How Do Corporate Venture Capital Back Acquisitions Create Value for Acquiring Company?

[How do corporate venture capital back acquisitions create value for acquiring company?]

Abstract:

Corporate Venture Capital (CVC) is equity or equity linked investments in young privately held companies where the investor is a financial intermediary of a non-financial corporation. While there are many entities, that offer finance for entrepreneurs such as banks, venture capital, IPO and others, CVC differs from them in the sense that its involvement is deeper and closer. The CVC may be used to invest in a venture not only for financial prospects but also for many other reasons like education and training and to achieve strategic objectives. Differing from other funding vehicles, CVC attempts to add value to the acquisition by using a variety of means. Thus, if there is no accountability expected from the venture on how the funds are being used, this would lead to a very unhealthy situation. The paper has examined the issue of joint control and cash flow in detail.

Introduction:

Corporate Venture Capital (CVC) is the "purchase of mostly minority equity positions in independently managed start-ups or growth companies by an established corporation." CVC is a significant form of financial intermediation and its study is important since it is widely used in different industries; it has had its share of success and failures in leveraging enhanced productivity and benefits. In 2000, in US, the absolute level of CVC investments was at 21 billion USD, out of which 17.4 billion USD was invested in start-ups and the remaining 3.4 billion USD were invested indirectly by non-financial corporations and committed to VC funds as limited partners. Some prominent companies such as Dow, DuPont, Ford, General Motors, Exxon, and others started CVC activity in late 1960's. There are more than 240 CVC companies across the world and there is a strong pitch towards funding Internet enabled services and technology companies, software and communications (Poser, 2003).

Despite the growing importance of CVC, the VC industry has received less academic scrutiny than other parts of the financial sector. The latter applies in terms of theory and in terms of empirical investigation. From the theory perspective, the most fundamental question to ask about the venture capital industry is why it exists at all. Why have a set of specialized firms that focus on financing the entrepreneurial sector? Even if there were no dedicated venture capital firms, a combination of commercial banks, investment banks, private investors, and stock exchanges providing the necessary intermediation could still be imagined. In fact, among entrepreneurial firms, most finance is provided by banks and private investors (including family members), and many young entrepreneurial firms "go public" on stock exchanges without first seeking venture capital finance.

Too often CVCs are created and funded to drive the highest levels of ROI and IRR on new ventures, yet there are many more facets to successfully managing a portfolio of emerging businesses than relying on financial measures of investment performance alone. Too much reliance on financial performance alone can lead to stifling the innovation necessary for growth to occur. There instead needs to be a balance between financial systems and strategic objectives, using a framework that also promotes agility of processes linking the effects of competitive advantage on valuations. This paper will attempt to examine the different ways of managing the cash related ventures with the respect to various controlling forms.

Research Question:

CVC involvement in ventures extends to more than just providing capital and finance. They get involved at a much more intense level than other funding entities. This study will attempt to examine the role of CVC and provides a conceptual framework for the study. In addition, it will attempt examine the financial investment pattern of CVC to understand how finance is disbursed at various stages of the project. From the wide reasons as to how CVC infuses value to the venture, how joint control and cash flow best help to add value to san enterprise. Previous literature has focused on specific areas such as finance, sales and marketing, productions, etc. but this paper provides a unique and integrated encapsulation for different theories and provides a definitive view on how CVC adds value to a venture.

The existence of CVC industry is explained by the presence of high risk in the sectors it targets. Despite the fact that this explanation is unsatisfactory, the existence of specialized, relatively small VC firms should be an anomaly. Amit et al. (1997) suggest another hypothesis to explain the existence of this industry. They postulate that VC firms exist because two types of asymmetric information are present when an outside investor signs an investment contract with a firm: hidden information and hidden behavior. Hidden information exists when the entrepreneur has better knowledge of the firm's prospects than the investor does. This type of asymmetry may result in the phenomenon of adverse selection, in which projects with less potential dominate the market. Hidden behavior, which is generally associated with "moral hazard," occurs when the investor cannot monitor the amount of effort supplied by the entrepreneur.

CVCs provide finance to upcoming and unknown companies and provide them with the required finance and support to get them started (Dushnitsky, 2005). Maula (2001) has defined CVC as "equity or equity linked investments in young privately held companies" where the investor is a financial intermediary of a non-financial corporation. The main difference between venture capital and corporate venture capital is the fund sponsor. In CVC, the only limited partner is a corporation or a subsidiary of a corporation. While seed money is one of the key driving forces and the means to get a business rolling, the involvement of CVCs is not limited to only providing finance and then taking a backseat like a silent partner and wait for results to come in. CVCs on the other hand take an active interest in the company they have invested in and add value to it.

The research question that this study will attempt to answer is "how do corporate venture capital back acquisitions create value for acquiring company?" While ample literature is available on the manner that CVCs function and the benefits that they provide, a single published work that provides empirical evidence on how they add value has not been published. This paper will conduct an extensive literature review to explore the extent of involvement

...