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Technology hub - sector of ups, downs, rides out storm

There's nothing like a recession to bring corporate America back from a trek in the wilderness. While companies are fretting about boosting profits in their core businesses, extras like venture capital are definitely out. This retrenchment comes as no surprise to the rest of the VC world. Beth Healy from the Boston Globe considers the future prospects for corporate venturing.

Investors are familiar with the pattern: Corporations jump into venture in good times, drawn by the lure of seemingly easy profits and expansive thinking about where new technology could lead them. And they back out when the boss says to knock off the extracurricular activities - especially money losers.

‘Corporate VC is a creature of good times,' says Rosabeth Moss Kanter, a professor at Harvard Business School and author of ‘Evolve,' a book about corporate change in the new economy. For at least six months, she says, ‘Investments in general have been put on hold at big companies. Things that are speculative or have a longer-term payoff are naturally last on the list' of priorities.

In the past few years, many companies learned the hard way that venture capital is no stroll in the park. Ask Starbucks and Amazon.com, for starters. Corporate money in venture deals soared to $14bn, or about 13 per cent of total venture investing, in 2000 - six times 1998 levels and double the deal volume in heady 1999.

The cascade of cash began to drop off sharply by the second quarter of 2001, according to research by Thomson Financial Venture Economics and the National Venture Capital Association. Companies put $4.3bn into young firms last year, accounting for less than 4 per cent of total VC investments. The deceleration may have stopped in the third quarter, as it appears to have in mainstream venture, when companies invested $708.3m in start-ups, or 2.6 per cent of the total; in the fourth quarter, those numbers nudged up to $770m, or 2.9 per cent.

That's still ahead of the pre-bubble days. Back in 1998, companies invested no more than $421m per quarter, or less than 2 per cent of total VC deals.

Stephen Kahn, a managing director at Advent International, a Boston-based venture and private-equity firm, thinks interest could continue to drop in the near term but will recover. He knows the cycles in corporate venture better than most, having done venture deals for other companies since 1988.

Across the country, he says, ‘There was so much interest in corporate venture capital in the last two years, you had companies that had no business doing it.'

Advent's service is pretty unusual - and not for trendy investors. Only a handful of venture firms will act as a venture arm for corporations. Most VCs don't like to deal with major corporations as clients at all. They prefer to raise their funds among foundations and endowments, where priorities don't shift with the pressures of Wall Street and corporate politics.

Most of the $5bn Advent manages is run the usual way - doing venture deals and buyouts for a variety of institutions. But the firm also has courted corporate investors since 1985. Apple Computer used the firm's services at one time. So did Alcoa, the aluminum giant. Kahn says the firm has worked with some 40 companies in all. The firm's latest corporate fund, Digital Media and Communications, was raised in 2000 and manages $345m.

Current investors include Japan's NTT DoCoMo, a mobile communications company; electronics titan Toshiba; and, Dutch telecom player KPN. Japanese investors have been among the steadiest of Advent's relationships, including Asahi Glass, Tokyo Electric Power, and Samsung. US investors have included BellSouth, GE Capital, and Hughes Electronics.

Two others, Tyco International and Polaroid Corp., are examples of companies facing pressures that will likely distract them from venture deals. Polaroid has filed for bankruptcy protection, but a piece of its $900m pension fund is still invested with Advent. Most clients, including Tyco - which is under scrutiny for complex accounting practices and for an unpopular breakup plan - invest directly with Advent's corporate VC group, not through a company pension plan.

Several clients keep an office at Advent, but a few, such as Hughes, recently have pulled their executives back to other assignments, Kahn said. Some foreign clients, too, have removed their people since the economy turned down.

But the busy turnstile is part of the deal, Kahn says. The firm welcomes executives for the doors they can open, and the help they can provide in reviewing potential investments and products that start-ups are working on. Kahn has made about 60 trips to Japan, he says, and he usually brings an entrepreneur from a portfolio company with him, making introductions that would otherwise be all but impossible.

‘The market intelligence and due diligence they offer justifies the effort involved in servicing [corporations],' Kahn says. It's an effort all VCs are having to make these days anyway - wooing big companies as customers for their entrepreneurs.

Advent isn't giving away this extra layer of service. It takes 25 per cent of the profits on deals, instead of the usual 20 per cent. ‘If we don't deliver, they don't pay,' Kahn says.

The firm keeps control over the investment process. While clients like to get involved in reviewing deals, they don't have veto power, he says.

Kahn admits the firm's 1998 fund ‘is going to be tough,' meaning returns could miss the 20 per cent-plus annual target. Many funds started in 1998 and 1999 are suffering losses. But even in these lean times, Kahn says, he's not seeing clients try to bail out. (Over the years, there have been a few.)

‘You're always going to have a lot of churn inside the big corporations,' Kahn says. ‘We've found these programs have been able to withstand a lot of those organizational changes.'

Beth Healy can be reached by e-mail at bhealy@globe.com.

This story ran on page C3 of the Boston Globe on 2/11/2002.

© Copyright 2002 Globe Newspaper Company.