Google Climbs Onto Corporate VC Funding Bandwagon

Google "does not comment on market rumor or speculation" company spokesperson Andrew Pederson told the E-Commerce Times in an e-mail response to a request for comment.

Google is the latest in a long line of large companies across several sectors to create a venture capital arm. Chipmaker Intel (Nasdaq: INTC) , pharmaceutical giant Johnson & Johnson and the Dow Chemical Company (NYSE: DOW) all have units dedicated to making early stage investments in startups.

Venture Investment on the Rise

More and more companies are getting into the venture capital game, Mark Heesen, president of the National Venture Capital Association, told the E-Commerce Times.

Corporate venture capital investment topped out during the heyday of the technology bubble in 2000, when corporate venture funds invested a mammoth US$16.6 billion, according to data from the NVCA. After the collapse of the stock market and the Sept. 11, 2001, terrorist attacks, corporate venture investment fell 70 percent to $4.9 billion in 2001. Corporate venture investment bottomed out at $1.3 billion in 2003 and has steadily increased every year since then. Last year, corporations invested $2.5 billion in venture capital.

"It's a way for corporations to get into a new company on the bottom floor," Heesen said. "It's a very positive thing."

Corporate VC Challenges

However, corporate venture units do come with inherent challenges that traditional venture capitalists don't face. One problem, Heesen said, is that corporate efforts in early stage investing can be fleeting.

"If the leadership at, say, Yahoo (Nasdaq: YHOO) changes, that corporate venture arm could be gone tomorrow," he pointed out. "Management might ask, 'Why are we in this?' The new CEO could say, 'We're not doing this anymore.' You're at the whim of any changes in the front office."

Also, corporate venture capitalists have a history of starting venture funds during good economic times and exiting the sector when market conditions go south.

"Corporations often get in at the best time and get out at the worst times, economically, which doesn't endear them to their other venture partners," Heesen noted. "That said, I think that issue was more pronounced after the technology bubble burst in 2001 than it is today."

Corporate venture capital arms can also find it hard to attract seasoned venture capitalists due to compensation issues.

The Compensation Issue

"Will they be compensated as a typical VC or as an employee of the corporation?" Heesen asked.

In a traditional venture firm, general partners -- the investors who manage the fund -- are compensated in two ways: management fees and carry fees.

A management fee is a percentage of the total amount of money a general partner manages on behalf of the fund's limited partners, typically large financial institutions, other corporations, pension funds and endowments.

A carry fee is a percentage of the profits on investment; it provides the bulk of the financial rewards venture capitalists make from taking risks on early stage companies.

"Normally, VCs can go a long time without getting a carry check. In the meantime, they're getting a management fee from all the money they've raised from endowments and institutions," Heesen said.

What Corporate VCs Bring to the Table

Despite the numerous drawbacks, corporate venture arms bring a great deal of value to the table, Heesen observed.

For one thing, corporations like Intel and Johnson & Johnson have contacts in their respective industries that traditional venture capitalists may not.

"They have a different Rolodex," Heesen said, "and they can test a new product within their corporate structure. They might have engineers that can give an inside look at new products or services."

Most large businesses have an international presence, which can open up new markets to early stage companies in which they have invested, he said.

Corporations also have the potential to provide an exit strategy for their traditional venture capital partners. In some cases, corporations that make early stage investments in new companies often end up acquiring them, Heesen said.