CORPORATE VENTURE CAPITAL Since the start of the 1980s there has been a significant rise in the number and forms of collaborative inter-firm relationships, driven largely by increasing competitive pressures in the global marketplace. One form of collaboration is Corporate Venture Capital Investment, or Corporate Venturing. This involves large, non-financial companies taking minority equity stakes in small unquoted firms, and can be beneficial for both parties. The levels of corporate venturing are, however, reportedly low in the UK, particularly when compared to levels in the USA. This volume addresses the lack of academic and practical research into corporate venturing by examining the role of this activity both as a form of large firm-small firm collaboration and as an alternative source of equity finance for small firms. These issues are explored through surveys of thirty-nine independent fund managers, seventy-three corporate executives and forty-eight technology-based firm directors. The book finds corporate venturing to be a valuable source of equity finance for early stage, technology-based firms, as well as for the institutional venture capital funds which specialise in investing in such ventures. Implications for both academic theorists and practitioners are considered. Kevin McNally studied for his PhD at the University of Southampton, during which time he published his findings in a number of books, academic journals, trade publications and national newspapers. He is currently Head of UK Private Equity at Initiative Europe, the leading providers of publishing and research services to the European venture capital industry.
Downloaded by [37.44.207.145] at 13:16 21 December 2016 ROUTLEDGE STUDIES IN SMALL BUSINESS Edited by David Storey 1. SMALL FIRM FORMATION AND REGIONAL ECONOMIC DEVELOPMENT Edited by Michael W.Danson 2. CORPORATE VENTURE CAPITAL Bridging the equity gap in the small business sector Kevin McNally
CORPORATE VENTURE CAPITAL Bridging the equity gap in the small business sector Downloaded by [37.44.207.145] at 13:16 21 December 2016 Kevin McNally London and New York
First published 1997 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group Downloaded by [37.44.207.145] at 13:16 21 December 2016 This edition published in the Taylor & Francis e-library, 2005. To purchase your own copy of this or any of Taylor & Francis or Routledge s collection of thousands of ebooks please go to www.ebookstore.tandf.co.uk. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-44339-X Master e-book ISBN ISBN 0-203-75163-9 (Adobe ereader Format) ISBN 0-415-15467-7 (Print Edition)
Downloaded by [37.44.207.145] at 13:16 21 December 2016 This book is dedicated to Mum, Dad, Nick and Lauren without whom it would not have happened.
CONTENTS Downloaded by [37.44.207.145] at 13:16 21 December 2016 List of figures List of tables Foreword Preface Acknowledgements 1 INTER-FIRM COLLABORATION Increasing levels of inter-firm collaboration Theoretical considerations: some explanations for increasing levels of collaboration Increasing levels of collaboration between large and small firms Summary and conclusions 2 CORPORATE VENTURING AND CORPORATE VENTURE CAPITAL Introduction Corporate venturing and corporate venture capital: some definitions Corporate venture capital: nature and forms The potential benefits of corporate venture capital investment Evidence and trends in corporate venture capital investment Summary, research aims and methodological overview 3 CORPORATE VENTURE CAPITAL INVESTMENT IN THE UNITED KINGDOM Introduction Research aims and methodology Numbers and characteristics of investing companies Corporate objectives for making CVC investments Companies that have not made CVC investments: the use of alternative strategies
Downloaded by [37.44.207.145] at 13:16 21 December 2016 Corporate investment in venture capital: UK/US comparisons Potential future levels of CVC in the UK Conclusions 4 THE CVC INVESTMENT PROCESS Introduction Research aims and methodology Organisational strategies in CVC investment Characteristics of CVC investments UK CVC: post-investment experiences of investing companies Conclusions 5 EXTERNALLY MANAGED CVC Introduction Research aims and methodology Significance of corporate sources of finance for UK-based venture capital funds Corporate investment in venture capital funds: some characteristics Characteristics of venture capital fund investments Advantages and disadvantages of indirect CVC Current and future levels of indirect CVC Conclusions 6 TECHNOLOGY-BASED FIRMS AND CVC Introduction Research aims and methodology General characteristics of sample firms The role of CVC relative to other finance sources The search for CVC finance The perceived advantages of CVC financing Nature of the CVC relationship The post-investment experience of CVC Conclusions 7 CONCLUSIONS Corporate venture capital: summary and main findings CVC and inter-firm collaboration theory
Downloaded by [37.44.207.145] at 13:16 21 December 2016 CVC and the equity gap Practical implications An agenda for further research Notes Bibliography
FIGURES Downloaded by [37.44.207.145] at 13:16 21 December 2016 1.1 Main forms of inter-firm collaboration 1.2 Spectrum of firm growth strategies based on degree of integration 2.1 Spectrum of venture strategies 2.2 Corporate venture capital strategies 2.3 US venture capital: funds raised by source, 1994 2.4 UK venture capital: funds raised by source, 1994 3.1 Industrial sectors of investing companies 3.2 Major objectives of CVC: indirect and direct comparison 3.3 Views of survey respondents regarding future levels of indirect CVC among UK-based companies 3.4 Views of survey respondents regarding future levels of direct CVC among UK-based companies 4.1 Internal organisation of CVC investment 4.2 Country of origin of fund managers 4.3 Dates of corporate investments in externally managed funds and amounts invested, 1984 94 4.4 Capital commitments to UK independent venture capital funds from all sources, 1984 93 4.5 Country of origin of fund portfolio companies 4.6 Stages of business development of investments by venture capital funds in which corporates have invested 4.7 Technology focus of investments by venture capital funds in which corporates have invested 4.8 Country of origin of direct investee firms 4.9 Dates of direct CVC investments and amounts invested, 1981 94 4.10 Stages of development of direct investee companies 4.11 Technology levels of direct investee companies 4.12 CVC performance: indirect and direct comparison 5.1 Countries of origin of named corporate investors 5.2 Investment sizes of funds that have raised finance from non-financial companies 5.3 Investment stages of portfolio investees of funds that have raised finance from non-financial companies 6.1 Industrial sectors of firms that have raised direct CVC finance 6.2 Industrial sectors of firms that have raised indirect CVC finance 6.3 Spatial distribution of TBF survey sample
Downloaded by [37.44.207.145] at 13:16 21 December 2016 6.4 Stage of investee firms when direct CVC was initially raised 6.5 Stage of investee firms when indirect CVC was initially raised
TABLES Downloaded by [37.44.207.145] at 13:16 21 December 2016 1.1 Summary of main theoretical approaches to collaboration 1.2 Generic motives for inter-firm alliances 1.3 Characteristics of firm growth strategies 1.4 Forms of large firm-small firm collaboration 1.5 Advantages of large firm-small firm collaboration 2.1 Percentage numbers and value of technology investments (excluding MBOs/MBIs) in the UK, 1984 93 2.2 Companies active in CVC in continental Europe 2.3 Capital committed to independent funds by non-financial corporations in the UK, 1986 94 2.4 Summary of survey aims 3.1 Ranked major corporate objectives for CVC investment 3.2 Ranked major corporate objectives for direct and indirect CVC investment 3.3 Views of survey respondents regarding the different levels of indirect CVC in the USA and the UK 3.4 Views of survey respondents regarding the different levels of direct CVC in the USA and the UK 3.5 Plans for future CVC investment related to prior involvement in venture capital 3.6 Form of future CVC investment among sample companies 3.7 Nature of the major motives of companies planning to make CVC investments by 1998 4.1 Internal organisation of CVC investment among survey sample 4.2 Ranked importance of factors in selection of fund managers 4.3 Ranked importance of factors in selection of investee firms 4.4 Forms of nurturing provided by investing companies 4.5 CVC performance ratings for individual parameters indirect and direct CVC 4.6 Rankings of obstacles to successful CVC performance indirect and direct CVC 5.1 Criteria for selection of fund managers 5.2 Number of corporate investors in venture capital funds 5.3 Corporate contributions to venture capital funds relative to fund size 5.4 Sectors of investment of funds receiving corporate finance
Downloaded by [37.44.207.145] at 13:16 21 December 2016 5.5 Spatial distribution of fund investments within the UK: comparison of survey funds and mean BVCA figures, 1989 94 5.6 Corporate willingness to invest in UK and US venture capital funds 5.7 Indirect CVC: future involvement of surveyed fund managers 5.8 Possible future levels of indirect CVC in the UK 6.1 Amounts invested in direct investees by stage and source 6.2 Rounds invested in direct investees by size and source 6.3 Stage distribution of rounds: direct CVC 6.4 Rounds invested in direct investees by stage and source 6.5 Summary of amounts and rounds invested by non-financial companies by stage 6.6 Amounts invested in indirect investees by stage and source 6.7 Rounds invested in indirect investees by size and source 6.8 Stage distribution of rounds: indirect CVC 6.9 Rounds invested in indirect investees by stage and source 6.10 Amounts invested in indirect investees by stage and source: comparison of indirect CVC funds and other funds 6.11 Rounds invested in indirect investees by stage and source: comparison of indirect CVC funds and other funds 6.12 Factors taken into account by direct investees when finally selecting corporate investors 6.13 Factors taken into account by indirect investees when finally selecting venture capital fund managers 6.14 Respondents perceived motives of companies making direct CVC investments 6.15 Factors considered by investee firms to be the main advantages of direct CVC over other forms of equity financing prior to receipt of finance 6.16 Respondents perceived motives of companies making indirect CVC investments 6.17 Degree of hands-on involvement of companies investing directly 6.18 Degree of hands-on involvement of venture capital fund managers investing in indirect investees 6.19 Benefits for investee firms that have arisen as a result of direct CVC finance 6.20 Benefits for investee firms that have arisen as a result of indirect CVC finance 6.21 Post-investment problems experienced by companies that have raised direct CVC finance 6.22 Post-investment problems experienced by companies that have raised indirect CVC finance
FOREWORD Downloaded by [37.44.207.145] at 13:16 21 December 2016 Nobody could describe the equity gap experienced by small firms as a new or inadequately investigated subject. The description of it in the Macmillan Report of 1931 still has a contemporary ring sixty-five years later. Moreover, the contention of the Radcliffe Committee in 1959 that the equity gap had been largely closed by the establishment of the Industrial and Commercial Finance Corporation in 1945 would now be regarded as highly optimistic, notwithstanding the important contribution made by 3i and the venture capital industry as a whole. It was certainly the view of the Bolton Committee in 1971 that the Macmillan Gap still existed, and academic research and other investigations since have confirmed this view. During the last few years, however, a number of developments have brought the subject of the equity gap increasingly to the fore. One has been simply the greatly increased focus on the economic contribution of small firms and the consequent importance of ensuring that their financial needs are adequately met. The very serious difficulties that emerged in the relationship between the clearing banks and their small business customers in the early 1990s prompted Eddie George, the Governor of the Bank of England, to take a direct initiative in the area of the financing of small firms. Relationships are now on a more constructive footing, with a strong emphasis on the importance of ensuring that finance is appropriate for the use that it is put to whether it be bank debt, assetbased finance, or equity. While much of the recent discussion about the financing of small firms has centered on debt finance and the role of the clearing banks, there has also been general acceptance that many smaller businesses in the United Kingdom continue to be under-capitalised. There have been a number of recent public policy initiatives aimed at ameliorating this: for example, the Enterprise Investment Scheme and Venture Capital Trusts. None the less, recent concentration on the particular needs of technology-based small firms has reinforced the point that small firms that are perceived to be in the high risk category whether this perception is accurate or not do not find it easy to raise
Downloaded by [37.44.207.145] at 13:16 21 December 2016 risk capital, even in relatively small amounts. The Bank of England s report, The financing of Technology-based Small Firms (October 1996), made a number of recommendations aimed at improving the financing of this sector. Two of the Bank s recommendations related to the broad subject of corporate venturing: one called for further research on the current extent of corporate venturing in the United Kingdom, while the other suggested that the CBI and others might act to increase awareness of the opportunities offered by corporate venturing and collaborative partnerships between larger and smaller firms. The Bank certainly regards corporate venturing as potentially a very important source of finance for technology-based small firms. Moreover, in the case of direct corporate venturing, the investee firm may also benefit from a high level of corporate investor involvement. Against this background, Kevin McNally s book is both timely and stimulating, focusing as it does on corporate venture capital (CVC) as one particularly important manifestation of a wide range of forms of corporate venturing and collaborative partnerships. Dr McNally draws out very clearly the important distinction between direct and indirect CVC and suggests that the direct form is of particular interest for technology-based small firms. This is because the package includes not just finance but also frequent contact between investor and investee firms, nurturing, and other collaborative links. Dr McNally confirms the widely-held view that CVC is an under-developed corporate strategy in the United Kingdom, particularly when compared with the United States, although he also makes the point that some CVC activity probably takes place in the United Kingdom without recognition. He identifies two specific reasons for previously active investor companies withdrawing from CVC: poor investment experience in the past, and the trend towards concentration on core businesses. Other aspects of the analysis in the book support the view that CVC, especially in the direct form, is potentially an important contributor to filling the equity gap for technology-based small firms. A typical CVC direct investment is for less than 300,000, and the pricing may well be more attractive than other forms of venture capital finance because corporate investors are strategically motivated. In other words, they are looking for more from the investment than a simple financial return. Dr McNally s analysis merits careful consideration by both potential investor and investee companies, by public policy makers and by fellow researchers. Adrian Piper, Senior Adviser, Business Finance Division, Bank of England
PREFACE Downloaded by [37.44.207.145] at 13:16 21 December 2016 This book is the product of a PhD thesis completed between October 1992 and September 1995 in the Department of Geography at the University of Southampton. Why geography?, you may ask, particularly given that the subject of the research appears, at least at first glance, to be more at home within a business school environment. By way of response I feel that it is important to stress that a thesis on this topic could have been researched and written within the context of any one of a number of academic or practitioner-based disciplines, and that to this extent it provides evidence of the typical interdisciplinary nature of research into small firms and entrepreneurship. Academic commentators in the fields of strategic management, industrial organisation, technology, economics, sociology and geography have contributed to the outcome of this thesis alongside practising venture capitalists, corporate executives and entrepreneurs. Whether their views and opinions were conveyed directly through face-to-face or telephone interviews, through more informal discussions or through their writings, I hope that my attempts to draw together, contrast and compare experiences from such a wide variety of sources have resulted in a rich and accurate insight into a field of inquiry which is becoming increasingly important to many people. Small firms and entrepreneurship, and also the interrelated topics of company collaboration, networks and industrial districts, are all currently of particular interest to followers of contemporary economic geography. While geography, by definition, concerns itself primarily with a study of space, the inherent spacial dimension of many subject matters means that geographers are found in many places where they perhaps wouldn t be expected; many people would be surprised to see what is taught on a modern human geography degree course! As an undergraduate in Southampton I was first introduced to the various theoretical schools of thought underpinning the strategic alliance and entrepreneurship subject areas, as well as to the more practical issues concerning the start-up, growth and development of small companies. Attracted to this area, I decided to undertake an undergraduate dissertation looking at the problems faced by the UK s
Downloaded by [37.44.207.145] at 13:16 21 December 2016 growing band of microbreweries. Having thoroughly enjoyed this research, not least because of the subject matter, but also because of the exposure it allowed me both to issues of small firm growth and to the science of methodological technique, I began to research the topic of small firm financing and inter-firm cooperation more thoroughly. It subsequently became clear that our knowledge both of the so called equity gap for small companies and of the nature of specific forms of collaboration between large and small firms was incomplete, and that a study of corporate venture capital investment, or corporate venturing, grounded in these two areas of discussion would be of use not only to geographers, but also to academics and practitioners from a wide range of disciplines. I hope that the results of my efforts to this end, which extend far beyond the investigation of spatial patterns that might be expected from a geographer, will command the attention of the broad audience that I believe this subject matter deserves. Kevin McNally
ACKNOWLEDGEMENTS Downloaded by [37.44.207.145] at 13:16 21 December 2016 I am indebted to a large number of people without whom the completion of this research and the resulting book would have been impossible. I would therefore like to thank: My supervisor Colin Mason, whose enthusiasm, advice, support and patience during the course of my undergraduate dissertation and PhD were invaluable. The ESRC, for its financial support throughout the course of my studentship. All venture capital fund managers, corporate executives and small firm managers who agreed to participate in the research. I hope that my findings have been of use to them and their organisations and go some way to repaying them for their time and information. Everyone who has given me advice and guidance during the course of the research. In particular, I am grateful to William Bygrave, Kevin Caley, Richard Harrison, Ian MacMillan and Hollister Sykes for their ideas in the early days, to Maurice Anslow for a steady stream of up-to-date information on the venture capital industry, and to Gordon Murray, for numerous suggestions during the course of the research. My parents, for their endless encouragement and support in everything I do, and Nick, for being my best mate and helping me to see this through. Good luck in your own PhD! Lauren. Thank you for your love and support at all times. I wouldn t have made it without you. Finally, I would like to thank Taylor & Francis and MCB University Press, publishers of the journals Entrepreneurship and Regional Development and International Journal of Entrepreneurial Behaviour and Research respectively, for granting permission for material previously published in the above journals to be reproduced in this book. Kevin McNally October 1996