One in which the slow, steady capital of corporate investors becomes more important.
One of the drivers behind the accelerating sell off on the Nasdaq index — a proxy for technology and high growth company share prices — is the retraction of hot money flowing into tech stocks which led to nosebleed valuations.
Take for example, Tiger Global, a hedge fund which claims to have lost over $17bn this year alone from an overweight position in tech stocks, while Softbank suffered a $27bn loss from its infamous Vision Fund as Masa-san asked his team to slow down investment plans. Their retreat may herald a new era for venture investing, particularly for B2B enterprise startups.
CVCs, famed for a more conservative approach to investing, may become sought after as tech founders seek a partner less susceptible to market gyrations. I am not saying that VCs are unreliable, but those with a direct public market connection (ie. investing in pre-IPO companies or later-stage deals) can be pulled each way with market volatility and will be the first to retreat.
“I am not saying that VCs are unreliable…but they can be pulled each way with market volatility and will be the first to retreat.”
Building a tech business takes time, giving weight to the adage that “it takes years to build an overnight success”. Through the combination of talent and capital, innovation happens but this requires the long view. Consider the current space race between Elon Musk and Richard Branson: lots of capital combined with great talent to implement an unknown and untested business model. Yet investors clamour for the opportunity to participate.
Enterprise startups need slow, steady and reliable capital — ideally with add-ons. When the bubble pops, what private tech companies need to know is that a capital partner has the capacity to support them through tough market conditions, where new rounds or exits may be difficult.
Hot vs reliable money
But how can you differentiate reliable capital from hot money? No VC is going to admit up front that they want their money out fast.
“No VC is going to admit up front that they want their money out fast.”
One group of investors who want more than just a commercial return are CVCs. They are seeking to infuse the startup technology and sometimes the “out-of-the-box” thinking into their teams and cultures. The commercial return is a core component of any investment analysis and, in some cases, is referred to as the objective of such investment. But when compared to a pure VC model, the CVC has a wider lens through which to evaluate the investment. In practice, a CVC investment combined with a commercial contract could significantly enhance the valuation of the startup.
“We use the technology in our operations and it has realised value, so we invested in the company.” This would be a strong testimony for any startup from a CVC investor.
The startup wants a strong and supportive commercial partner. A reliable commercial partner and CVC backer, in a volatile market, is a valuable foundation on which to build investment.
At Finboot, our first CVC investor was Repsol Energy Ventures — part of the eponymous Spanish energy major. After a relationship building period of more than a two years — and positive support from their business units following a pilot — Repsol’s CVC unit decided to lead our seed round.
“VCs often consider CVCs as a lower grade investor. Which is odd.”
This was unexpected, as typically a CVC looks at later stage companies. Actually, many CVCs are not set up for early-stage investing. Sometimes, for example, the corporate legal process alone can drive up the costs so much the total investment becomes uncommercial. CVCs don’t tend to use standard (like the BVCA standard) template investment documents, instead opting for their own bespoke terms, which can drive up legal costs further as well as adding to the time to close an investment. For a startup, this approach may be cumbersome — although tailoring the agreement can actually help clarify the motivations and objectives for both sides beforehand.
VCs often consider CVCs as a lower grade investor – a somehow less worthy suitor. Which is odd.
A core ingredient of startup valuations is product market fit assessed by the number of enterprise customers; the larger the enterprise, the lower the number required to support your thesis, particularly at early stage. If an enterprise buys your product and invests, surely that should count for double?
In these markets, I would argue that it does. If your enterprise customer has ‘skin in the game’ to make your product a commercial success, hopefully growing sales revenues will reduce the need for regular funding rounds, de-risking the overall business. “Time to profit” is one of the parameters being used to separate the winner from the loser in the current market turmoil.
CVCs should lead rounds
CVCs should also be the ones to set an effective valuation. Ask any VC and they are likely to favour VCs over CVCs when it comes to leading rounds. But, as the world of easy money retracts, those with a real business understanding to verify the market fit of a product — a key investment criteria — should prevail. There can be nothing more reassuring to any investor than seeing an enterprise both buy and invest in a solution that address real pain points.
CVCs do need to learn from history. During previous bubbles, including the most recent dotcom bubble, which burst at the beginning of 2000, CVCs initially retreated, only to later relaunch their units. This damaged their reputation and brand amongst the startup community.
Today, in the world of accelerating digital transformation we need to build businesses that are “built to last”.
And this requires partners who are reliable, supportive and in for the long haul: enterprise startup + CVC = winning combination. Time to tie the knot.
Nish Kotecha is chairman and co-founder of Finboot.