Automotive and other industrial businesses are adapting and diversifying by making new bets on emerging technologies and new types of business models. Although many businesses will continue to rely on traditional M&A or joint venture activity, a recent Pinsent Masons survey of senior executives of fast-growing manufacturing and technology businesses in western Europe showed that taking minority stakes are increasingly popular with these businesses in particular, with almost nine in 10 (89%) having invested in this way over the past three years.
Why corporate venture capital?
Businesses in the automotive and industrial sectors are now constantly facing technological disruption; the need for new products and services; and competition from new ‘challenger’ brands responding to these needs. CVC and other less formal arrangements, through which companies are able to take minority stakes in innovative businesses, allow them to experiment and to spread their net wide, without committing to a full-blown acquisition. In some cases, the alliance may ultimately lead to a formal merger while in others, one side or the other may back away.
Taking a stake in another business through the CVC route may provide much-needed access to new technology or talent, while still allowing the target business to maintain its independence. This may be important where, for example, the cultures of the two businesses are very different: there are numerous examples of large businesses buying smaller ones but failing to successfully integrate the acquisition because of a culture clash. Managing the relationship between the acquiring corporate and the smaller investee company has become one of the main objectives when attempting to maximise the success of the CVC investment.
Attracting a target
Trade buyers often struggle to compete with private equity investors in a ‘hot’ M&A market. The CVC model offers an alternative, allowing the founder to continue to ‘own’ the business – the importance of which to a founder should not be overlooked – and to be incentivised on an equity based model.
On top of capital, corporate investors may offer the founder a reputable brand to be associated with, a ready-made customer or supply base, complementary technology or R&D experience and support. However, they will still need to convince the founder that they will be welcome and thrive in the large corporate world or that they will be kept at arm’s length.
Corporate investors, as opposed to most financial VC investors, are also a potential exit partner for founders and existing investors.
Clarifying the investment rationale
Minority stakes come with risk. Difficulties can arise when, for example, the rationale for investing or the approach to the underlying product or business model is unclear or changes over the life cycle of the investment. Corporate investors have a greater focus on the strategic, rather than financial, rationale for investing – for example, the investor may require an exclusive right to use the technology being developed.
For the corporate investor, investment in a start-up may offer immediate access to know-how by way of licences or technology partnerships; or access to new innovative products in the near to long-term future. For start-ups, this type of investment may bring access to additional manufacturing and distribution capabilities, help with product certification and other regulatory requirements, access to joint R&D and otherwise inaccessible market insights and know-how outside of their core competencies.
If the commercial rationale does not ultimately prove to be successful, it can be difficult for the investor to admit ‘failure’ and shift its mind set to a purely financial one. Businesses that have been successful with CVCs accept that some will fail or simply not prove to be the right fit. In these circumstances, allowing the target to sell the product to a competitor or exiting the business quickly may be the right thing to do.
Corporate investors also need to be ready to deal with abrupt changes of strategy within their group, often predicated by a change in CEO. Given that CVCs often take time to deliver a return – whether financial or in terms of a technological goal – the model can fall out of favour with these groups.
Beware of reputational risk
Depending on the size of the stake being acquired, the corporate investor may have little or no control over the target company. Those new to CVCs can struggle with this conceptually, given the controls ordinarily placed over their group companies; and it can even leave the investor exposed to reputational or regulatory damage in the event that the smaller business behaves irresponsibly.
