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January 22, 2014
Google recently announced its plan to acquire Nest Labs for $3.2 billion. The beneficiaries of this massive jump in valuation—from an $825 million pre-money valuation in its January 2013 Series C round—will be KPCB, Shasta Ventures, Venrock, Lightspeed Venture Partners, Generation Investment Management, Intertrust Group Holdings, and most interestingly, Google Ventures. It would seem almost natural for Google Ventures to exit its portfolio companies to its parent company. However, in its five years of prolific investing, Nest Labs is only the second portfolio company to be sold to Google. Google Ventures has sold an equal number of portfolio companies to Google as it has to Yahoo and Cisco Systems. Is this the norm for corporate venture capital firms or is Google Ventures an outlier?
It turns out that in a majority of cases, corporate VC firms do not ultimately sell their portfolio companies to their parent company. PitchBook data show that the average rate of successful exits to a corporate VC investor’s parent is 3%. The gold standard of corporate venture capital, Intel Capital, has sold seven of 259 successfully exited portfolio companies to Intel. It has sold the same number of portfolio companies to Cisco Systems and close to that number to Microsoft. Even firms that have semi-explicit mandates to fund companies that align with their parent companies’ core businesses rarely exit to their parent.
Johnson & Johnson Development Corporation (JJDC), for example, states on its website, “Unlike traditional venture capital firms, JJDC determines the success of an investment’s performance not only in financial returns, but also in the viability of providing strategic growth options for Johnson & Johnson.” Yet, JJDC has only exited two portfolio companies to Johnson & Johnson. Meanwhile, JJDC has sold companies to numerous other major pharmaceutical and medical devices companies, including competitors, such as AztraZeneca, Amgen, Merck, Medtronic and Pfizer. This trend can be seen across most of the major active corporate VC arms, regardless of whether they are in the IT or healthcare and biotech industries.
Henry Chesbrough, an adjunct professor at the Haas School of Business at the University of California, Berkeley, wrote in a paper called “Making Sense of Corporate Venture Capital,” that the strategy of exiting to their parent is not the main driver of investment for these firms. However, in addition to acting somewhat as an incubator and producing explicit financial returns for the parent company, corporate VCs are also in the business of making “enabling investments.” These investments combine financial gains as well as operational gains by exploiting complementarity. Chesbourgh looks to Intel Capital as the archetype of this strategy, as it invests in dozens of companies whose products drive demand for high performance microprocessors. More demand for processors means more business for Intel. This strategy may help explain corporate VC firms’ willingness to exit to their parent corporations’ rivals.
The enabling investment strategy can afford corporate VCs more time and capital to commit to growing their portfolio companies’ brands before an acquisition or IPO. This tends to lead to longer periods of venture backing and larger exits. The median holding period for a company that has received funding from a corporate VC has hovered between six and six and a half years over the last four years, whereas a company that did not receive any funding from a corporate VC remains venture backed for about four and a half years.
This has also translated into larger exits, with the median exit size for companies that received corporate VC money in the low $70 million range over the last four years. Companies that never received corporate VC money exit for around $55 million, on average. Additionally, corporate VC firms tend to make their initial investments in the second or third round, and rarely come in at the last minute to fund companies at the brink of an exit (similarly to institutional VCs). This shows that corporate VC firms aren’t all that different from institutional VCs, and, as a result, don’t sell more of their portfolio companies to their parent.