
funds typically do.

Corporate venture capitalists’ share of overall
venture-capital dollars invested in U.S. companies fell to 7% in the
first half of 2008 from 8.4% in 2007, according to
PricewaterhouseCoopers and the National Venture Capital Association.
Corporate venture capitalists were involved in roughly 20% of the
venture-capital deals signed during the first half of 2008, compared
with 21% in 2007.

All businesses are about talent and the best talent in the venture industry doesn’t work in large companies and won’t work in large companies. So corporate venture investors start with a big talent handicap and eventually face employee churn in their venture groups.

And to make matters worse, corporate investors don’t really share the profit motive with the entrepreneurs. Let’s say Google (or any other corporate VC) invests in a startup and buys 20% of it for $3mm. Let’s say that startup is a huge success, sells for $1bn and Google (or any corporate VC) makes $200mm on the deal. None of the employees who made that investment get rich. The founders of Google and the CEO of Google don’t get rich (they are already but that’s not my point). The company "gets rich". But Google makes $1.5bn of pre-tax profits every quarter. So this big win generates another 12-13% to the bottom line, but just once. It’s not a recurring gain.

And that’s the big problem with corporate structures for venture investing. One time gains in corporations don’t make anyone rich. Wall Street ignores the gain. The company can’t put the gain into the pocket of its management. So it just doesn’t matter very much.

Corporations have other motives for doing venture capital. But those motives aren’t particularly well aligned with the founders, managers, and financial investors. So there’s always tension in a corporate venture investment and it’s not always healthy.

Please don’t get me wrong. There are corporate investors in many of our portfolio companies. Six of our eighteen active and announced portfolio investments have corporate investors in their capital structures. That’s one in three, well above the 20% number cited in the quote from Jessica’s WSJ piece above. We like working with corporate investors in the right situations and we’d certainly love to work with Google considering all that they bring to the table.

But I do think that venture investing is not the best use of a corporation’s capital and that it is inevitable that it will produce sub-par returns at best and significant losses at worst. And as a Google shareholder, I’d prefer to see them do something else with all that money they are making.

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Comments (Archived):

  1. Chris Dodge

    Fred,I would assume that Google’s interest would be not in ROI on their use of cash, but rather using a VC arm to “incubate” – for lack of a better word – new products and attract entrepreneurial talent.IMO, Google has hit a point in it’s lifetime where is has too many non-core projects/products that end up being a distraction. As many others have said before, they do need to start focusing and showing a bit more discipline. Given their huge quarterly profits, it’s easy to ignore these all of these side-projects that are going nowhere. However, I think the time has come for them to ratchet things down a bit.Having a VC arm would potentially be a way to keep involved in such “blue sky” projects, however distance it a bit from their core operations. Personally, I’d rather see GOOG use their cash in such a manner than keep supporting lots of these tiny distractions and the resource-drain they inflict.That said, I think any startup should think long and hard about what it may mean to have GOOG as an investor and whether there might be any potential conflicts of interests.

  2. Pascal-Emmanuel Gobry

    The problem with incentives in corporate venture capital is when the VC “firm” is just an arm of the company, but if it’s an independent firm with the company acting as an LP and actively recruiting the best VCs to run the firm as partners then I think the incentives could be properly aligned.Then you have to think of why a company starts such a firm? There are three potential reasons in my view: 1- money; 2- technology; 3- people.1 is a non starter. The best VC firms make eye popping returns to shareholders but these are only the top few and anyway if you need that to provide your shareholders/investors with the returns they’re looking for maybe you should rethink your core business instead of setting up a venture arm.2 can be a smart play in my view. It’s kind of like an outsourced research lab. Instead of setting up Xerox PARC you set up a VC arm that invests in interesting technologies that you can later snap up. The danger of course is that since it’s out in the open other people can buy the companies or copy their ideas but that’s life, and generally entrepreneurial teams are more innovative than indoor researchers and the openness and sharing of ideas brings its own benefits as well.3 in my view is the killer. Look at a “VC firm” like Y Combinator. I think Google would be much better off creating something like Y Combinator in every major city in the world and using it not to create new technologies that they could eventually buy (although it would be a big plus) but to *recruit*. They would get much more innovative, talented people in-house by buying founder teams at $2m for 3 after six months (and they have been doing that, of course) than by hoovering the top 10% of cookie-cutter CS graduates at Stanford and MIT each year. I think this was the thinking behind Yahoo! Brickhouse but it seems to be a non-starter.History has proved time and time again the truthness of that great Doriot quote: “someone, somewhere is making your product obsolete.” And history has taught us that this someone is a small startup founder because it’s in the nature of big companies to not be as nimble and innovative and to not notice the fastball flying into their blind spot until it’s socked them in the jaw (and even then…). It’s the classic story of Yahoo! refusing to buy Google before they were big.Google is a tremendous company that I admire endlessly but it is also standing on tenuous ground: if tomorrow someone invents a way better search engine or a way better advertising network they’ll be dead walking. If I was Google I’d start a $100 million or even $1 billion prize for anyone who comes up with a brilliant new search product. Because someone somewhere *will* make their product obsolete and the odds that that someone is a Google employee are pretty damn low. It was too late for Yahoo in 1998 and they didn’t realize it until 2004 (or they still haven’t realized it if you listen to Jerry sometimes). Maybe it will be mobile/location search, maybe it will be a new social advertising paradigm that will make AdWords useless and all ads will go through Facebook and Loopt, but some day Google as we know it will be obsolete, even before their competitor has launched their product. Cuil and Powerset are jokes but some day some startup won’t be. And Google had better be there with a blank check when that day comes. Maybe that VC arm will help them spot that.

  3. tacanderson

    Fred, I’m no expert but most corporate “VC” investing (that I’ve seen) is really more motivated as a way to outsource innovation. They see a promising innovation they may want to acquire and it’s usually cheaper to invest in a company and see if it goes where they want. Honestly they probably shouldn’t even call it Venture Capital.

  4. markjosephson

    In almost every VC meeting I’ve been in, they always ask “What are you going to do about Google?”I can now ask the same of them!Demonstrates how there are some things that you can control in your business — what a potential competitor might do is not one of them.

    1. fredwilson

      Google isn’t going to change the competitive landscape in VC, I can tell youthat. In your business they could do it in a nanosecond. I think that wouldbe a very bad comment to make to a serious VC investor.

  5. qwang

    Corporate VC has always been a talent and idea acquisition motive, not a ROI motive.But if it were, it brings up an interesting point that has bothered me for a while: Why must companies always grow? Isn’t there a point where company has exhausted all feasibly opportunities to deliver returns above their cost of capital, given their competencies? Why keep growing, when they can return a big chunk of cash to shareholders, some of which will find it’s way back into a real VC firm?

    1. tacanderson

      Companies don’t *have* to grow. PUBLIC companies have to increase share holder value. So public companies are competing against other public companies. If you don’t grow, investors pull their money and invest in other companies that will return more value. Hence the necessity for growth.

      1. gregorylent

        ok, here we go, econ 101, but for the edge economy new age … so what if investors pull their money, sell their stock? that has nothing to do with customers, income, sales, product development, does it? isn’t that investment action all taking place over there in a sort of parallel market where guys bet on which things will go up and down, and win or lose from each other? does it change anything about day to day business of the company itself?

        1. Jayrag

          duh yes.. For example, if the stock price of a company doesn’t grow, a company like google cannot attract or retain good talent. If it doesn’t have good talent, then it can’t continue its business as efficiently as it was.I am sure you can find several other reasons for having a good stock price.

  6. jeremystein

    they should allow employees to invest in the fund via 401k

    1. markslater

      how would that work? wait till your 55?

      1. jeremystein

        Not necessarily through 401k, but I think you get the point.Goog also has its fair share of accredited investors.

  7. Pierre Henri Clouin

    The primary motives for a corporate VC arm are attracting talent and innovation – as mentioned by many of the comments here. It begs to ask if it is a sign of slowing internal innovation and lower attractiveness for Google (outside of search). Even Google start up acquisition seem to have not delivered on par with expectations.

  8. Eben Thurston

    They’re probably looking into VC because their size has made it difficult to keep homegrown ideas, like Friendfeed and Ooyala, in house. If they’re doing this just to keep some exposure to products they would otherwise lose entirely, then this may end up being more of an external product incubator initiative than a traditional VC initiative.That said, at first glance Google doing traditional VC seems like something that could work well, because they already do a lot of investment in tech startups through the M&A side, so presumably they have people with the right skill set and maybe even an edge. However, a big company buying a startup because the startup’s products or services can be monetized by the big company is a fundamentally different kind of investment than VC. If Google VC invests in a firm that achieves success what is the exit strategy? Do they buy the firm outright, or sell it to a competitor at a profit? I would think the present value of an investment in a new internal product with a predictable revenue stream is greater than the PV of an investment in an external firm with a necessary yet uncertain liquidity event.Time will tell how it works out for them, but as a GOOG shareholder, I agree with Fred. I think Google and their stakeholders would be best served by focusing on the online advertising business and leaving the startup investment business to professional startup investors.

    1. Taylor Davidson

      “Keeping homegrown ideas” in-house is perhaps the best reason for Google getting into VC. But couldn’t they have done this in a more innovative structure, perhaps an in-house marketplace for ideas, or “space” (corporate, physical, org) for people to pursue new ideas 100%? Is this an admission that the much-vaulted and misunderstood 20% policy isn’t successful?I’m a bit confused by the strategy because Google has been an active early-stage acquirer, and I always thought that was an intelligent way for Google to get access to ideas and products.The gains from acquiring and leveraging ideas internally *should* be more valuable than just participating the financial returns from funding new companies, right?(and it they are not, isn’t that admitting that the internal org structure is insufficient for letting good/new ideas percolate through the value chain?)

  9. kenberger

    The heart of the matter is that corp vc, at least as it’s existed for the most part so far, is really about strategic for the corp’s bottom line. There are a few exceptions that have come and gone but it’s true for the long-term ones. They are beholden to a very different success metric than IRR.Here’s 2 examples of corporate VC that I find fun to think about:1. Intel Capital: Biggest fund in the world, from what i remember. They can lose a ton of money but it’s still seen as a success for Intel if resulting acitivities translate into billions more Centrinos sold (which is exactly what was argued at least at one point). But the principals are not paid a carry (there usually isn’t one) and so they get a different type of talent than a garden variety vc might.2. Nokia Ventures: Started as strategic but then quickly took on a syndicate of LP’s, then later completely morphed into an independent fund and even changed their name largely to emphasize that they can and do take investments competitive to their erstwhile parent.It could very well be that Google can think of some innovative tricks and create an entirely new model. They certainly have the correct mentorship among current board members and alumni. Or maybe not, and they scrap the plan!

  10. kenberger

    WSJ says: “taking corporate money limits their options and comes with strings that could turn away other potential investors”.True, and perhaps just as importantly, it can also preclude landing some key customers. That’s not to say that a company won’t do business w/ a company funded by a competitor, but it does happen and I’ve lived through it.

    1. fredwilson

      It happens all the time and its a big issue with taking corporate money

  11. pedalpete

    The quick and easy assumption here is that any VC investments that Google makes will be focused on Internet/IT start-ups. But the google boys may be going against the grain. The internet based VC market is already changing due to lower start-up, development and operating costs. Maybe google has a model which will better serve this market. Potentially they would focus on environmental, energy or medical start-ups. With the diverse PHD’s working inside the company, and 20% of their time being devoted to non-core work activities, they have the brain-power internally to understand these businesses and potentially make very good decisions, and they may have lots more to offer these companies.I like to think the S&L haven’t gotten old and that they still like to shake things up.

  12. leigh

    “Their [corporations who invest directly in venture deals] track records have been mixed.”Hum…but truth be to told their start up acquisition strategy has been a bit mixed as well n’est pas? I assume they are trying to move up that food chain as well as likely invest in the start up ideas that their own employees are probably coming to them with on a daily basis…..

  13. asifrahman

    Google has $12 billion of cash on their balance sheet right now and they generate $1.8 billion of cash every three months from operations. Does anyone have any suggestions on how they should spend that money? Buy treasuries? Upgrade the free food? VC seems like a pretty logical place to put it given the massive potential synergies.

    1. Brian

      How about a dividend to shareholders?Eventually growth is going to slow. It may be better for shareholders to receive a dividend than spend money on ideas that will have a terrible rate of return.Managers are always biased to throw good money after bad in the hope of maintaining growth. Maybe Icahn should lobby for a spot on google’s board?

      1. asifrahman

        How about both? It seems like they have enough cash on hand to give a nice special dividend (a la Microsoft) and still deploy a massive VC fund. Just guessing, but it would probably take them more than a year to invest a $1 billion dollar fund, which is how much cash they generate in less than a quarter. Google isn’t betting the farm on this, so it seems pretty risk-free from the company’s standpoint.The more important discussion is how the VC industry will be affected by this. I think founders benefit from Google’s presence in this field because of a better alignment of incentives.

      2. fredwilson

        I am a day behind on this comment thread and just suggested the same thing!That’s exactly right

    2. fredwilson

      You can’t invest that kind of money in vc. The best firms can’t figure out how to manage fund sizes much larger than 500mmThe best funds over the history of VC have been even smallerThat kind of money is very hard to invest intelligently. I’d advise them to start paying a dividend of about 1bn per quarterFred

  14. Farhan Lalji

    how do you reward corporate venture staff in a way that a – doesn’t make them feel like the poor cousin of the regular venture pros while at the same time b – doesn’t piss off other employees because the venture guys are making big payoffs – if they ever actually exit an investment.

  15. Jerry Neumann

    “…the best talent in the venture industry doesn’t work in large companies and won’t work in large companies…”Well, jeez, don’t tell Brad you said that. 🙂

  16. Marco

    Times are changing….. Nokia Fund, BlackBerry Fund …….

  17. Amarnath

    dont you think google is gearing up for a great showdown? they rock!!

  18. Antman

    “One time gains in corporations don’t make anyone rich. Wall Street ignores the gain. The company can’t put the gain into the pocket of its management. So it just doesn’t matter very much.”This is a great point. Motivation is a critical component in any endevour. With out proper alignment, the best of intentions is comprimised. This is a great post, great perspective, great insight.

  19. Allan

    Corporate venture groups, if they’re halfway successful, end up leaving the parent’s safe corporate umbrella. The guys at Scale Venture Partners flew the Bank of America coop after some great performance investing in breakout successes like Omniture. I can think of a half dozen other firms that have sought independence from their corporate sponsor. Strong investing talent wants to operate on its own and reap the bulk of the rewards.

  20. Web Design

    what I believe the companies must empower their workers. The main benefit why some people prefer to be a big fish in a small pound is the fact of being more close to the central body and less hierarchy mean more chances to get rich and climb vertically up to the ladder. Their are big giants which have very good employee police and no doubt they are moving leaps and bounds.

  21. jhi247

    IMO venture investing has a lot to do with brand. E.g. Sequoia has a great brand, this attracts the top entrepreneurs, they build the best companies, Sequoia’s brand further improves, … Over the course of the years this becomes a money making machine that is hard to screw up. Why wouldn’t Google try to do the same? They are THE brand in the Internet era. Which entrepreneur wouldn’t want to boast that Google is an investor in his or her company?