Making it big
Article Date: Nov 01 2004Corporate Venturing, or convincing a big company to invest in your business, can give you a pipeline to finance, production, distribution and guaranteed customers.
If you head a young company which has an idea for what could be a hugely successful product or service, but you lack the resources in production, distribution, people and market presence to bring it to fruition, what can you do? One route you should consider is corporate venturing.
It describes the process by which large, established companies, with an eye to new potential areas of diversification and/or innovation, provide younger, smaller groups with help in these key areas to develop new ideas — in return for an eventual slice of any profitable business which may result. Many large groups, from aerospace and defence group BAE Systems to telecoms player BT, engineering group Rolls Royce, banking group Lloyds TSB and Government agencies, go in for corporate venturing This is either as a regular feature of their continuing business, whereby they will invest in internal ventures, or opportunistically when particularly interesting proposals come their way.
The innovation test
As Michael O’Leary Collins of corporate venturing intermediary Greenhouse Ventures puts it, ‘corporate venturing is a tool to find ways of testing growth opportunities, using the leverage of four assets which a large company has’ and a young one probably lacks. These are: ‘production, distribution, technology and customers’.
With the rapid acceleration of technological processes, world-beating inventions can quickly become mundane, turning a high-margin exclusive service into a low-margin ‘commodity’. So for the big companies the search is on to add extra value and, crucially, gain access to the people who can bring that about.
‘Corporate venturing is about innovation,’ insists O’Leary Collins, ‘but big company structures often militate against that. Their procedures and bureaucracy can be a problem’ and that is one reason many are going outside to form corporate venture partnerships with small companies which can think and act quickly — given the necessary resources and networks.
Negotiating terms of a corporate venturing partnership with a big company and any intellectual property issues arising is, predictably enough, usually a tough process. ‘Big groups like to own everything and they tend to be risk-averse,’ comments one player, ‘but small companies have to realise that ten per cent of a lot can be better than 90 per cent of a little.’
The new order
The nature of corporate venturing has changed since many large companies burnt their fingers backing promising-sounding projects in the heady atmosphere of the high tech and dotcom booms, which then failed to meet expectations. A more ‘focused’ approach, seeking to transfer technology generated by people with ideas appropriate for large corporate venturing companies’ own fields of expertise, is now the order of the day.
‘Spinning-out’ a new venture from inside is now often the ultimate objective, as much as ‘spinning-in’ from outside. ‘We would look for a trade sale or a flotation’, says Bob Flint, director of ventures at BAE Systems, ‘but the jury is still out on the best exit route.’
Ron Stewart, creator of Hampshire-based High Integrity Solutions (HIS), is one head of a young company who has benefited from this BAE Systems approach. HIS has developed systems which can cut 25 per cent off the cost of developing complex software. Flint, who heads a three-man department at BAE’s Farnborough office, says the company decided to invest in HIS because it saw ‘huge cost benefits for us’ in the products HIS wanted to develop.
Timing and risks
This is beginning to pay off, as HIS has ‘now come good with a product used by BAE. It is actively looking for external customers,’ adds Flint. Up to 2002, he recalls, BAE used to invest in smaller companies whose products could enhance its own efficiency or benefit from BAE’s distribution power.
But, explains Flint, ‘we decided we were out there, taking big risks, putting in money where we were often the only investor and we were not getting the returns to justify it.’ Since early 2003, BAE has concentrated more on transferring its technology to other sectors where it can be applied. This is through licensing deals, partnerships, sweat equity (where equity is acquired by a company's executives on favourable terms, to reflect the value the executives have added and will continue to add to the company) or other routes.
Adapting technology devised for marine applications or fighter planes to medical equipment or an increasingly software reliant commercial transport sector is a typical goal for BAE Systems’ venture department. Flint, who unsurprisingly says the entrepreneurs he deals with often start out with unrealistic hopes as to the terms of a deal, says it can take nine months between first meeting and reaching agreement.
After that, it can take from 12 to 18 months to have the original idea embodied in a product. So far, Flint’s section has met its targets and he maintains there is ‘much more exciting work’ on the horizon, moving away from developing very specifically defined products towards ‘nascent work in target markets’.
Incubating tomorrow’s winners
Corporate venturing, which is longer established in the USA than here, is a two-way street and is far from being simply a matter of big companies waiting for inventors to knock on their doors. Mike Carr, director of research and venturing at BT, says his department sees 300 to 400 companies a year.
‘We do run small funds to invest in companies and we have a small team in California to investigate some fantastic technological opportunities’. But Carr says BT is as much concerned with using its central research laboratory to develop new revenue-generating projects and spin them out.
A frequent formula is to bring in an outside venture capital group and spin out the new operation, typically with the venture capitalist owning 40 per cent, the management 20 per cent and BT 40 per cent. ‘When we take it into the wider market’, argues Carr, ‘they get the economies of scale and we get the technology.
‘We have done five like that so far and it works brilliantly,’ he insists, though he does concede there is a defensive motive, too. In today’s tough corporate climate, ‘it is no longer possible to develop products only for your own internal market and sustain the massive investment that needs.’
One instance is BT Home Computing, set up to grow a niche business using the facilities of BT’s ‘man in a van’ service for fast installations. This operation is reckoned to be on track for revenues of £50 million a year.
Another success story is BT Rich Media, a new venture launched to increase the value and potential of broadband. BT set this up with the assistance of Edengene, a leading corporate venturing consultant.
Going against the grain
Three years ago, when many other groups were smarting from dotcom losses and pulling out of corporate venturing, Lloyds TSB decided to move in the opposite direction. The banking group set up Lloyds TSB Strategic Ventures to identify and back long-term projects which could make use of its own unique facilities and skills.
Rahan Shaheen, head of venture strategy, and Bindesh Shah, head of venture development, point to several successes already spawned by this unit. One is Ideal, a joint venture with Scottish Power which sells gas and electricity to bank customers.
Another was Create credit cards, involving ‘dynamic personalisation’, which led to the ‘Goldfish’ service. Specialist mortgages from Cheltenham & Gloucester for the ‘non-standard market’ also stemmed from Lloyds TSB Strategic Ventures.
It now no longer looks for fresh outlets for existing bank services, but for ‘businesses with the potential to make ‘a £30 million economic profit after five years’ on their own. Cross-selling gas with banking has given way to more ‘blue sky’ projects, with perhaps four chosen out of 200 considered every year.
Demand depends on business cycles
The rise – and demise – of corporate venturing reflects business cycles and many companies, such as Diageo, Royal Sun Alliance and beleaguered Marconi, withdrew after the dotcom bubble burst. Nevertheless, corporate venturing does seem to have become an established part of British business life.
Sixty per cent of ‘captains of industry’ interviewed last year in a survey carried out by pollster MORI said corporate venturing was already part of their business strategy or would become part of it in the near future.
More than half cited potential profit opportunities as their motive for corporate venturing, with 49 per cent similarly seeking good investment returns, 23 per cent hoping to generate consumer demand and 19 per cent concerned to ‘create an entrepreneurial culture’ within their companies. Failure rates were high: 93 per cent of the industrialists either knew of or had personally experienced corporate venturing flops.
Of heads of large companies, 28 per cent preferred small and medium-sized companies as potential partners, with 19 per cent favouring academic institutions and 16 per cent looking to Government. And 26 per cent advocated using consultants.
Greenhouse Ventures is among the more active of these. It is part of the Digital Solutions Group (DSG), headed by Sir Paul Judge, ex-Conservative party director general and Cabinet adviser who led the 1980s buy-out of Cadbury Schweppes’ food business, later sold to Hillsdown Holdings for £310 million.
DSG is raising £100 million for a defence-related venture capital group. This will back corporate venturing spin-offs from big companies.
Government support
Less fortunate, however, has been Corporate Venturing UK, a subsidiary of the National Business Angels Network, which received funding for three years from the Department of Trade & Industry. This ran out and has not been renewed, as the Government seeks different channels for routes to build up Britain’s science base and small businesses.
Since 2000, the Treasury has allowed similar tax relief for corporate venture investments as are available under the Enterprise Investment Scheme. These include corporation tax relief, deferral of capital gains tax and loss relief.
The latest Finance Act introduced several improvements. But some concerned people, such as Sir Peter Williams, chairman of the Engineering & Technology Board, fear they are not widely enough publicised among those who could benefit most from them.
Case Study - Helping out the big banks
‘Real Time Nostro’, is a banking information system devised by Bob Blower, managing director of Gresham Computing. Four years ago, having left information group Reuters to join telecoms giant Cable & Wireless (C&W), he met a physicist on an aeroplane who pointed out to him that, as communications networks grew ever cheaper and more efficient, their value would diminish.
Eventually, in theory at least, one tiny, purely clear fibre could carry infinite numbers of messages. That could spell bad news for the likes of C&W unless it could diversify into new services, for which it could charge premium rates.
“I did a business plan’, recalls Blower, ‘with a group of bankers in a room. Clearing banks handle some £1.5 trillion of payments around the world every day and they would make more money out of that if they know accurately and immediately – in real time – across different time zones – what was in all the accounts they held with each other’.
The existing SWIFT clearing system was too rigid for this to be done. The people Blower talked to in 2001 agreed that, if someone else could do it, it could be a winner.
Gresham, a young, quoted company then valued at about £10 million, had the specialist knowledge to tackle the project. But, recalls David Schoch, vice president of strategic development at C&W, Gresham lacked the muscle and credibility to go to the banks for data and support.
