In the wake of the dot-com crash and the global financial crisis, many corporate venture capital firms ran for the hills with their capital, earning a reputation of being fair-weather VC investors, but this time might be different.
Since then, CVCs have significantly increased their presence in VC deals with their participation in global rounds rising by 462.5% in the 10 years ending in 2021. Firms like Coinbase Ventures and GV have found themselves among some of the most active investors in VC deals in recent years. But as a new downturn hits, many investors are wondering if the past will repeat itself.
“Everybody’s hurting, so of course CVCs are pulling back, but they are behaving more similarly to their institutional peers than ever before,” Touchdown Ventures President Scott Lenet said. “A few will quietly ‘press the pause button,’ but they are not abandoning ship like they did in previous downturns.”
So far, the data suggests that CVCs are retrenching quicker than traditional VC investors but not altogether retreating from the asset class. In Q2 2022, CVCs participated in 2,167 deals worth an aggregate $53.1 billion, according to PitchBook data, a quarter-over-quarter decline of 18.9% and 33% respectively. In comparison, the number of rounds closed featuring just traditional VCs saw a QoQ decline of 10.3% over the same period.
A key difference in CVCs’ behavior in this downturn compared to others is that they have become much more sophisticated in how they approach investing, Lenet said.
In the earlier days of corporate venture, most of these investors were more focused on their parent companies’ priorities rather than those of the startup, even including terms in deals allowing them to block acquisitions to competitors or IPOs if they didn’t align with the former’s interests. As their activity increased, and to improve their image with the wider community, CVCs have modeled themselves after traditional investors, becoming more financial-first in their approach in order to receive solid returns as well as strategic value.
The extent to which CVCs slow their investment activity may not reveal itself fully in the short term due to their structure. Most corporate arms operate out of evergreen funds, with their parent company allocating predetermined amounts of capital at set intervals. With a budget having already been set before or in the early stages of the downturn, CVCs still have plenty of dry powder to invest and don’t have the same fundraising concerns as traditional VCs who are reliant on LPs to replenish the coffers.
However, if the downturn persists and recession hits, we could see a further pull back in activity, said Matthew Gilmour, corporate finance manager at accounting firm BDO‘s growth advisory team. With more pressure on corporations to shore up their balance sheets, they could cut the amount allocated to venture activities in the next annual budget.
“A recession naturally means that the focus will be more on the core business away from riskier projects like venture,” Gilmour said. “You’re more likely to make stable returns off large capital projects than [investing in startups] and I think the bar could be set higher for investments than before.”
The CVCs who are more likely to step back from venture will most likely depend on how their parent company’s core business is performing, Lenet believes. Corporations that are highly reliant on consumer spending or offer products and services that are seen as non-essential could tighten their budgets as revenue contracts.
“If you have the cash on the balance sheet, and it’s financially responsible to continue with the same rate of capital deployment, then they will invest,” Lenet said. “But if your revenue is shrinking and you’re worried about cash, then I think those companies will question whether it’s the right type of thing for them to do. It also depends on how much they perceive a need for external innovation.”
A deeper downturn could not only affect the investment activities of existing CVCs but also the creation of new ones, according to BDO growth advisory director Adam Baron. Only four new corporate venture arms are on record to have launched so far in 2022, according to PitchBook data, compared with 42 in 2021.
“I spoke to a company that was supposed to launch a corporate venture arm last month and that’s been pushed back because 20% of their market cap has been wiped out,” Baron said. “With the current environment, I think venture has fallen down the list of priorities for a lot of companies.”
While Baron believes that new CVCs may be launched at a slower pace, corporations with a clear strategic and financial purpose will still go ahead with plans but will perhaps wait and see how the next few months will play out before jumping in.
The natural instinct when the economy becomes more challenging is to become more defensive, but investing in innovation can give corporations an advantage during a crisis, Gilmour said.
A well-defined and managed CVC program offers valuable market intelligence to see where an industry is heading and how it can be disrupted. It can also be a powerful way to accelerate a company’s digital transformation by giving larger organizations access to new technologies. With depressed valuations and less competition for deals from investors like hedge funds, which have largely fled the market, it can be a buyers’ market for CVCs looking to put their capital to work.
The continued participation of corporate investors is also vital for startups, Lenet said. With trickier times ahead, it is even more important to have board members that have experience in building and running a successful business, as well as giving startups access to services that are beyond the remit of traditional VCs.
“For the most part, VCs are there to write checks and give advice, but corporates can potentially do a lot of things that they can’t,” Lenet said. “Corporates can bring revenue, distribution and product expertise, which leads to getting the product out to market and reduces risk. They’re effectively forms of non-dilutive capital which you need in a downturn, providing a unique competitive advantage to startups.”