Venture sands shift with time

The most dangerous phrases in finance are “this time it is different” and “paradigm shift”.

Finance is as cyclical as the society it reflects. A series of seemingly endless booms and busts as trends and ideas come into and out of fashion and interest rates rise and fall and money supply increases, whether directly, through credit or other ways, such as derivatives. And it is hard not to look at commitments made to a close a $100bn venture fund organised by Japan-based conglomerate SoftBank with an expectation that last year was a high point in private capital markets and innovation capital.

For context, the entire venture capital-backed deal market last year was worth an aggregate $134bn across 9,717 deals globally, according to data provider Preqin. It was the second, successive year of $100bn in deal value, Preqin said, reaching a high watermark last seen in the dot.com bubble year at the begining of the millennium.

Corporations were an important part of the increased value of deals, even if they made up a fifth of overall venture investment volume. Last year, GCV Analytics tracked 1,952 corporate-backed venture rounds worth $83bn. This was about double the value of corporate investments compared to 2014’s $42.95bn, although deal volumes only increased by less than a third from 1,590 two years ago.

But SoftBank’s fund, reportedly oversubscribed in months, might not be the signal of ‘peak venture’ that it first appears for two reasons that became clearer over the past year – supply of capital is changing from purely financial-focused principals to those with often more strategic reasons and opportunities to invest.

Looking deeper at the SoftBank fund, the disclosed sources of capital are corporate, government and individual rather than institutional investors, such as life assurers, looking for a financial return.

SoftBank has said it is investing at least $25bn in the fund and has been in talks with Saudi Arabia’s state-backed Public Investment Fund for another $45bn commitment. SoftBank said the remaining money was being committed by others, including US-listed technology firm Apple, Taiwan-based manufacturer Foxconn, database provider Oracle founder Larry Ellison’s family office and chipmaker Qualcomm.

“We believe their new fund will speed the development of technologies which may be strategically important to Apple,” company spokesperson Josh Rosenstock told newswire Reuters, confirming in January its plan to invest $1bn in the SoftBank Vision fund. Given Apple had $237.6bn in cash in its fiscal fourth quarter, finding uses for this mountain of cash that could provide financial returns and strategic insights seems reasonable.

Saudi Arabia seems to agree, probably for similar reasons – the SoftBank fund and technology offers it potential financial returns for its oil-derived wealth and a chance for the kingdom to find the new ideas and technologies that could help its population.

Almost every other leading company, university and country is thinking along similar lines.

Over the past 12 months, Global University Venturing has tracked more than 50 new funds, including $650m for Oxford Sciences Innovation, MIT’s $150m Engine initiative to provide long-term patient capital and workspace to fledgling spinouts, and the sweeping $7.6bn plan unveiled by Tsinghua University in June.

Over the past 12 months, Global Government Venturing has recorded more than 200 funds, including the EU’s $1.7bn VC fund (see our Global University Venturing and Global Government Venturing reviews of 2016 at the back of this publication).

Carlos Moedas, European Commissioner for research, science and innovation, delivered the 2016 Guglielmo Marconi Lecture last month and laid out his vision of the European Innovation Council and a fund of venture capital funds as key elements in helping member states through “open innovation, open science and [being] open to the world”.

Hiro Mizuno, chief investment officer at Japan’s $1.4 trillion Government Pension Investment Fund (GPIF), in a speech at the Coller Institute of Venture at the end of November said he was “really keen promote science and small business”.

He added: “Venture investing makes no sense in a financial sense [to GPIF] but what makes global economy more sustainable is global entrepreneurship. GPIF is the ultimate beneficiary – more IPOs. That is why I encourage [venture and entrepreneurship] everywhere I go.”

Ding Xuedong, chairman of the state-funded $810bn China Investment Corporation (CIC), this month said it would pay more attention to alternative investments and set up a sustainable development mechanism to prevent risks. Previously, CIC mainly invested in equities and fixed income, although it had taken a stake in alternatives asset manager Blackstone.

Corporations, perhaps unsurprisingly, have already moved faster than this. Three-quarters of the Fortune 100 list of biggest companies are active in corporate venturing by investing in venture rounds directly or through commitments to third-party funds, and 41 of them have specialised CVC units, according to GCV Analytics. Of the 25 outliers, almost all are non-US-listed, usually state-owned enterprises based in China, such as State Grid, Sinopec and China State Construction Engineering.

Two years ago, for our inaugural World of Corporate Venturing 2015, and GCV Analytics found 47 of the Fortune 100 were involved in corporate venture capital (CVC).

In 2016 alone, GCV reported 60 new CVC units were launched, along with a record number of 142 corporate-backed VC funds and even more accelerators and incubators. Many corporations have started investing without setting up a formal CVC unit.

Over the past six years, GCV Analytics has tracked 1,667 corporate investors which have participated in at least one VC round, and 857 out of those 1,667 also have a specialised CVC unit.

This diversity of approach creates concerns. Many corporate investors are episodic, with 965 making a deal last year, according to GCV Analytics (see chart below).

The top 20% of CVCs, such as GCV Leadership Society Luminary members Intel Capital, Tencent, Capital One, Merck Global Health Innovations, GE Ventures and Johnson & Johnson Innovation–JJDC, are responsible for about 85% of dealflow, according to GCV Analytics. A fifth of CVCs – often the same ones – also generated an annual rate of return of 30% or higher, according to GCV’s annual survey.

These are the leaders in the industry but their good work and professionalism risks being drowned by the noise of less thoughtful peers doing a handful of deals then retreating, leaving entrepreneurs confused and competitors for quality investments with a marketing edge.

As GCV noted in its December and January issues regarding the end of the so-called golden age of corporate venturing, there is greater professionalism in the industry as old-style amateur venture capitalists are disrupted by investors, whether philanthropic and angel, university-focused, corporate, government or the top VCs, offering a better service around entrepreneurs’ need for cash, customers, staff and exits.

In our annual survey, carried out this year in partnership with academics from Harvard, Stanford, Chicago universities’ business school, Mark Sherman, managing director at Telstra Ventures, said: “Strategic growth investing will become an increasing force in 2017 and in years to come. Corporates will move from under 15% of total ventures dollars invested in the early 2000s to 25% today to over 35% in the next five to 10 years.

“Strategic growth investing is different from CVC in that it is larger investment sizes, global orientation, and providing commercial relationships to attract the best entrepreneurs.”

Thomas Grota, investment director at Germany-based phone operator Deutsche Telekom, as part of his annual review and outlook blog, said: “Corporates will still be active in the investment scene to support startups but not by traditional VC investments in early rounds.

“Most of them will hand over the seed and early-stage investments to external funds. They will use the dealflow for innovation screening but not as an active investor.

“In growth stage they will evaluate investment rounds but rather as a dominant shareholder outside VC terms.”

Claudia Fan Munce, venture adviser at New Enterprise Associates, former managing director of IBM Venture Capital Group, chairman of GCVs Leadership society advisory board and winner of the industry’s Lifetime Achievement Award, said 2017 would be about: “How innovations that drive growth of the parent corporation has been sourced through its corporate venture activities, investing, incubating, business development for commercial partnership, M&A and other things that are part of the corporate venture portfolio of activities.”

This “portfolio of activities” might be broadening but the goal remains the same – to find the innovative ideas and products and services of the future.

And while innovation capital and its sources are increasing and diversifying, opportunities to invest it are also increasing.

Global Corporate Venturing’s table of tech to watch out for last year included:

•   3D printing and additive manufacturing

•   Advanced materials

•   Advertising tech

•   Agritech

•   Antibiotics

•   Artificial Intelligence (AI), machine learning and big data

•   Augmented and virtual reality

•   Blockchain and cryptocurrency

•   Boutique food and drink brand startups

•   Brain research

•   Crispr, genome editing and bio-precision medicine

•   Communication platforms

•   Crowdfunding and peer-to-peer lending platforms

•   Drones and autonomous vehicles

•   Education, including Moocs

•   Energy and storage

•   Gaming experimentation

•   Internet connectivity and access

•   Internet of things with sensors-RFID

•   Messaging

•   Mobile

•   Modularisation

•   Robotics

•   Security, cyber and physical

•   Sharing and on-demand economy

The first part of the last year’s outlook covered genome-editing tools and their progeny and a possible future evolution of computing to support artificial intelligence through quantum computing; the second part looked at companies fuelling the mind and body through virtual reality and improved food production; the third part covered communications through emerging space and internet access providers and application platforms; and the fourth part looked at the energy space, with a focus on the niche startup area of nuclear and more critical area of batteries.

Peter Diamandis, co-founder of Singularity University, in his review of tech trends from last year, noted the accelerating connectivity of people and the march of AI, how solar and renewable power was cheaper than coal, the first glimpses of the end of cancer and other diseases, and an extension to human life, and the development of autonomous vehicles, drones, flying cars and the conquest of space, in part through breakthroughs in physics.

This year these major themes are still driving developments (see outlook predictions from our survey).

Benedict Evans, partner at VC firm Andreessen Horowitz, borrowing the seminal quote from his boss, Marc Andreessen, in 2011 about how software was “eating the world”, laid out last month his view that “mobile is eating the world”.

Evans said: “As we pass 2.5 billion smartphones and head towards 5 billion, and mobile moves from creation to deployment, the questions change. What is the state of the smartphone [60% of time online involves smartphone apps], machine learning and Google, Apple, Facebook and Amazon [which have more than $400bn in combined annual revenues with capital expenditure of nearly $30bn], and what can we build as we stand on the shoulders of giants?”

But Evans had already identified the seeds of the next transformation, quoting the view of Sundar Pichai, CEO of Microsoft, that we will “move from mobile-first to AI-first”.

And Evans said imaging – cameras – combined with machine learning,“may be becoming a universal sensor” and asked: “What if computers can read images as they can read text”?

Looking at what these platform technologies could enable, he said frictionless computing, such as voice controlled applications and technology including Amazon’s break-out Echo system, automotive and e-commerce would be important opportunities.

His colleague, Peter Levine, partner at Andreessen Horowitz, noted how the shift into cloud computing was being impacted by developments in edge computing – effectively servers and processors held locally rather than remotely – to help autonomous cars, drones, home automation systems and consumer electronics work.

The predictions of Fred Wilson, legendary VC at Union Square Ventures, included: “Tech investors will start to adopt genomics as an additional information technology investment category, blurring the distinction between life sciences and tech investors that has existed in the VC sector for the past 30 years.

“This will lead to a funding frenzy and many investments will go badly. But there will be big winners to be had in this sector and it will be an important category for VCs for the foreseeable future.”

Competition from non-specialists will impact healthcare companies’ openness to a broader range of venturing. Last year, Bruce Booth, veteran investor at Atlas, noted how over the past 20 years, “externally-sourced programs – in-licensed – have delivered almost a twofold higher rate of success in development versus in-house programs” and by 2015 more than 75% of its deals had corporate venture groups as co-investment partners compared to below 5% a decade earlier.

Just as the context to the venture industry’s shift to being able to raise $100bn funds through new sources of capital, so the ability of technology-enabled companies to have hundreds of billions in revenues is significant. The five largest US companies by market capitalisation at the start of this year were:

•   Apple: $570.7bn

•   Alphabet, parent of Google: $560bn

•   Microsoft: $434bn

•   Amazon: $365bn

•   Facebook: $354bn

Oil major ExxonMobil was sixth with a $351bn market cap.

In China, Tencent surpassed China Mobile to become the country’s largest corporation with a HK$1.99 trillion ($256.6bn) market cap in September.

With the market caps of just these six tech companies totalling nearly $2.5 trillion, no wonder large amounts of venture money can now be raised and companies are buying more portfolio companies. GCV’s analysis in its December issue revealed about a fifth of M&A exits over the previous three years went to a parent of a corporate venture-backed company.

Semil Shah, investor at Haystack, in his summary last year said there were “incredible shifting sands underneath traditional VC, with more funding checkpoints, the number of startups and VC firms continuing to increase, the returns coming in, but concentrated, and people slowly leaving traditional VC”.

He added: “Limited partners [LPs – investors in venture funds] see tons of opportunities to find and partner smaller or newer firms and find new ones that can scale and perhaps not get too big.

“We now see dozens of firms which started as smaller seed firms now managing well over $100m in a fund and taking on the new series A; now seed firms are looking for traction and data to analyse; now pre-seed is actually a category that institutional LPs have added to their lexicon; and, perhaps most important, the next crop of founders are not as swayed or in awe of the larger institutional VC brands that many LPs have admired for years.

“And, new LPs are in the mix too – it is not clear which models and vehicles and managers will build the best flytraps to catch the next big outcomes. It is all up for grabs.”

Not everyone, however, will grab an equal share, even if some form of universal basic income is introduced to help ameliorate the shock of moving to an AI-first world. Concentration of wealth and economic fears can lead to macro instability, regardless of the impact of technology on politics by alternative means – war. With cyber being the fifth battleground and conflicts being generally regarded as more likely in a balance of power, technology changes create opportunities for emerging powers.

In politics, voting results in 2016 lead to plenty of change from the Philippines to the UK to the US. But the unhappiness, or hope in different forms, expressed by large parts of these electorates – potentially to be replicated in elections in Germany and others this year – that challenged the liberal consensus, could just end up reinforcing the issues concerning people rather than finding ways to tackle them.

In GCV’s October’s editorial – Is now the “most treacherous” moment? – the magazine looked at the zeitgeist of low yields and high valuations and how society was starting to separate intelligence from consciousness in its search for human immortality, bliss and divinity.

Yuval Harari’s latest book – Homo Deus (Man as God) –argues that some people might upgrade themselves to live longer and with more power, but those who cannot do so appeared to become politically and economically less important. Perhaps the most insightful part of Harari’s book, which is out in the US this year, was the examination of how the past three centuries’ broadly humanist approach is being superseded by one, born in Silicon Valley, of “dataism”.

Harari concluded his book with a question: “What will happen to society, politics and daily life when nonconscious but highly intelligent algorithms know us better than we know ourselves?”

It is a question with which investors are increasingly starting to grapple as part of a shaking of fundamental entrepreneurial tenets, such as whether it is better to ask for forgiveness than permission.

But while some things shift and change and the questions they raise are renewed, other things remain the same – our gratitude.

Thank you to our partners, Paul Gompers at Harvard University and National Bureau of Economic Research, Will Gornall at University of British Columbia, Steven Kaplan at University of Chicago Booth School of Business and National Bureau of Economic Research and Ilya Strebulaev at Stanford University Graduate School of Business and National Bureau of Economic Research, for helping GCV with our annual corporate venturing survey; to Jody Thelander, CEO at J Thelander Consulting, for running the compensation survey analysed by Bell Mason Group; and to all the thousands of readers and hundreds of members of the GCV Leadership Society for sharing your data, insights and support over the past year, and to the sponsors and commercial supporters that enable us.

Wendell Brooks, president of Intel Capital, described in his first keynote at the Global Corporate Venturing & Innovation Summit last year his own moment of enlightenment that the industry was about “asking not what your portfolio companies can do for you, but what you can do for your portfolio companies”. For us, the same spirit applies. So, how can we help you?