Monday, August 19, 2013

On Corporate VC

I know I'm a bit late to this, but I just ran across Fred Wilson's comments about corporate VC from two months ago. “I am never, ever, ever, ever, ever going to do that again," he said of investing with corp VCs, because "they suck." Why do they suck? "They are not interested in the company's success or the entrepreneur's success. Corporations exist to maximize their interests. They can never be menschy or magnanimous."

On his blog Wilson clarifies a bit: corporate VCs are of two types, passive or active. If they are passive, they can be good, because they act like VCs; if they are active they are bad, "The corporate strategic investor's objectives are generally at odds with the objectives of the entrepreneur, the company, and the financial investors." And, "I strongly advise against entering into these kinds of relationships."

There's certainly some truth here. I was an active corporate VC in the 90s and I've been a stand-alone investor for the past five years so I've seen both sides. And I agree with Wilson, pretty much everything he says except that last sentence*.

I ran Omnicom Group's venture division back in the 90s, a strategic corporate investor if ever there was one. For the first few years there I invested primarily in interactive agencies. The mid-90s were a good time for this and we got to seed-fund some great companies: Razorfish,, Organic, etc. Our strategy was to invest in the best people we could find, people doing amazing creative work and coming up with awesome customer solutions; a good product, in other words. We looked at pretty much everyone but made few investments, we were pretty picky. We did not think that professional services companies would go public--it was very rare and a bad idea for all but the largest--we thought that we could help build the businesses until they were profitable enough for us to buy out the interest owned by the founders**. We also knew that we could not acquire (or start) world-class companies at that time, but we needed agencies that were connected to Omnicom so we could bring clients looking for an interactive agency to someone in the family: we did not want another holding company to get a toe-hold at our clients. This was our strategic rationale and we did indeed try to maximize our own interests. But our interests included making our investments as successful as possible, and I did everything in my power to that end.

But I understood, and made sure my portfolio companies understood before I invested, what was in my power and what was not. I could not bring them clients, I had no clients, the clients belonged to the other agencies, who did not report to me. I could not bring them partnerships with the ad agencies, those agencies made their own decisions. All I could do was make qualified introductions and go reason with (and otherwise harass) the agency heads. I could also provide unparalleled benchmarking, access to best-in-class advice on how to run a client services organization, M&A, and Omnicom's brand name. This last was what convinced most of the portfolio companies: being associated in a client's mind with the company that already provides their advertising services, PR, etc. was enough to tip the RFP their way.

These investments did phenomenally well. Well enough to draw in VC firms to a space (professional services) that they traditionally avoided. One of the at-that-time well known venture capitalists invested in a second-rate company, one I had passed on. Mystified, I called up the VC and asked to have lunch. I think when he discovered that his lunch date was not the overture of a potential acquiror but a young whippersnapper asking for advice, he was somewhat displeased. It was a short lunch. As the lunch turned chilly I did get to ask him the question I wanted to know the answer to, though: "why did you invest in ____?" His answer, reasonable though curt, was "Because I expect to make money."

It's true that corporate VCs and VC firms should think twice before investing together. They have different goals. But let's understand this.

Strategic VCs invest because they want to make their own company stronger. As Wilson says, they exist to maximize their interests. Maximizing their interests, of course, usually means maximizing the success of their portfolio companies.

VC firms invest because they want to make money. They exist to maximize their interests. Maximizing their interests, of course, usually means maximizing the success of their portfolio companies.

These things are the same, no? Except they're not, because corporates and VC firms define success differently. For a VC firm success is selling their equity to someone else for a lot more money in a relatively short time frame. For a corporate VC success is having a company become powerful and entrenched so they can learn many things from them (and prevent competitors from dominating a market.)

You can see the reasons for frustration. Dominating an industry does not necessarily mean becoming extremely valuable. Most of the ad agency holding companies would have preferred owning a piece of, say, Donovan Data Systems to a piece of Yahoo! back in the 90s. Because, as an Omnicom exec said to me back in 1997 or so, "there's no amount of money you can make that would make any conceivable difference to our market cap."

But this cuts both ways. Because a corporate VC does not need to exit their investments in a relatively short time-frame, they can be more supportive than a VC firm. Since corporates are not necessarily in it to make money, they can put money and time into a company for strategic reasons, even if it doesn't increase the market value of the company in the short-term.

But we did make money on these investments. Quite a bit of it. Much more than the VCs who invested late in the bubble in companies whose sole purpose was to build something that could go public. Good VCs, of any stripe, know that the best way to avoid financial risk is to build an amazing company. I'm not saying that corporate VCs are always better at that, far from it. But they are not always worse.

When I was a corp VC we didn't want to invest with stand-alone VCs, for reasons analogous to Wilson's: their definition of success was different so we had disagreements, brickbats were thrown***, and we had suboptimal outcomes. Whose fault was that? Both sides blamed the other.

Now, knowing what I do about both sides, I invest with corporate VCs, but carefully. The passive VCs are great for filling out rounds, but I don't ever rely on them being around three years from now: because they have no corporate rationale (neither strategic nor profit) they are arbitrarily shut down when VC stops being fashionable, late in any boom. Passive corporate VCs are classic buy high, sell low players. The active VCs can be extraordinarily helpful (one corp VC I've coinvested with has brought some of the first customers to pretty much all of its portfolio, and you know how important getting those first customers is) but I wouldn't put money into a deal that a corporate VC is leading because I recognize that our interest diverge, especially around exiting.

But entrepreneurs should take Wilson's complaints--the tension between two very different types of venture investing--with a grain of salt. I agree that if you take money from strategic investors you need to be careful what kind of control they have over your company. You need to retain reasonable control of the exit, certainly, and of raising more money. The corp VC can have very different ideas about what you should do here, what is best for them. You should also be realistic about what you can expect the corp VC to bring you in terms of strategic advantage. In the end they can't bring you much more than money, advice and some intros. They will rarely bring you customers or tactical help.

But note that all of these caveats hold true for VC firms as well. You should be careful about how much control they have over your company and be realistic about the help they can give you.

Razorfish took Omnicom's money not because they thought Omnicom would bring them clients but because they knew that being backed by the world's largest marketing services firm would enhance their own brand. No venture capital firm would have had this effect with Razorfish's clients. Every company is different and needs different things to succeed. Pick your investors wisely, always, but if a strategic investor is going to bring you more success than a VC, and all else being equal, take their money.

* And the last sentence of the first paragraph. Wilson can be menschy and magnanimous beyond what's solely in his firm's best interests because he's had so much success already. Kind of like how Neil Young could experiment with Trans in the early 80s. Most VCs do not have the leeway to be menschy or magnanimous, corporate or not.  Also, I'm going to ignore the passive corporate VCs because they are, in fact, simply stand-alone VCs that have been conglomerated; much like GE makes jet engines and refrigerators, Intel makes chips and does venture capital. There are lots of reasons to criticize this sort of conglomeration, Sarah Lacy has all of them--and a few more--here.

** Because of the way Omnicom was managed--acquisitions were always accretive to earnings--and the disconnect between a business' earnings and value during the steep part of the s-curve, we could not acquire the whole thing up front. We also thought that buying out the entrepreneurs when there was still substantial growth ahead would not motivate them as much as letting them profit more directly and substantially from realizing that growth.

*** I once had a very, very well-known West coast VC tell me on a conference call "You will never invest in California again." The other corp VCs on the call bought me lunch for months for that out of pure glee. The West coast VC in question followed-on into my first angel deal. To be fair, it wasn't in California.


Anonymous said...

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Chet said...