The German management consultancy group Mackewicz & Partner recently concluded a second study on venture capital.
In an earlier study, Equity Partnerships in the Medium-sized Capital Goods Industry In Germany, Mackewicz & Partner showed that the German development finance market had not yet reached a stage of maturity sufficient to prevent German medium-sized enterprises falling further behind their international competitors. In parallel, the study confirmed that Mittelstand managers were insufficiently aware of the potential of private equity as a funding instrument.
In the new study, Venture Capital and Corporate Venture Capital: Financing Alternatives for Innovative Start-ups and Young Technological Companies, “venture capital” refers to early-stage private equity capital allied with intensive support – in other words, investment following the US model, rather than the bank-dominated private equity which Mackewicz & Partner says is still the norm in the German market. It may be this aspect of Germany’s private equity industry that leads the consultants to describe venture capital – perhaps a trifle unfairly – as “an avant garde subject for Germany”.
The study, which originated as a project for Deutsche Telekom, focuses particularly on corporate venturing, still a relative rarity in Germany and, indeed, in Europe as a whole. The following article has been condensed from the last of the study’s four chapters, Venture Capital and Corporate Venture Capital as an Alternative to Bank-Dominated Private Equity.
A dynamically growing company can only be financed with suitable investors.There are some noted early-stage investors active in Germany, among them TVM Techno Venture Management, Technologie Holding, Atlas Ventures, LBB Seed Capital Fund and Apax Partners & Co. However, despite the presence of such groups, and the important roles played by the Technologiebeteiligungsgesellschaft, the technology investment division of the Deutsche Ausgliechsbank, and the state-owned development bank Kreditanstalt fur Wiederaufbau, the study’s authors believe that the number of venture firms able to provide young technology-based companies with both the financial support and entrepreneurial advice required for optimal development is insufficient for the market’s needs.
Further, they believe that, if a sustainable platform is not created for financing young, innovative companies, there is a danger of Germany losing its international competitiveness.
The Corporate Venture Capital Alternative
It is therefore worth considering how financing alternatives can be provided. The provision of corporate venture capital by industrial companies can represent a viable source of financing. Industrial companies have the potential to give innovative companies a helping hand in terms of capital and expertise, and this could go some way towards solving Germany’s unemployment problem.
Mackewicz & Partner beleives that that the characteristics of large and small companies can be combined advantageously and that companies in the following areas are most likely to have this potential:
* IT and communication technology
* Telecommunications
* Microelectronics/electronics
* Chemicals and biotechnology
* Energy supply
* Automobile construction
The objectives of industrial companies which provide venture capital illustrate the clear difference between corporate and “classical” venture capital. While institutional investors are mainly concerned with anticipated profits (returns on investment), industrial companies are motivated primarily by strategic goals.
There are four basic models for industrial groups’ investment in young, innovative companies
* Direct investment in promising companies
It is nothing new for large companies to invest directly in smaller, innovative enterprises: for decades, industrial companies have sought to obtain advantages for their businesses by investing in smaller companies in this way. This type of investment is presumably responsible for some reservations on the part of small innovative companies regarding industrial groups as investment partners. In view of this factor, it is important to lay down joint goals, and the ways of achieving them, clearly.
For example, some years ago BMW invested in Softlab and Kontron. From a venture capitalist’s point of view, these ventures had very uncertain prospects of success. The motivation and dynamism of the small companies slackened off noticeably as they became increasingly dominated by BMW.
By contrast, BMW has adopted a more “arms’-length” approach towards another investee, the ASIC manufacturer Elmos, which has been developing successfully.
* Investment in an independent venture capital fund
International Venture Partners (IVPC), founded in 1983, should be mentioned in this context. It was established as a result of the efforts of Dr Klaus Nathusius and Dr Thomas Kuhr. WC Hereaus assumed the role of lead investor, contributing both know-how and capital.
Other investors in IPVC included Johnson & Johnson, Westinghouse Electric, Olivetti and ELF Acquitaine. The fund has now come to the end of its life and IVPC has ceased operations.
In a sense, though, it has been succeeded by TVM-Techno Venture Management, which was established in late 1983 and has just raised DM150 million for a third venture fund, which includes corporates such as Austrian Industries, Bayer, Boehringer Mannheim, ELF Acquitaine, Mannesman and DASA among its investors.
In general, industrial groups that have agreed to invest in venture funds are not homogenous. Investment in an external fund is perceived as a good means of gaining experience of venture capital as an instrument.
* Establishment of an “intrapreneurship programme”
Such programmes aim mainly to foster entrepreneurship within an individual corporation. Employees from the R&D department are thus encouraged to pursue certain ideas and development avenues, the costs of which are covered by the group. There is normally little awareness of such initiatives outside the corporations concerned. In general, unlike direct investment or investment in third-party venture funds, intrapreneurship is not believed to provide much momentum for the dissemination of new technologies.
* Establishment of a stand-alone independent venture capital operation
US industrial companies are pioneers in supporting small companies in this manner.
Among the US’s pioneering corporate venturers are Dupont and Montsanto. Microsoft, AT&T, Xerox Venture Capital, Amoco Venture Capital, Hewlett-Packard Company Corporate Investments, Sears Investment Management Company and Caterpillar Venture Capital are further examples.
All in all, over 100 large industrial companies in the US have been able to gain experience with venture capital.1
Pioneers with Independent Corporate Venturing Units Operating in Germany
In Germany, Siemens is one of the few industrial companies to have both an investment fund and its own venture capital firm.
One of the country’s most recent examples of corporate venture capital provision is Heidelberg Innovation GmbH & Co Bio Science Venture KG. This initiative brings together 20 LPs, among them corporations active in the biotechnology field such as BASF, Boehringer Mannheim, Knoll, Merck and Abshagen Consulting.
Bayer also recently formed its own venture capital firm, aiming to integrate external research and development resources into its own innovation process.
Daimler Benz recently established Daimler Benz Venture to encourage innovative start-ups.
The recently merged groups Badenwerk and Energieversorgung Schwaben have been investing since last year in early-stage companies via Innotech GmbH.
Meanwhile, SAP plans to set up an investment fund for young technological companies in its own product area. The software company will pay particular attention to providing support for marketing, sales and administration, areas where SAP believes investees are likely to experience difficulties.
SAP places clear emphasis on strategies for exiting, and has set itself the goal of establishing healthy companies capable of reaching critical mass and surviving using their own resources thereafter.
An impressive example of combining strategic and financial interests to the advantage of both parties can be seen in the co-operation between PentaTec and DOMED. PentaTec, a DASA spin-off, invested DM50,000 as lead investor in the DOMED start-up in the form of a typical “sleeping partnership”. Its aim was to gain entry into the area of medical technology with its integrated hardware and software solutions.
DOMED profited from the partnership by obtaining the funding it needed (from PentaTec and Bayern Kapital) and by acquiring a partner for technical development and market introduction.
Beyond this, Mackewicz & Partner has to date only encountered clearly formulated corporate venture capital activities in the form of an independent stand-alone firm, Jahr Beteiligungsgesellschaft. This venture capital company aims at long-term majority shareholdings for diversification purposes, rather than seeking windows on technology in the areas of its own core activities.
With regard to other parts of Europe, it is worth mentioning that France Telecom has invested approximately DM120 million very successfully in 77 companies via its independent venture firm Innovacom. Innovacom has been operating for ten years and focuses on early-stage and growth financing in information and communications technology, software and electronics.
It is widely acknowledged that the market for early-stage financing in the UK is relatively small in comparison with its position as Europe’s largest single private equity market. However, early-stage financing is also on the move in the UK, as demonstrated by, for example, Microsoft’s activities in Cambridge.
The Deutsche Telekom Model
Drawing on the experience of other corporate venturers internationally, Deutsche Telekom has developed a new investment strategy for Germany (Table 1).
The Deutsche Telekom corporate venture holding model is characterised by a dual investment policy of direct investment in suitable young technological companies (50%-100% owned subsidiaries supervised by their own investment managers) and indirect investments in independent venture capital funds.
This way, Deutsche Telekom benefits from the advantages of both investment alternatives.
T-Telematik Venture Holding (T-Venture) will provide young technology-oriented companies with both capital and entrepreneurial know-how. According to Deutsche Telekom, T-Venture will mainly invest in companies at an early stage of development that need capital to realise innovative ideas – products, processes, applications or services. Follow-on investments will be made to take companies to the first expansion phase (i.e., increasing production capacity, entering new geographic new markets, etc.).
Perceptions of Corporate Venturing
Investments by large companies in young innovative ventures were often criticised in the past because too much influence was exerted on the smaller company’s business policies.
Mackewicz & Co asked the smaller companies in the research sample what general reservations they had about raising equity backing and how they perceived the alternative of equity from industrial companies in comparison with “institutional” venture capital.
The companies were particularly concerned about losing their entrepreneurial freedom and were also doubtful about how to identify an appropriate partners.
However, the similarity of the companies’ evaluations of industrial investors and institutional venture firms (Table 2) showed that corporate venturers are viewed more positively by young innovative companies than public discussion of the subject to date has suggested.
This comparison is also interesting with regard to the management support provided by different types of investor. Responses concerning the importance of additional services showed that companies require their equity backers to make valuable contributions from their investment partners in the following areas:
* Procurement of additional financing
* Recruitment of personnel
* Enhancing their image with customers, suppliers and banks
* Support insetting up control systems
* Support for stock market flotation
Industrial companies were perceived to provide far better management support for operations than venture capital firms (Table 3). Small companies find professional support in operational areas particuolarly beneficial because of their weakness in marketing, sales and business know-how.
Venture firms, however, were given a better evaluation in the areas of procurement of further financing, support for flotation and enhancement of image.
Looking at the criteria which smaller companies consider strategically important for their ultimate success, it appears that it is better for small, innovative companies to enter a partnership with a venture firm belonging to an industrial company (Table 4).
Small Companies and Corporations Can Complement One Another
The particular characteristics of industrial companies with significant financial power, established market position and ample human resources – but also with a lack of flexibility – complement those of small companies with motivation to achieve and the willingness to innovate and take risks. Small companies are distinguished by their short decision-making routes, efficient internal communications and closeness to the market. Although industrial companies and young innovative ventures have different objectives in an investment partnership, both parties can capture and benefit from the powerful synergies created.
Industrial companies hope to achieve the following through their involvement with venture capital:
* Strategic advantages through long-term co-operation with companies with leading-edge technologies and products. Establishing contact with emerging technologies at an early stage was always one of the key factors driving the foundation of corporate venturing units in US industrial groups.
* In addition, a corporate venturing firm can help its parent identify attractive new business areas and suitable joint venture or acquisition candidates.
* The closeness of large companies to the young and innovative technology companies in their venturing portfolios provides a window on technology that enables the corporations to get to know new markets as they come into being.
* This experience can also help the corporation grow through the introduction of new products or services into existing markets.
* Corporate venturing can encourage start-up potential within the parent corporation and support promising in-house product developments.
* Venture capital activities can also help the investing corporation achieve marketing objectives (public relations, corporate identity, image) and contribute towards job creation.
* The attractive returns on investment that can be achieved on exiting corporate venturing investments are also an important factor.
Meanwhile, stand-alone and independent corporate venturing firms can be of inestimable value to young companies in the following ways:
* They act as flexible financing partners, providing the necessary equity resources and helping to extend credit lines with banks.
* They provide support in different areas of running the company, especially in marketing and sales.
* They can provide access to their customer base and help turn innovations into marketable products.
* They can help enhance the image with customers and suppliers.
Conclusion
Industrial companies, because of their closeness to the market and practical experience, are often able to evaluate opportunities and risks associated with planned innovations better – and faster – than institutional investors. The prerequisites for this are well-functioning transfer methods and a clear definition of interfaces between the venture capital unit and other areas of the industrial corporation.
An institutional venture capital firm has to plan fast growth for the venture company and a short-to medium-term exit from the investment. Corporate venture capital firms tend to adopt a more long-term approach and can plan for longer investment horizons. Because of the strategic objectives pursued by industrial companies with venture capital involvement, earnings targets are usually lower than for institutional investors.
In Mackewicz & Partner’s opinion, successful corporate venture capital activities have to fulfil the following criteria:
* The formulation of clear objectives with a focus on strategic interests (windows on technology) in conjunction with financial interests (integration into overall company goals; increasing shareholder value). The corporate venturing firm should adopt a policy of minority participation and use suitable investment agreements to indicate to potential investees that it will act in the common interest of all parties.
* All parties involved, the industrial corporation, its corporate venturing firm and the investee, must set themselves realistic goals and face the fact that the investee will need intensive support from qualified investment managers.
Table 1:The Dual Investment Strategy Adopted by Deutsche Telekom AG
Deutsche Telekom AG
100%
Telematik Venture Holding GmbH
Indirect investments Direct investments
(various independent funds) (via subsidiary funds)
* Additional information on market
and technology trends via
increased deal flow * Limitation of liability because
of low company capital
* Contact with high-tech companies * Flexibility in ownership
structure
* Contact with other fund investors * Possibility of establishing
distance between investment
fund and parent company
* Use of venture capital funds
international networks * Orientation as profit centre
* Co-investment opportunities * More neutral representation
to the outside world
* Additional acquisition opportunities
in funds’ investment portfolios * Main emphasis on success of
investment fund rather than of
individual investees
* Possibilities for personnel
development * Realisation of different
acquisition strategies
* Mixture of risk in portfolio
* Enhanced access to government
subsidisation programmes
* Improved marketing to target group
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