Scott Orn
Corporate venture capitalists (CVCs) are booming in the startup space as large companies look to take advantage of the fast-paced innovation and original thinking that entrepreneurs offer.
For startups, taking funding from CVCs can come with many benefits, including new opportunities for marketing, partnerships and sales channels. Still, no founder should consider a corporate investor “just another VC.” CVCs come with their own set of priorities, strategic objectives and rules.
When it comes to choosing a CVC with which to enter negotiations, the most important step is doing your own diligence beforehand. An entrepreneur’s goal is to find the perfect match to partner with and guide you as you grow your business. So before you start discussing terms, you’ll want to understand what’s driving the CVC’s interest in venture investing.
While traditional VCs are purely financially driven, CVCs can be in the venture game for a variety of reasons, including finding new technology that might generate marketplace demand for their products. An example is Amazon’s Alexa fund, which invested into emerging companies that drive use and adoption of Alexa. Alternatively, a CVC’s parent company may be looking to invest in tech that will help them operate their own products more efficiently, such as Comcast Ventures investing in DocuSign.
As a rule of thumb, the bigger CVC funds like GV and Comcast tend to be financially driven, meaning they’ll be approaching negotiations through a financial lens. As such, the negotiating process more closely resembles an institutional fund. You as a founder have to do the work to figure out what’s driving your CVC — is this a customer acquisition or distribution opportunity? Or are they seeking to find a source of knowledge transfer and/or bring new tech into their parent company?
“Before negotiating, always look at a CVC’s existing portfolio,” says Rick Prostko, managing director at Comcast Ventures. “Have they made a lot of investments, at what stage, and with whom? From this information you’ll see the strategic thinking of the CVC, and you can determine how best to position yourself when you begin negotiations.”
You also can ask the CVC directly about what drives their decision-making, who makes the ultimate calls, how they decide the amount of an investment and the length of their typical deal time frame.
“Any venture investment is a marriage, and entrepreneurs should approach it as such,” says Grant Allen, general partner at SE Ventures, the CVC arm of Schneider Electric. “Founders should talk to CEOs who are already in a CVC’s portfolio, as well as CEOs who have tried to do a deal with the group, and ask them all how the negotiations went.”
Questions to anticipate during negotiations with a CVC
Once you’ve determined that a CVC would be a good partner and you’re ready to negotiate a deal, it’s important to know the ropes. You’ll be facing some scenarios and questions that you won’t find with traditional VCs, so you’ll want to be prepared and stay several steps ahead.
The following questions will guide you through negotiations and help you avoid common pitfalls.
Do they want a board seat? To the extent that a CVC is motivated by more than the pure financial return from the investment itself, a CVC’s potential for a conflict of interest is greater than it would be for a financial investor sitting on your board. While a venture fund’s sole goal is to increase ROI and maximize the financial return from your company, a CVC has more than just the monetary future of your company at stake. Many CVCs have motives tied up with their parent company, including wrapping up your tech and preventing their competitors from getting access to it.
Given this potential for conflict, if a CVC takes a board seat, it’s important to negotiate whether you can force him or her to recuse him/herself from a board meeting if a conflict-causing situation arises, such as the need to make a strategic decision involving one of the parent company’s competitors. It’s not uncommon for a startup to seek a deal with a CVC’s competitors at some point down the line. With this in mind, be sure to negotiate the board rights ahead of time to avoid any complications down the road.
Sometimes you can ask a CVC to accept an observer seat and back them down from a board seat, and if the investment is small, founders can push back on the grounds that the CVC hasn’t invested enough to warrant it.
“Ultimately, if a CVC is leading the round and/or their heart is set on having the board seat, it’s tough to talk them out of it,” says Allen.
Keep in mind that it also could benefit a startup to have a high-value-add CVC on the board. “If the CVC group is well-run and the potential board member can offer unique expertise, then there could be major upside to having them,” says Eric Budin, director at Touchdown Ventures.
Do they want to lead your round? CVCs can and do lead investment rounds. Major CVCs like Intel Capital even lead the vast majority of their deals. When it comes to seeking a lead investor, the biggest factor to note is ensuring that you have the proper skills in the boardroom — many financial VCs have great track records as company builders, so if you can get a top institutional VC in your next round, go for it. But in a more complex industry such as energy, having a corporate-backed fund can help tremendously.
“Startups should be selfish when it comes to adding investors to their cap table,” says Allen. “Take money from one or two great institutional VCs, then look to CVCs who can provide a new angle that traditional VCs can’t offer. Pure financial VCs can bring a wealth of knowledge around company building, but can they really turn on revenue, especially in more difficult industries like energy, automotive and industrials?”
Do they understand your future fundraising strategy? Sophisticated CVCs know that your early-stage company will be raising future rounds — but less sophisticated ones may not. As we’ve discussed before, it’s critical that you determine which type of CVC you’re dealing with from the outset. Still, once you hit negotiations, it’s always useful to establish that you’ll likely be raising future rounds, which will require CVCs to make a decision to invest their pro rata or face ownership dilution. An experienced CVC will understand that if they decline to participate up to the pro rata, it could send a negative signal to other potential investors. Take this opportunity to lay out future plans and intentions of your startup in order to set expectations and avoid conflicts down the line.
Will they be using knowledgeable and experienced lawyers? Don’t forget to ask about the lawyers who will be closing the deal! If the CVC plans to use in-house counsel, that may be a red flag. Even the best attorneys inside large corporations may not have the experience to know how to negotiate a VC deal. Often, a CVC will follow lead investors and rely on the firm that the lead is using. But if a CVC is leading your round, you’ll want to ask and make sure they’re planning to use a law firm with experience representing CVCs in venture financings.
If you’re at all uneasy, feel free to suggest an option to the CVC: “The lead VC on our round is working with X attorney, so do you want to see if they can represent you on this as well?”
Will they adhere to your rules on ownership percentages? As a rule, don’t let any single CVC own more than 19.9% of your company. If they own more than that, the CVC’s parent company will likely need to consolidate your financials into their annual and quarterly reports. If that happens, you’ll be required to get an expensive audit done, meet strict reporting deadlines and invest in financial planning and projections, all of which can hinder your bottom line. It’s crucial to stay aware of ownership percentages during every round that the CVC participates in — and if you think the CVC plans to increase their ownership over time, you’ll want to offer some cap table sensitivity projections during negotiations to ensure that the CVC won’t trip any ownership levels in future rounds.
Ideally, before you enter negotiations you’ll have the chance to ask how the CVC thinks about ownership percentages and pro rata rights, which will enable you to stay prepared for this part of discussions. A CVC’s view on both will be tied to the objective of their fund — is this CVC investing in products and companies that they ultimately want to own, or sprinkling drive-by investments across a number of companies to see what develops in the future?
Will they waive audit requirements? As we mentioned above, do everything you can to avoid any audit obligations. Audits are notoriously time-consuming and expensive — we’ve seen audits by Big Four firms cost startups over $30,000. While many investor rights agreements “require” an audit, traditional VCs usually waive this requirement to avoid wasting a founder’s time and money. You want a CVC investor to do the same. This is an issue where working with an experienced law firm can help you avoid trouble down the road.
Will they demand a Right of First Refusal (ROFR) on a sale of your company? This one is crucial, for the simple reason that you’ll want to give a resounding “no!” Under no circumstances should you let a CVC get a ROFR, which would give the parent corporation the right to “beat” any other potential acquirer if and when you try to sell your startup. In practice, a ROFR means that no smart competitor to the parent organization will try to purchase your company because they know the CVC’s corporate arm will be able to swoop in and steal the deal. If a CVC requests a ROFR, you can usually negotiate it down to a notice right, which means that you’ll put the parent company on notice if and when you plan to sell. But even a notice right can give the corporation more information than you’d want a potential bidder to have once you begin looking for buyers.
“You want a CVC who is entrepreneur-friendly, who isn’t looking for onerous terms or significant exclusivity that could harm your business,” says Budin.
Ask other CEOs how they did it
The best prep you can do for a CVC negotiation process is to speak with other CEOs who have done deals with the CVC. Ask these CEOs how difficult the investors were to work with during diligence, if they were supportive of the CEO’s needs during negotiations, how hard the CEOs pushed back, on what, and whether they hit any snags. This feedback can give you invaluable leverage during the deal-making process.
“You as an entrepreneur have every right to get references for your investors,” says Allen. “And if you find out during this process that they haven’t actually done a lot of deals, that’s important information as well.”
It’s all about relationships
Throughout the process, remember that you’ve chosen to partner with this CVC because you think he/she will bring unique value to your company, as well as new capital. Negotiations should be a pathway to a strong relationship that avoids pitfalls, not a stressful battle over terms.
Choosing a sophisticated CVC who is in the game for the right reasons and has every incentive to see your company win is the most effective way to ensure that the deal gets done on terms that are right for your company, and sets you up to grow a strong business.
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