NVCA Today

By Tom Hawkins, Director, Arcapita Ventures & Dan Lenahan, Associate, Arcapita Ventures

As expected, the Q1 2009 MoneyTree report showed sharp declines in funding activity as venture-backed companies and their investors continued to feel the pinch of the economic slowdown.  With many investors sidelined due to fundraising difficulties and others focused on portfolio management, there are significantly fewer sources of new capital available to companies looking to weather the economic downturn.  In light of the dearth of traditional venture capital funding, companies and their investor syndicates are increasingly approaching strategics in search of corporate venture capital investments and business partnerships.  For many companies, investors have stressed the importance of lowering burn rates to preserve cash until a more favorable fundraising environment emerges.  Often times, this entails a reduction in sales and marketing dollars, placing an even greater emphasis on securing channel partnerships as a means of driving revenues.

Meanwhile, large corporations with established venture capital groups and sound balance sheets are intensely focused on accessing the innovative technologies of more agile startups in the current environment.  "It's teamwork that makes the dream work," states Luis Llovera, Managing Director at Robert Bosch Venture Capital, the venture investment arm of the Bosch Group.  "Innovation never stops and when it comes to seeking out new technologies, Bosch is more active now than we were 18 months ago. Whether the objective is to drive additional revenues through complementary partnerships or to take the next logical step in the extension of our strategic initiatives, the time to attack the market is now."

Claudia Munce, Managing Director of the IBM Venture Capital Group, refers to the existing market dynamic between venture-backed companies and large corporations as the push/pull effect.  "On the push side, we have a large number of venture-backed companies approaching our venture capital group and our business units regarding strategic partnerships.  On the pull side, we are actively working with IBM's business units to refine strategies and identify attractive partners that will help us fill gaps and address white spaces."  IBM's customers continue to demand new solutions, particularly those that offer significant cost advantages.  Energy management throughout the enterprise and green data center initiatives are high priorities.  Another large pool of IT spending exists in the government sector, where the stimulus package has created a wealth of new opportunities.  Time is of the essence, and developing a new capability internally is far less cost-effective than partnering with a company that already has a solution. 

A key shift of late in the relationship between venture companies and strategics has been an increasing willingness of venture companies to accept direct investments from strategics.  In more attractive fundraising environments, some companies may choose to decline investments from strategics out of fear that taking corporate money will limit potential exit opportunities.  Dr. Andrew Jay, Partner at Siemens Venture Capital and Head of the Medical Solutions Fund, is seeing any remaining reluctance to entertain strategic funding fade rapidly.  "The once common misperception that taking a strategic investment limits exit opportunities has all but vanished in today's market."  Siemens Venture Capital has traditionally asked for a right of information with an investment.  If the company is for sale or considering a transaction, management will inform Siemens and give them the right to conduct concurrent due diligence. This clause enhances the potential for an auction process and could raise the exit valuation for the company.  Dr. Jay's fund has never asked for a 'right of first refusal' with a deal as he views it as having deleterious repercussions on valuation.

Siemens, with over $100B in annual revenues, is taking a disciplined approach to spending in the current economic environment.  However, its external search efforts for partnerships and interesting technologies have not abated.  In the healthcare space, investments in molecular imaging and molecular diagnostics present compelling growth prospects for existing Siemens Healthcare businesses as well as opportunities for attractive financial returns.

Another option many companies are pursuing is raising capital from traditional venture funds that are affiliated with larger private equity groups.  Arcapita, Carlyle, Bain Capital, and H.I.G. Capital all have sophisticated venture capital units.  These groups work with their venture portfolio companies to drive business with larger private equity portfolio companies.  John Huntz, Executive Director of Arcapita Ventures, has found this to be a major point of differentiation in the market.  "Although our current venture fund is focused on investing in US-based companies, the broader Arcapita has offices around the globe and manages an equity portfolio in excess of $7 billion.  That message resonates well with companies seeking international expansion and a direct line of entry into a large potential customer base."