Historically, corporates have been ardent supporters of innovation and will soon control the growth of the venture capital (VC) ecosystem. A trend that many resist acknowledging.
Before the establishment of large-scale private equity (PE) and VC activity, most of the research capability resided within academia and large organisations. The continuous flow of investment into patented technologies, incremental development and the release of new products to the market have enabled this structural progress.
Over the last three decades, the innovation and business development cycles shortened on an exponential curve, following Moore’s law to a fault.
Considering the ingrained dependency we have on our devices, it is increasingly comfortable to ignore the complexity of the advancements we all enjoy; for example, the 80,000 patented technologies that enabled the infrastructure and 4G networks, or the 200 patented technologies that enabled the iPhone (for more follow this link).
Fast-forwarding, we observe a proliferation of corporate venture capital (CVC) funds across the globe, stages of investment and sectors. Over 50% of all public listed companies have venture arms or dedicated teams. The number of registered CVCs has increased by 66% (from 112 to 186).
The list of most active CVCs remains constant to some extent, compared with previous years, with Intel, GE Ventures, Microsoft, Qualcomm Ventures always making the cut.
2018 could be a record year, for deals and level of investment, a natural trend observed over the last five years (CB Insight Data).
It is clear that Software solutions will continue to have a head start, and their allocation could potentially increase, especially for artificial intelligence and machine-learning-based technologies, which have proven especially sticky, doubling from $2.1 billion in 2016 to $3.8 billion in 2017.
Its sibling, R&D investment, dwarfs the $31bn record achieved in 2017. The first top 10 companies have invested more than $120bn, over four times more than the combined CVC investment for the same period, signalling that actually for the right type of innovation and technology advancement, legacy organisations have plenty of capacity to play. The first top 20 company investments in R&D exceed the whole global VC market.
It is quite likely that this may be the beginning of a reallocation across significant corporations to CVC investments. As M&A activity level reduces, we can expect capital allocation to move earlier in the funding cycle.
Why will CVC activity increase?
To answer this, we need to have a clear understanding of the strategies CVCs adopted in their early-stage activity.
First, for larger corporates, early-stage activity is indeed a cheaper alternative to internal R&D, plus it has the benefit that many of the market variables are already tested, to some extent.
Second, CVCs have more flexibility across their investment portfolio, being able to cross-pollinate, implement complementary strategies, enhance existing product offering, integrate operations and address scaling challenges across regions.
Third and most important, the corporate world has started to observe more stability and balance sheet improvements, at least from 2008–2009 onwards. The sentiment is positive, especially in the context of early and growth investments. The risk and level of funds allocated to such portfolios are negligible compared to M&A or very late-stage activity.
The M&A activity in North America and Europe totalled $2.93 trillion across 19,510 deals in 2017, technology claiming a record 17.8%, according to Pitchbook M&A Report 2017.
It is possible to imagine a future where the M&A activity slows down, a trend which is well underway, as shown below (Pitchbook data).
Counterbalancing this, we could observe the CVC activity picking up. Here are some of the reasons why that may happen:
- in-house, new-found models to incubate, accelerate and at a fraction of the cost – understandably this is a leaner approach, considering the average tech acquisition resides somewhere around $75m;
- an ability to secure controlling stakes in growth companies, influence strategic decisions; and
- an ability to benefit from the regional presence, product coupling, intel sharing, and earnings ahead of an acquisition – in effect, CVC activity bookmarking and pre-vetting future M&As.
Alphabet, Oracle, IBM, Intel and Cisco have engaged in such models for quite a while now, and there is no reason to believe they will stop – quite the opposite, pointing to a shift toward VC-level investments.
Flavia Richardson, Funding London