October 09, 2005

What motivates a corporate VC?

Until 2004, Intel Capital was probably the sole active corporate VC investing in the Indian technology sector. As I have written earlier, Flextronics with its string of rapid acquisitions of telecom R&D companies in 2004 - quite a few of them, interestingly, with Intel Capital as an investor - has emerged as a significant new player.

2005 has seen the VC arms of Nokia, Cisco, IBM, TI and other hi-tech companies - begin to actively scan the Indian market for potential investments. Add to this, the active investments in by some of the Indian business groups - like the Godrej Group and more recently, Reliance Capital - it certainly seems as if corporate VCs are going to play an increasingly important role in the Indian technology landscape.

In this context, it is important for Indian entrepreneurs to understand the factors that drive corporate VCs vis-a-vis pure financial investors. A recent Knowledge@Wharton article, quoting the work of Gary Dushnitsky from Wharton and Michael J. Lenox of Duke University, provides some useful pointers.

The authors feel "venture capital is an essential tool available to a corporation to increase its innovativeness".
Corporate venture capital is one leg of a three-legged stool whose other two legs are a strong internal R&D capability and strong alliances with academic or government researchers.

Corporations that have stayed the course with venture investing -- DuPont, Johnson & Johnson, IBM and others -- tend to make equity investments in innovative startup companies with strategic rather than simply financial motives, and in time reap both strategic and financial benefits.

While having an VC arm might be good for large companies, start-ups can often discover that having such strategic investors on board may not always be a great idea.
Over the years, many examples have arisen of disputes between entrepreneurs and their corporate suitors over alleged misappropriation of trade secrets during the process of negotiating a corporate investment or acquisition, according to Dushnitsky. He cites a litany of such disputes: Simple.com versus McAfee.com; CardioVention, now defunct, versus Medtronic; a Stanford University professor versus Rockwell International. "The logic is that in these environments, because you cannot protect your idea, more of the technology is likely to be kept secret," Dushnitsky says.

So, when does it make sense for a start-up to go with a corporate VC?
"When corporate venture capital is least likely to attempt imitation," Dushnitsky writes. Based on a matched sample of 258 entrepreneurial ventures and 74 corporate venture capitalists, he concludes that the probability of a relationship between the two parties "decreases if the products are potential substitutes and increases when the products of the two are complementary."

If the products are potential substitutes, "there are incentives for a corporate venture capitalist to behave opportunistically and copy the venture's novel technology," he writes.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.