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Ventures away

Corporate venturing has become part of the investment landscape in Germany. Can this development outlast the market downturn, asks Tornado Insider.

Thomas Kuhr was one of the pioneers. Having first spent his early career in the fledgling German venture capital industry, in April 1997 he left his job at Kommunale Investitions- Treuhand - a company that set up public-private partnerships for eastern German companies - to develop T-Venture, the corporate venturing arm for Deutsche Telekom. ‘We're not simply a financial investor. We create innovation management for Telekom,says Kuhr.

Companies such as Siemens had been investing their funds in a haphazard way in other companies for more than a decade, but the idea of a focused unit that made venture capital investments for both strategic and financial gain was new when T-Venture began. Not any more: since then, a steady stream of heavyweight German companies have followed in Deutsche Telekom's footsteps - among them Siemens, DaimlerChrysler, SAP, Deutsche Post, Holzbrinck, Deutsche Bank, and Bertelsmann.

The phenomenon is new enough that the German Venture Capital Association doesn't yet keep data on corporate VCs, but the trend toward corporate venturing is clear. A networking group for Germany-based corporate VCs in May counted no less than 19 companies at a meeting in Stuttgart this year, more than double the number at its first meeting in 2000, according to Kuhr. Why the stampede? As in other European countries, corporates in Germany have twigged to the advantages of becoming more directly involved in venture capital.

The financial argument for companies to invest in technology start-ups was a compelling story until quite recently. One only had to look to US companies such as Intel, Cisco, or Reuters to see hefty returns coming from private equity investment. For example, at one point in 1999, some 10 per cent of Reuters' operating profit came from its Greenhouse Fund, whose investments included then high-flyer Yahoo, as well as Verisign and Infotec.

T-Venture, for one, entered the market just prior to its record bull run, and quickly scored a home run with one of its first investments - 7m euros in a then-unknown East German company called Intershop. The company went public half a year later on the Neuer Markt, and by the time T-Venture sold out its remaining shares (in December 2000) it had made a tidy pre-tax gain of E149m on the deal.

Viewing these kinds of returns likely made the decision to open a VC arm go down more easily with corporate executive boards. Many corporates looked only to co-invest on deals with ‘pure-play' VCs, lending their brand name and financial muscle to a deal, but leaving the corporate oversight to the others.

But if all companies wanted were a financial gain, they could just as easily invest in a fund. Most get into corporate venturing because they also perceive strategic advantages. These goals can vary from company to company. Some firms are in search of potential customers, others want to keep an eye on possibly competitive technologies and incorporate them into their products, whereas others are seriously interested in acquiring the companies outright.

A deal that Bertelsmann entered into this year demonstrates the potential for synergies. It took a E2m stake in Publishers Market, a Munich-based company that makes software to automate the process of developing and sending advertisements for print media. ‘We can provide them with lead customers, and using that technology will give us dramatic costs savings,' notes) and Kantowsky, head of Bertelsmann Capital Ventures, the new VC arm of Bertelsmann in Munich. If Bertelsmann really likes what it sees, it may decide to acquire the companies it invests in, he notes.

In many cases, corporate VCs hold out the unspoken promise that the mother company will buy the start-up's products, giving them a kick-start. That can be welcome for the start-up, but is also a two-edged sword if it fails to diversify to a broader customer base. ‘As a VC, you don't want to invest in a company that's too dependent on one customer,' notes Claudia Blumhuber, a founding partner with
consultancy Global Startup in Munich. That can put the corporate VC's ‘financial hat' in conflict with its strategic one.

Another conflict can arise if the corporate VC expects to heavily influence strategic decisions at the portfolio company that might be in the corporate VC's interest - such as the start-up's choice of suppliers - but not necessarily in the interest the start-up. The start-up's financial agreement with the investing team should prescribe which decisions the corporate investor may or may not influence, notes Blumhuber.

Corporate VCs, in turn, can also find themselves hampered by the strategic requirements of their own parent companies, which can prevent them from making a decision on a solely financial basis. ‘We do have to answer to corporate requirements, which means there are limits to what we can do,' concedes T-Venture's Kuhr. ‘On the other hand, without Telekom behind us, there would be some deals we couldn't do.' It is important that a corporate VC decides what kind of VC its is-more financially oriented or more strategic, say market participants. It's hard to be both at once.

Whatever the drawbacks, the trend toward more corporate venturing is in the interest of start-ups, as it broadens the potential financing landscape and holds out the promise of both revenue and corporate expertise. But over the short-term, a shakeout is expected among corporate VCs due to dwindling exit opportunities and the poor performance of portfolio companies. IT companies such as Intel, Compaq, and Cisco are themselves under economic pressure, which has pushed them to scale back their VC activities.

In Germany, few corporate VCs have made formal announcements of cutbacks. But
Bertelsmann backed out of ambitious plans for a $1bn ‘eBertelsmann' fund to launch a more modest effort. Siemens has also announced a consolidation of its many-pronged VC efforts. And Compaq has pulled out of Germany after it announced in July that it would drastically curtail its venture capital efforts. ‘Some companies that have been thinking about it [corporate venturing] may put their plans on hold,' believes T-Venture's Kuhr.

Some corporate VCs who were actively involved in the Internet investing frenzy are experiencing the same hangovers that afflict their pure-play counterparts. SAP Ventures for example, has been quiet this year after a hectic 2000, in which it invested heavily in the now- floundering B2B sector. SAP Ventures doesn't release numbers, but says it has made about 40 investments in its four-year history. Jeffrey Nolan, head of SAP Ventures, says the firm is not scaling back, however. ‘We actually doubled the size of our team this year from two dealmakers to four,' he notes in an email, but later concedes, ‘Venture capital is not a core activity for SAP.' An SAP spokesman says the unit is currently focused on staff changes and ‘portfolio adjustment and nurturing.'

Corporate VCs can also generally afford to wait if they are funded by a corporate budget, rather than using a formal fund structure; the parent simply decides to put the cash elsewhere. And indeed, many corporate VCs have stayed on the sidelines this year. Deutsche Post Ventures, the venture arm of the newly privatised German postal service launched in September 2000, is proceeding more slowly than initially expected with investment, according to managing director Martin Fritsch. It made three investments in 2000, and has not yet used up its allotted DM 100 m in funds. ‘In the first and second quarters, we consciously made fewer investments,' Fritsch says. He expects to conclude some deals in the second half of 2001, but says the lack of liquidity in the market doesn't make it easier. ‘We have one firm we are very interested in, but we see too few other investors out there.'

But not all corporate VCs are laying low. T-Venture has expanded since its early days and now has some E500m under management. It also recently created two new funds-the T-Online and T-Mobile funds-and has two others in the offing. These funds invest in businesses more closely related to their business units. Mobile phone subsidiary T-Mobile, for example, announced in August its investment in BlueFactory, a Swedish wireless entertainment company. The funds also let Deutsche Telekom's subsidiaries participate in the potential successes - either strategic or financial-of the company's private equity investments, notes Kuhr. This motivates the subsidiaries to go out themselves and find good companies.

Mary Lisbeth D'Amico,

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