CVCs are usually structured as separate venture capital entities, with a single LP, the parent corporate. They have a defined investment thesis and their areas of investment focus are usually strategic and around the sectors and adjacencies that the parent corporate is involved in. In this article, we will cover the following topics - (i) Typical structures of CVC entities, (ii) Deal sourcing and pipeline, (iii) Decision making, and (iv) Compensation.
Structure
While CVC investments grew by around 15% in 2017, it is interesting to note that direct corporate investment has outpaced CVC investments, and grown by over 42%. Some CVCs like Cisco and Citibank do not have a separate CVC entity, but prefer to do direct balance sheet investing.
The most common CVC unit structure (41%) is to draw money from the parent company each year with a dedicated team and operating budget. 42% operate either as (i) a completely separate entity (16%) or (ii) through an LLC or off-balance sheet with an annual investment budget (26%). Only 17% rely on obtaining investment funds from the parent company on an ad hoc, case-by-case basis.
Source: Pitchbook-J.Thelander Report, 2017
In principle, CVCs are not constrained by the typical VC fund life of 10 to 12 years. Surprisingly, CVCs appear to be temporary divisions that have shorter and non-uniform life cycles. When defining CVC termination as stopping the search for new startups, the duration of the CVC life cycle is around four to six years.
Deal Sourcing & Pipeline
The quality of deal sourcing is key to the success of the CVC. Whether the CVC is focused on financial or strategic returns, volume and quality are two important variables to be considered. High volume is necessary since many startups that seek funding will not meet the investment criteria of the CVC.
Some ways in which CVCs source deals are
(i)Institutional venture capital firms: Building relationships with them is one of the most important ways to increase deal flow. These firms have established networks and a strong high quality deal flow pipeline. Many of the deals that pass through may be relevant to the CVC and often these deals can be syndicated.
(ii)Accelerators or Incubators: Many companies have internal startup accelerators or access to external accelerators that operate in the same space. These are good sources for proprietary early or seed stage investment deals that have strategic fit, since there has already been some internal vetting conducted by the accelerators and only high-quality startups are selected. With these, you can track the execution and traction of these startups.
(iii)Research platforms: Many firms have teams of analyst who scour through various startup research platforms (like Pitchbook, CBInsights, Crunchbase, etc), informal networks and referrals to identify the startups which they feel would be the right fit to support.
It is said that founders make the best VCs, since they are best positioned to determine who has a great model, knows their customers, and has the grit as an individual to build a great business. In the words of Victoria Fram of Village Capital - “You can’t just set up shop, build a website that accepts applications and expect opportunities to come pouring in. It takes building a team that is really intentional, and that will go out and find high potential founders, no matter where they are or who they are.” (Forbes, 2018)
Sean Jacobsohn of Emergence Capital in his 2014 Venturebeat article about the deal funnel says, in order to make 10 investments, the average venture capital firm reviews approximately 1,200 companies. These 1,200 come from network introductions, conferences, in-bound inquiries, proactive efforts, portfolio company referrals, and seed investors. Of the 1,200, approximately 500 lead to face-to-face meetings with someone on the investment team. Yet only 10 percent progress from that stage – i.e. the firm may perform due diligence on approximately 50 companies in a year. Due diligence consists of a product review, customer references, executive team references, financial modeling, market analysis and competitive analysis. Post the due diligence, term sheets would be issues to around 10 companies.
Source: Kapur, How VC Funnel works, 2017
While investments grow at CVCs, the partners at CVCs often cannot make investment decisions independently (there are of course some exceptions). They need to consult with senior leadership, business units, and various internal stakeholders of the parent corporate, who contribute to both the diligence process and final approval. While this usually improves the probability for the CVC to get buy-in for post-investment internal collaboration, it can also result in a deal not getting done. The more complex the approval process, the longer the time from initial meeting to funding, an important consideration for entrepreneurs that are contemplating CVC capital. CVCs usually work to get approval (from the first meeting) within 2 months, with a 2-4 month turnaround, and around 4 months to come to a decision. Of course, this is also subject to size of investment and stage of company. (CBInsights, Inside CVC minds, 2015)
Source: CBInsights, Inside CVC minds, 2015
It is important for the CVC to have a sound investment committee which has the requisite expertise to be able to take the right decisions for the CVC, especially in the context of strategic investment thesis of the CVC and pairing it with the long term goals of the parent corporate. A good mix is of senior people at the parent who understand the corporate culture, strategy and long term goals and seasoned investment professionals who have credibility with the parent corporate executives.
A major challenge however continues to be the frequency of senior management rotations and executive sponsors for the programs, who are often the lead sponsors for the various deals that are brought forward by the CVC. This churn often results in CVC program reviews, especially changes in reporting structures and often slowing the CVCs investment momentum and long term goals. However, a good (albeit recent) development is that the investment talent available at such CVCs has improved significantly, since the compensation gap between talent at CVCs and institutional VCs has reduced.
Compensation
There are usually 3 components to the compensation paid out to people working in VC – Salary, Bonus and Carry. Salary is usually paid out of a fund’s management fees. Most VC funds will charge a 2% or 2.5% management fee for the active investment years. Smaller funds will likely have lower or nil management fee percentages. Bonus is not as common, but several firms do pay this annually, albeit not a large number like in investment banking. Carry is the percentage of investment profits (often 20% or higher) that the partners in the VC firm get paid in addition to fund management fees, and typically does not get assigned to junior members of the team. “Carry” is typically only realized after the limited partners in the fund have received an amount equal to their invested capital back. There are many nuances to carry distribution, with some firms employing different mechanisms such as “cliffs” and “accelerations” to incentivize partners and/or lower level employees to remain at the fund longer. as a general rule of thumb, most mid and low-level employees at a fund do not earn much carry.
Vice Presidents and Principals at VCs usually get around $250,000 in yearly compensation, while corresponding talent at CVCs got around $175,000. Senior associates at VC firms get an average of $190,000 in total compensation, while counterparts at CVCs get $150,000. Junior associates at VC firms get an average of $130,000 in total compensation, while counterparts at CVCs get $140,000. Analysts get paid around $60,000 to $80,000 annually. (Gannon, 2018 VC Salary Survey) There is inevitable friction in balancing CVC compensation and career path opportunities between established corporate HR bands and external venture and VC risk-reward structures.
Building stable, long-term, professional CVC teams creates compensation and HR challenges for corporate parents who are increasingly forced to compete externally for the ‘right’ mix of talent in a pool comprised of talented internal resources as well as CVCs, VCs, Private Company and Private Equity personnel. The chart below captures the sources of competition for CVC investment talent.
Source: Pitchbook-J.Thelander Report, 2017
Pitchbook along with J. Thelander Consulting conducts an annual survey of CVC compensation. The 2017 CVC survey provides data from more than 228 CVC executives representing 160 leading programs at Global 2000 corporations. The survey shows that CVC unit leaders earn, on average, $328,160 a year plus $163,000 in cash bonuses; with a maximum exceeding $1.5 million. Although the performance of the corporate parent continues to be an important factor in determining annual bonus, in 2017 nearly two-thirds of companies reported individual and CVC team/portfolio performance to be equally important factors. Supplemental individual bonuses paid in the form of (3-year) vesting RSUs can enable corporations to offer predictably competitive packages relative to comparable roles with institutional investors. Team and portfolio performance against the CVC charter (strategic and financial metrics) is also getting factored in overall bonus structures. (Pitchbook-J.Thelander Report, 2017)
Increasing efforts are being made to define and reward individual/unit performance beyond deal sourcing/closing and traditional financial metrics (e.g. IRR, Exits). respondents also said they were granted options or shares (in the form of Restricted Stock Units ‘RSUs’) in their corporate parent in addition to the cash bonuses. This structure closely emulates the risk/reward dynamic for individual and teams in the external venture world. Around 15% of the survey respondents also reported some flavor of carried interest program to calculate ‘shadow’ or ‘phantom’ carry as a component of non-cash CVC compensation. (Pitchbook-J.Thelander Report, 2017)
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