Keep it complicated, stupid

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Tom Whitehouse, LEIF (by the way, the picture above is not me. I have more hair and a smaller beard)  

If God had wanted term sheets to be simple he would never have created corporate venture capital. I was reminded of this truth at LEIF’s and GCV’s recent conference on advanced materials investing.

One corporate VC asked the panel, which included SAEV, Airbus APWorks and Pangaea Ventures, for advice on how to incorporate ‘side agreements’ into investments. The questioner was referring to the ‘parent’ of the corporate VC  seeking to combine investment with various commercial terms, such as exclusive rights to sell the technology in a certain region, a stake in ‘process IP’ developed through collaborative development agreements and a right of first refusal when it comes to selling the company.  A thorough and heated discussion followed. Here’s my take on this knotty but fundamental issue for VCs (corporate and financial).

  1. If they’re not seeking ‘side agreements’ then they’re not corporate VCs.

My advice to companies seeking venture capital is to only approach corporate VCs if they’re looking to blend their capital requirements with specific and detailed programme of commercial acceleration. Otherwise, keep it simple and go to financial VCs.  The real value that a corporate VC can add is its ability to develop, prove and thereby commercialise markets to which it has proprietary access.

This looks like the rationale behind Sakti3, a US battery technology business, raising $15m from the UK engineering group Dyson. According to the Financial Times the deal gives Dyson exclusivity to manufacture and use Sakti3’s batteries in its existing products, such as its cordless and robotic vacuums, as well as its new product areas. The Sakti3 investment is Dyson’s first foray into corporate venturing.

  1. But side agreements need to be ‘take or pay’

Technology start-ups can sometimes find side agreements intimidating because they fear either being smothered by a giant business or being forgotten and neglected (following a change of management or some other turn of the corporate wheel).   Start-ups should therefore negotiate some kind of penalty for the corporates if things don’t work out. For the investee, “side agreements need to be ‘take or pay’,” one family office investor told me recently, which is good advice.

  1. Start-ups – keep ‘the juiciest peach’

And to avoid being smothered, it’s best to make sure that the commercial deal with your corporate VC is not your only route to commercialisation. “I generally recommend that our portfolio companies focus on commercialising a product where they actually can penetrate the market and/or hold the ‘juiciest peach’ for themselves,” says Keith Gillard of Pangaea Ventures, the Vancouver based advanced materials VC. Though I don’t know the details of the Sakti3 deal, it’s possible that its juiciest peach is not with vacuum cleaners, but with one of the other several applications for its batteries, such as electric cars or renewable power ‘smoothening’. Interestingly, Sakti3’s other corporate VC is GM Ventures.

  1. Start-ups – allow time

I’m surprised when technology businesses think they can raise capital off corporate venture capitalists in less than a year. The time to start looking for capital from corporate VCs is at least a year from the date when you really need it. Why? Because you need this time to negotiate the side agreements.  “My advice to companies seeking money is that if you want money fast, don’t approach us,” says Nuno Carvalho, head of venturing at Bekaert, the Belgium-based steel wire transformation and coatings business.  “A [Bekaert] business unit has to assess a technology before the venture professionals like me can really start our work in earnest,” he adds.

  1. But ROFRs are a no-no

If a corporate VC tries to insert a right of first refusal (ROFR) in its terms sheet, a start-up should run a mile. A ROFR gives its holder the option to enter a business transaction with the owner of something, according to specified terms, before the owner is entitled to enter into that transaction with a third party. This can kill any competition to buy the business from other parties, leaving any financial VCs and shareholding-management, with lower returns.

  1. Corporate VCs should demonstrate their independence

A good corporate VC is more likely to win over a potential investee business by citing examples of when it has either sold its portfolio businesses to parents’ competitors or negotiated highly commercial teams for sale to the parent (which happens, but is rarely talked about).

I hope to see you at the GCV symposium in June, where I may be touching on some of these issues in the two sessions I’m moderating; ‘Collaboration within the corporation’ (with BP and BP Ventures) and a break-out on advanced materials venturing with Pangaea and others.

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