Corporate and Other Investors

Introduction

Industrial companies in the United States invest large amounts of money in R&D, most of which is invested within the companies themselves. In recent decades companies, some of which also invest in venture capital funds, have started channeling large amounts of money to direct investments in companies and to the development of in-house startups in various formats.

The high rates of return demonstrated in the 1960s by venture capital funds motivated companies to establish investment organizations within the companies. The basic idea was to take advantage of the know-how accumulated in the companies and their surplus cash to yield higher returns than the company itself could generate. A mid-1970s crisis in the capital market drove most of the investment funds which had been founded within the large companies away from the market, but with the revitalization of venture capital funds starting in the early 1980s, the number of industrial companies investing in startups and creating their own venture capital funds increased. The 1987 crisis in the capital market landed a hard blow on these programs and their number declined again. Since then, though, many companies chose to focus on seeking strategic investments for the company and to invest money in external venture capital funds to gain a high return in the venture capital market.

A widespread phenomenon in the field is companies which finance ventures created by company employees who otherwise would have retired from the company and established independent ventures. However, the company will typically prefer to have a reputable venture capital fund co-invest in the project as early as possible, since such participation signals to the company that the startup is indeed promising. In addition, since in many cases the companies have no experience in initiating startups, the participation of professional investors considerably reduces the burden imposed on the financing company.

Most companies that are involved in venture capital investments invest in fields that are related to their main business. Even if they manage a separate venture capital fund in one form or another, they often limit the funds to investments in the company's field of expertise. Alternatively, the companies establish investment funds to identify investments in fields which will enable the company to branch out in new directions.

Direct Investments by Companies in the Field

Many entrepreneurs are delighted to receive financing from companies which operate in the startup's field. There are many strategic reasons for this, including the following: The investing companies lend credibility to the company and provide a stamp of approval for the company's technological edge; cooperating with such a company, which usually supports its investment, provides the startup with much assistance in rapidly reaching the market and marketing its products; and, finally, corporate investors usually act according to technological considerations rather than just the financial considerations which guide most investors in startups.

On the other hand, entrepreneurs sometimes complain that investors which are companies in the field are often slow in their decision process and hence delay the company's financing rounds. In addition, due to the added reputation they bring with them, such companies can invest based on lower valuation than the value that would have been determined for an investment by other investors. The low valuation may be difficult to explain to future investors as well as to previous investors in the company. Furthermore, the relationship with the strategic investor may prejudice or "taint" the company's alleged independence when choosing other suitable technological partners and may bar its path to customers who are identified with the investing company's competitors. Finally, there are always issues revolving the protection of the startup's intellectual property against the investing company.

Aside from the strategic considerations in accepting such investors as well as from the economic perspective, direct corporate investments are similar to investments made by venture capital funds, both in the process of examining the investment and in the ongoing means for controlling it. Although the investments are usually made by funds which may be associated with the companies, they are typically managed as venture capital funds for all intents and purposes, except for the fact that in every investment they also weigh the added value which the investment will bring to their company as well as the added value which the investing company can contribute to the startup.

Corporate In-house Entrepreneurship and Incubators

In addition to direct investments in startups and indirect investments through venture capital funds, many companies now fund in-house startups. These startups enjoy an existing work force and infrastructure in terms of labor and know-how, and can benefit from initial in-house financing.

The main reason for the establishment of such in-house startups was the expanding phenomenon of workers departing to form their own, or join independent startups. For instance, many people attribute the decline of numerous established technology companies in recent years to the departure of workers with good business ideas to independent companies, either as entrepreneurs or as employees joining a new venture at a relatively early stage. The phenomenon resulted, among other things, from the fact that in the setting of a large organization, the share of the entrepreneur-worker in his initiative is typically smaller than the share he could obtain in an independent setting or at an earlier phase. In order to tackle this problem, many companies started in recent years to fund in-house startups to cultivate and finance workers' initiatives while allowing them to act as independently and quickly as possible. The companies give the entrepreneur-workers and the workers who join them considerable portions of the equity in their new venture, money, and financial, organizational, technological, and marketing support.

On the other hand, the operation of ventures inside an organization entails difficult issues related to the compensation of the employees and the various effects on the morale of workers who do not join the venture being developed. Many companies face complaints on the part of workers who do not move over to the startup, since they generally do not directly enjoy the success of the startup, whereas the workers who do move to the startup often continue enjoying the security provided by the parent company (the importance of which is enhanced during difficult times in the capital market), along with the possibility of benefiting from the potential success of the startup. The establishment of such startups often also involves the resolution of various issues such as conflicts between marketing channels (for instance, various pricing problems) and the recruitment of outside workers versus recruiting workers from inside the company.

Concurrently, some industrial companies have in recent years started leveraging their technological, financial, and marketing capabilities by establishing in-house incubators for outside ventures. These companies establish entities which specialize in identifying early-stage ideas and ventures in fields in which the company has an added value. Although these are not ideas which budded inside the company, as in the case of in-house startups, the principle of financial, technological, and marketing assistance is similar to that described above in the context of in-house startups.