In our first article, we considered some of the reasons that companies might embark on a corporate venture capital (CVC) programme, and some of the factors they should consider before doing so. In this article, we look at some of the challenges that arise from early interactions between CVC investors and investee companies, and suggest some ways in which they can be overcome.
Large companies and small companies work together all the time, and get along just fine. But there is a huge difference between ordinary business interactions and the investor/investee relationship at the heart of CVC. Getting things off to a good start is essential, but for a large company embarking on a CVC programme, the opening moves can sometimes be disorienting and unfamiliar.
Here are a few of the common challenges that we observe at the interface of large companies and early stage businesses, in the context of CVC:
- It’s different from M&A: many companies who set up CVC units understandably (and quite sensibly) turn to the business development executives and lawyers within their organisations who are most familiar with corporate transactions. This tends to be the M&A team. There’s nothing wrong with this, but whereas M&A can be more of a one-off, zero sum game, a venture capital investment is the beginning of a relationship that can last for many years. Venture deal terms have significant and long-lasting implications for both parties, and an understanding of how these deal terms work, and why they matter for each side, is important to ensure that negotiations proceed smoothly. A good feel for current market practice, and an awareness of the variations that exist in different markets, is also very valuable.
- Preparation is key: entrepreneurs will respond best to a process that is run to a tight timetable, with steps that are predictable and communicated well in advance. Delays or unforeseen requests can be very disruptive to early-stage businesses, many of which are run on extremely lean budgets and with little slack in their teams. It’s therefore important to be clear at the outset about expectations for financial and legal due diligence (what will be required, by when), key deal parameters (including any institutional “red lines”), and the timing of any back-end approval processes. For example, large corporates can sometimes take for granted the fact that that an investee company will be happy or able to wait for [X] days while a final sign-off process is completed at the end of negotiations. This may not always be the case, particularly where cash is running low. Equally, in a founder-led business where one or two people make all key business decisions, their uninterrupted availability throughout the deal process can’t necessarily be assumed.
- Entrepreneurial companies don’t necessarily behave or “think” the same way as large corporates: and nor should they. If an entrepreneurial individual or team has generated sufficient interest in their business to attract a corporate investor, they are likely to be doing something quite special, and to be highly focussed on it. A venture capital transaction will be an important event for them, but not necessarily one that they have done before, particularly if the business is relatively early-stage. Coming to the deal process for the first time, an entrepreneur may want to negotiate deal terms from first principles, and in doing so may raise points or make requests that the CVC investor finds surprising or difficult to reconcile with market practice. Here, we tend to find that it is important to explore the middle ground between accommodating or negotiating every such point or request, and simply “steamrollering” the entrepreneur with market/investor-standard documents. The former approach can result in a very protracted and difficult process which the CVC investor ultimately walks away from; the latter can be equally negative, especially if it results in a transaction where the entrepreneur needlessly feels that they have been forced into a bad deal. Often, a little creativity and willingness to compromise can result in an outcome that feels like a good deal for both parties.
- Know your counterparty as well as you know their business: in the entrepreneurial environment, boundaries between work/life and the personal/professional are rarely as well-defined as in the corporate environment. CVC investors can therefore be surprised by the degree to which negotiations with entrepreneurs can become emotionally charged. It is important to realise that entrepreneurs will have invested years of their lives, often at significant personal and financial cost, in building a business to the point where it is attracting external investment. Any CVC transaction will likely be a significant milestone in their journey towards a successful outcome. It’s therefore understandable that individuals can become quite impassioned in the course of negotiations, and/or take deal points somewhat personally – after all, it is often literally “their” company. In our experience, it is essential that someone within the CVC investor’s team spends time building a solid relationship with the entrepreneur, developing trust and a good understanding of what drives him/her and what he/she really cares about. Often, when negotiations get bogged down or stuck, it is simply because there is a lack of mutual understanding about what is really in play for each side.
- Things work best when the decision-makers are in the same room: an entrepreneur ought to be committing a significant amount of their own time to the deal process. They will often be the principal negotiator and want to be present at all key meetings/calls to drive things forward. In our experience, it is important that this level of commitment is reciprocated by sufficiently senior members of the CVC investor’s team. Entrepreneurs can quite understandably become frustrated if the counterparty to any conversation is unable to agree positions or take decisions without constantly sending things back up the chain of command for approval. We tend to find that the most successful CVC investors have relatively lean reporting structures, with investee-facing team members who have authority to trade points with entrepreneurs in real time (within appropriate parameters).
As so often in life, the key to getting a CVC relationship off to a good start seems to lie in a mixture of good preparation (with the right team in place), a willingness to understand the point of view of the other party, and being prepared to be creative and come up with solutions that each party feels are “wins”.
The corporate team at Bristows LLP advises the CVC units of some of the world’s largest corporations, as well as new entrants to this growing market. For more information, contact Marek Petecki.