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Microsoft and Dell corporate VCs: Our days of being second best to Silicon Valley investing firms are over

Key Points
  • Corporate venture capital activity reached historic highs in 2018, with $53 billion invested across 2,740 deals, according to CB Insights.
  • 264 new CVCs invested for the first time in 2018, an increase of 35%.
  • While VC arms at firms including Microsoft, Dell, Google and Salesforce are now among top VC investors, the corporate VCs still trail Silicon Valley in access to the hottest billion-dollar unicorns. 
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Bad reputations can be hard to ditch. Sometimes, they are even deserved. Corporate venture capital — efforts by major companies to competitively invest in start-ups versus the famed Silicon Valley financial VCs — is one such example. CVCs don't deny it. They admit the lack of faith even extended to within their own organizations.

"CFOs hated corporate venture capital," said Nagraj Kashyap, corporate v.p. and global head of M12, Microsoft's VC arm, speaking at the recent CNBC @Work Human Capital + Finance event in Chicago.

Then there were the attacks from giants within the traditional venture world, such as Union Square Ventures' Fred Wilson, who said a few years back at a CB Insights' conference, "[Corporate investing] is dumb."

If there is historical evidence to support Wilson's dig, and even the corporate VC officials say that there is, it is increasingly less true today.

"Fred Wilson is a great investor, but that's like saying all VCs are evil," Kashyap said. [Wilson once said something close to that about corporations as well.] "Painting with such a broad brush."

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The Microsoft VC executive said for current corporate VCs, "good CVCs that have financial discipline and have a longer-term time horizon," CFOs are no longer saying, "You need to return this, or we will shut you down."

These executives making venture bets for some of the tech industry's biggest companies say CVCs may even have an edge over Silicon Valley's established VCs in landing deals with hot start-ups and helping these young companies grow revenue.

A scene from HBO's Silicon Valley featuring founder of fictional internet start-up Pied Piper, Richard Hendricks, played by actor Thomas Middleditch.
Source: HBO

"We publish numbers," said Scott Darling, president of Dell Technologies Capital, who became head of Michael Dell's internal VC team after Dell acquired EMC. "We are at over 3.5 times the top decile threshold for financial performance. Michael is clear, we are a business and we produce. This idea of strategic return is not a vague concept. I can point to nine or 10 figures that even a CFO would agree is value that we have returned to the company."

Dell Technologies' case it has invested more than $600 million in about 100 investments over the last six years.

$130 billion in VC, one-third of it from corporations

Global investments made by CVCs are booming, according to CB Insights data. CVC activity reached a historic high in 2018, with $53 billion invested across 2,740 deals, and 264 new CVCs investing for the first time, up 35% from 2017. (There were 61 new CVCs in 2013.) The $53 billion was roughly one-third of total VC investments made in 2018.

"That's a big number," Darling said, though he noted that 80% of research and development is focused on "sustaining engineering" rather than innovation. "Every penny of the $130 billion is focused on disruption," he said.

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"Historically, the role of CVC in the VC marketplace and within their own organizations was unclear. These days, however, there are many 'veteran CVCs'" Gary Dushnitsky, associate professor of strategy & entrepreneurship at the London School of Business who has been studying CVCs for decades, wrote in an email to CNBC. His research shows that the longevity of many CVC units often surpassed that of the average CEO tenure. "Simply put, it suggests that the CVC will be there to see the start-up through its growth."

Even as the profile of CVCs grows — companies like 7-Eleven, Campbell Soup and General Mills have venture arms now — CB Insights data shows that they've yet to break through in terms of accessing the top deals for billion-dollar start-ups.

Corporations realized the best way to do this is like VC, but adding value through the resources of the mothership.
Nagraj Kashyap
Microsoft corporate v.p. and global head of M12

Only three CVCs have backed unicorns at the Series B stage or earlier, and all three of those CVCs are subsidiaries of tech companies, CB Insights found in a recent report.

"The dearth of unicorns in CVC portfolios recalls the critiques of past corporate waves in the VC world. Established companies may be pushing money toward innovative startups, but they still take too long to make decisions and take on too little risk to make those startups thrive," CB Insights analysts wrote. "The CVC fund, critics say, is often more a stab in the dark by corporates who see their industries changing around them rather than a cohesive strategy. That approach does not often lend itself to success."

But in 2017, 243 CVCs invested in at least one company at the seed round, more than two and a half times the 101 CVCs acting at the seed level in 2013.

'Capital is cheap. Value-add is not'

Their reasons for backing early-stage companies speak to the advantage these venture arms think they may have over Silicon Valley in the future. First and foremost, CVCs are looking to make a straightforward return on their investment. But they also want to get in on the disruptive start-ups as early as possible so they can ultimately incorporate their products into their own sales efforts.

"Corporations realized the best way to do this is like VC, but adding value through the resources of the mothership. But it is always financial first," Kashyap said. "When I or the team meet with a company, we look and feel like a financial VC. Post-investment we become a strategic VC. ... Capital is cheap. Value-add is not."

That's a key change and has made more CFOs open to corporate VC, the Microsoft executive said. "We have a longer-term orientation than VCs. When a founder comes in, we dont tell them we need to exit in 5 years."

When founder has reservations, Kashyap said, "We say, 'don't talk to us, talk to other founders we funded. That's the sale ... they did what no other financial VC could do for us."

Dell and Microsoft invest in companies they can help make commercially viable and often plug them into their product development, sales and distribution networks. This helps start-ups gain product adoption— and a first-mover advantage.

"Some of the most sophisticated angel investors, serial entrepreneurs, making tens of billions, they invest with the new breed of corporate investor, not the strategic VCs," Darling said. "They want the leverage they can get out of corporate partners. We have five people we work with carefully who will not invest with financial investors."

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It does not hurt to have a CEO like Satya Nadella of Microsoft. Nadella does not look at the deals ahead of investment, but Kashyap does regularly take a group of portfolio company founders to meet with the Microsoft CEO. "When I tell him [about the companies] it is not the same as when founders tell him," Kashyap said. "Satya and Michael are involved in this stuff because they are still founders, they grew up in this stuff."

Darling said after Michael Dell bought EMC and asked him to stay on and run the venture group, Dell's question to him was to explain the goal of VC. "At the end of the day, what you need to do is strive to be the single-most valued-added member of that [start-up] board. The board is bunch of people competing to do more for the entrepreneur."

Dushnitsky said this threat has been noticed by the traditional venture world. The recent rise of "platform VCs" and "applied VCs" can be viewed as a vindication of the CVC model.

"These new VC types include a set of people and complementary resources that aim to support and boost start-up growth. He said his research on CVCs in the pharmaceutical industry shows that an industry leader with a global footprint and over 100,000 employees may be seen as a powerful platform and VC competitor.

Founders walk a fine line in taking CVC money

But he cautioned against CVC taking a victory lap too soon. "The CVC is not a panacea. There is a host of things a start-up should consider as it contemplates CVC backing. For example, does it want to bolt itself to the corporate ecosystem? Does it want to become part of the Dell ecosystem, or the Microsoft one?"

That is a fine line for entrepreneurial-minded founders, and a reason why Kashyap said Microsoft's initial investment offer is purely made on financial terms. A hard sell from Day One on the platform opportunities could make founders skittish, even if it is ultimately their company's best path to growing sales.

"It may raise concerns regarding appropriation, Dushnitsky said, and he pointed to a recent headline about Amazon's Alexa fund.

It also may limit perceived flexibility. "Back in the day, RIM [now BlackBerry] launched a CVC arm. Many of its portfolio companies opted to feature the iPhone on their homepage, either along the Blackberry device or exclusively so," he said.

It also may raise concerns regarding valuation at "exit," the London School of Business professor said. "If the CVC-parent firm is to be your prospective acquirer – how does that affect valuation? Does it command a premium? a discount?"

Dell's Darling said the fundamental problem for all VCs won't change. "The data says 80% of private financial venture folks lose money. All the returns go to roughly 20%. I don't think it will be any different in the corporate world. The way you get in trouble in life is to lose track of who you are, what you do, and that's how you get in trouble in venture CVC. Do a cold- hearted assessment of what you are. The average return on capital is eight to 10 years away. The average CFO is in the job five to six years. It can't work without that long time horizon."

The Dell VC executive added, "You can't dabble in this. ... I can rattle off all these industries we thought were not subject to disruption and all of them are."