New Game for Corporate R&D and Venture Capital

Igor Sill, Managing Director, Geneva Venture Management LLC

It would appear that US innovation has never been brighter. US Corporations are spending in excess of $200 billion on R&D annually, most of it on technology advancements. The top technology R&D expenditures were from IBM, Intel, Microsoft, HP and Cisco, accounting for over $20 Billion. This outdated R&D model of the industrial organization that progresses through internal development has been eclipsed by the reality of new, venture capital backed start-ups that achieve far greater competitive advantage through rapid cycles of innovation, customer acceptance and global distribution. IBM accounted for $6 Billion of R&D which ironically exceeded all of the annual venture capital industry's investments made. Over this past decade, the rate of technology innovation has rapidly accelerated, challenging those Corporations' ability to maintain a competitive edge. The technology innovations and investment returns are obvious-- venture-backed technology companies have consistently exceeded every Corporate R&D outcome.

Today's corporate R&D is no longer a simple matter of new-product introduction, or merely adapting to the new technology realities. Instead, it has become a keenly strategic process that utilizes all available resources. Corporate R&D is realizing that they must partner with outside ventures in order to stay ahead of the game.

Corporate investments in tech start-ups are growing at an increased pace, according to the National Venture Capital Association. Corporations represented investments in 214 venture deals for 196 Silicon Valley companies, up from 185 deals in 170 companies in 2010, and 165 deals in 147 companies in 2009, according to the NVCA. These Corporations are eager to optimize Silicon Valley's tech talents into their R&D ambitions.

I've noted an interesting trend in the number of multi-national Corporations now opening up business development offices to capture access to the explosion of start-ups and the pace at which these deals are happening. Corporate venture arms invested nearly $3.26 billion in Silicon Valley companies last year, up from $2.6 billion in 2010.

Of foremost interest to Corporations is venture capital's emergence as an exemplary financial engine for the explosive growth of advanced new technologies that are changing the world while creating entirely new industries. The reasons for venture capital's success are many. The venture structure encourages innovation and gives entrepreneurs the tools they need to create, develop and launch their innovative ideas globally. These inherent incentives facilitates the creation of breakthrough, industry disruptive ideas. The more established corporations are increasingly dependent on innovative new technologies in order to remain competitive, thus it would seem natural to incorporate a venture capital model for a portion of technology development. Such an approach has proven successful for some companies such as HP, Facebook, Oracle, Dell, Apple, EMC, Google, Cisco, as well as other technically focused companies. Mature corporations are balancing their R&D exposure by funding some of their technology development through partnerships with venture capital teams. This approach exploits venture capital's efficiency in developing technology, its access to new advancements, its capacity to respond quickly to changing technology, its ability to leverage additional resources throughout the development cycle all while returning favorable financial returns. Also, these Corporations use their venture capital network to explore sectors of longer term strategic interest.

Getting in the venture investment game

The decision making process of either forming a corporate venture arm, selecting a top tier venture firm or participating in a "basket" of venture funds (Venture Fund of Funds) is a critical one. For purposes of this article, I am assuming that many Corporations have already recognized the many pitfalls of staffing a Corporate Venture Arm, and have long since abandoned that path. Of course, I'll exclude Intel Capital, which is an anomaly having developed a unique culture and successfully intertwined its venture relationships. Deciding between direct Venture Capital participation, or the more conservative Venture Fund of Funds path should entail research on each's respective track record of investments, actual hands-on value creation involvement within their investments, the firm or emerging fund managers' lure and stature within the entrepreneurial community (deal flow access) the ethical reputation and transparency in reporting performance returns, and, most importantly, your long term strategy.

Do some serious research here, as the term "success has many fathers" applies in spades to self-published venture performance stats. You may wish to consult with an experienced venture law firm or venture advisor who can draw on substantial limited partner (LP) and general partner (GP) expertise and expose the many significant incongruities and styles in how LPs and GPs generate and distribute returns.

I've come to learn that consistent, successful returns are achieved from only a few select venture capitalists who diligently identify and invest in technologies and markets on the leading edge of disruptive innovation. They tend to focus on building companies at the forefront of market forces, creating outstanding growth and exit opportunities. These particular venture capitalists are notorious for sourcing and developing fast-growing companies in large market growth sectors. They've also built a substantial reputation for value creation and thus are sought after and welcomed into the hot startups by seed angel investors as well as the best founding entrepreneurs.

The rational behind investing in a Venture Fund of Funds versus directly in a Venture Capital firm is simple, there are only 14 venture funds out of the approximate 3500 which have historically delivered consistent out sized returns. Makes sense, as the smartest and most capable entrepreneurs will only seek the top tier venture partners as investors before pitching the remaining "herd". The leading firms, consistently topping Red Herring's Top VCs, Preqin and Venture Economics performance lists are Accel Partners, Andreessen Horowitz, Benchmark Capital, Founders Fund, Goldman Sachs Investment Partners, Greylock, KPCB, NEA, Union Square Ventures, Index Ventures (non-US) and, in the seed investment class, Ron Conway's Silicon Angels.

Though there are bright pockets of venture activity globally, the epicenter of premier technology innovation continues to emerge from Silicon Valley. This is a very unique place with a supportive ecosystem ready to back entrepreneurs' requirements for launching startups successfully. The weather is excellent, the lifestyle is wonderful, and the scenery exquisite. Stanford University, UC Berkeley, USF and University of Santa Clara provide an abundance of research and continually spin off new patents along with a steady flow of budding intellectual entrepreneurially driven graduates. Hence, 80 percent of venture capital and angel investors operate in Silicon Valley; and, not surprisingly, 90 percent of the highest venture returns occur here. It is also the reason behind Swiss-based Index Ventures' move to Palo Alto, CA last year.

There exists a massive market with a strong rising tide for optimizing this new Corporate R&D paradigm, one with increased efficiencies and far better results. The opportunities of advanced innovations, globalization and the internet's disruptive nature make it a period of significant transformation that is creating extraordinary corporate value. Seems that learning from success tends to create more success.

Igor Sill, Managing Director, Geneva Venture Management LLC,

Igor Sill is managing director of Geneva Venture Management LLC, a Venture Capital Fund of Funds advisory firm. He is also a Silicon Valley venture capitalist and founder of Geneva Venture Partners. Igor manages his own angel investment fund at Geneva Ventures and is also a Limited Partner in Goldman Sachs Investment Partners, Benchmark Capital, Norwest Ventures, Granite Ventures, The Endowment Fund and ICO Funds through his Family Office. Igor resides in Silicon Valley and has 23 years of tech investment experience.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Igor Sill. This work reflects the law at the time of writing April 2012.