Corporate Venture Capital (CVC)

What is corporate venture capital?

Corporate venture capital (CVC) refers to minority investments by an established company, usually a corporate group, in young, unlisted companies, as a rule through a dedicated investment unit. Unlike a pure financial investor, which is concerned solely with the appreciation of its shares, the group also pursues a strategic benefit for its own business. The short form corporate VC is also in use, and the investment unit is called a CVC unit or CVC arm (corporate venture arm). The abbreviation has nothing to do with the identically abbreviated verification number on credit cards.

CVC units frequently take part in financing rounds from Series A onwards, usually as a co-investor. They then join the terms that a venture capital fund, as the leading investor, has negotiated. The parties involved are the investment unit, the departments of the group that support the project on substance, and the bodies that decide on the investment. The investment is governed by a participation agreement and a shareholders' agreement. Often a separate commercial agreement is added, such as a cooperation, supply, licence or distribution agreement.

Organisational forms of corporate venture capital

In Germany, mainly corporate groups from industry, chemicals, pharmaceuticals, energy, insurance and media maintain their own investment units, as do larger family businesses. They usually organise their investment activity in one of three forms:

• Direct investment: The group or a subsidiary invests directly; budget and decision lie with the group's management.
• Dedicated investment company: A subsidiary with its own team invests from an approved budget, often with no fixed term.
• Fund structure: The group is the sole or most important investor in a fund with a fixed term, which is managed by an in-house or external team. This form comes closest to a financial investor.

The form determines speed and reliability. Where group bodies have to give their approval, the decision takes longer than with a fund. Without a fixed term there is no pressure to sell, but the programme depends on budget and strategy decisions of the group.

Strategic motives of the group

The strategic benefit can take various forms. The group gains access to technologies that it does not develop itself, observes new markets and business models early and complements its own research and development. Further motives are new sales channels for its own products and the preparation of a possible acquisition. In the best case, the young company gains access to customers, sales channels, production or expertise that goes beyond the capital.

These motives affect the valuation. A group may be prepared to pay a higher price if it expects synergies, that is, additional revenue or cost advantages from the combination with its own business. Conversely, it often demands rights that a financial investor does not need. Whether a higher price outweighs these rights can only be judged with a view to the later exit options.

Conflicts of interest and information rights in CVC

A CVC investor is at the same time a shareholder and a possible customer, supplier, cooperation partner or competitor of the company. This gives rise to conflicting objectives: over the prices and terms of the commercial agreement, over cooperation with competitors of the group and over the question of which information reaches the group.

Limiting information rights

Customary information rights comprise monthly reports, annual financial statements, planning and information on material matters. Towards a group they are often restricted: competition-relevant information such as prices, customer lists, product plans or source code can be excluded. Confidentiality rules often ensure that information stays within the investment unit and does not reach the departments. Competition law in any case sets limits on the exchange of competitively sensitive information between competitors.

Advisory board and observer status

Instead of a voting seat on the advisory board (Beirat), a voluntary body of the GmbH (German limited liability company) for advising and supervising the management, a CVC investor often receives only observer status (observer seat). For both forms an exclusion rule is advisable: for agenda items involving a conflict of interest, the representative does not take part and receives no documents. This concerns, for example, negotiations with competitors of the group or the commercial agreement itself.

Merger control and investment screening

Even a minority stake may have to be notified under merger control, in which the German Federal Cartel Office (Bundeskartellamt) examines the consequences for competition. This applies, for example, from a share of 25% or where there is competitively significant influence, provided the statutory turnover or transaction value thresholds are met. Particularly for acquirers based outside the EU, a state investment screening under foreign trade law may be added. Both affect the timetable of the round.

Influence on later exit options

The investment of a group affects a later company sale. Competitors of the group may be reluctant as buyers if a rival is already a shareholder and has insight into the company. At the same time, the group itself is an obvious buyer in a trade sale, that is, a sale to a company in the same industry. Particularly critical are rights that give it priority in acquiring the entire company:

• Right of first refusal: The investor may step into a purchase agreement negotiated with a third party on the same terms. Other bidders know that their offer can be taken over and bid less often or more cautiously.
• Right of first offer: Before a sale process, the investor may submit an offer first. If the shareholders reject it, they generally may not sell to third parties on worse terms.
• Information and participation rights: The investor is informed of a planned sale or given the opportunity to take part in the bidding process. This form impairs competition among bidders the least.

To be distinguished from this is the right of pre-emption over individual shares, which shareholders' agreements usually grant to all investors. The obligation to join a sale (drag-along) is often drafted so that it also binds the CVC investor. The CVC investor then cannot prevent a sale to a competitor that is backed by the majority.

Practical example: CVC investment by an energy utility in a Series B

A provider of software for energy management generates EUR 6 million in recurring revenue per year. In a Series B, it raises EUR 20 million at a pre-money valuation of EUR 60 million. A growth fund takes EUR 12 million as lead investor, which negotiates the price and terms of the round. Existing investors subscribe EUR 3 million. The investment unit of an energy utility wants to contribute the remaining EUR 5 million. It demands a voting advisory board seat, a right of first refusal in the event of a company sale and a framework agreement on the use of the software in the utility's network companies. The outcome of the negotiation:

• Valuation after the round: EUR 60 million + EUR 20 million = EUR 80 million
• Stake of the energy utility: EUR 5 million divided by EUR 80 million = 6.25%, that of the lead investor EUR 12 million divided by EUR 80 million = 15%
• Instead of the right of first refusal: a right to submit an offer in a sale process, without a right to step into third-party offers and without sight of their terms
• Instead of the advisory board seat: observer status with exclusion on topics that concern competitors of the utility or the framework agreement
• Information rights: quarterly reports and annual financial statements; customer lists and pricing remain excluded
• Framework agreement: negotiated separately, on terms that also apply to other customers, and without exclusivity

The company gains capital and a reference customer without displacing other potential buyers from the outset. The lead investor makes sure that the utility's special rights do not undermine the rights of the other shareholders.

Distinction: CVC, venture capital, venture client and family office

• Venture capital: financial investors who invest the capital of their investors and earn solely from appreciation. CVC combines return with strategic goals of the group.
• Venture client: The group becomes a customer of a young company without taking a stake. The model is suited to trialling a technology before a decision on an investment is made.
• Strategic buyer: acquires the majority or the entire company. A CVC investor remains a minority shareholder but can be a preliminary stage of a later acquisition.
• Family office: invests, like the investment company of a group, usually without a fixed fund term, but pursues the investment goals of a family rather than the operating interests of a group.

Common mistakes

• Investment and commercial agreement linked. If the investment depends on a supply or cooperation contract, the company loses room for manoeuvre in both negotiations. Separate contracts with their own term and termination provisions are preferable.
• Right of first refusal over the entire company. A right to step into third-party offers reduces the willingness of other bidders to engage in a sale process, and with it the achievable price.
• Unlimited information rights. Without an exception for competition-relevant data, prices, customers and product plans reach a group that may at the same time be a competitor.
• Decision paths underestimated. Group bodies, departments and, where applicable, merger control extend the timetable. Involving the group late endangers the closing of the round.
• No independent lead investor. If a CVC investor alone sets the price and terms, the confirmation by a financial investor, which later investors look for, is missing.
• Dependence on the champion within the group. If strategy or contact persons change, interest in the investment and in follow-on financing may fade.

Frequently asked questions

Do CVC investors pay higher valuations?

In part. Expected synergies can justify a higher price. Groups often demand additional rights in return, so a comparison with a financial investor has to take the overall terms into account.

Can a CVC investor lead a financing round?

Yes, this happens. More often, however, CVC units take part alongside a financial investor who negotiates the price and terms. Later investors see this as confirmation that the valuation is not shaped by the interests of the group.

At what stage does a CVC investor make sense?

There is no fixed stage. A CVC investor makes sense above all when product and market are developed far enough for cooperation with the group to bring a concrete benefit. The earlier the investment, the longer it affects the later choice of buyers.

Can a CVC investor prevent a sale to a competitor of the group?

That depends on the rights agreed. A right of first refusal allows it to take the buyer's place. It can block a sale through a consent requirement for share transfers. A blocking minority (more than a quarter of the votes) works where the sale requires a resolution with a three-quarters majority. Without a drag-along obligation, it does not have to surrender its own shares, which deters buyers who want to acquire all shares. With a drag-along obligation, it must follow a sale supported by the agreed majority.

What happens if the group discontinues its investment programme?

The investment remains in place, and the group remains a shareholder. Such investments are often sold on to other investors later. So that the company has a say in who acquires the shares, the articles of association should make share transfers subject to the consent of the company or the shareholders (restricted transferability, or Vinkulierung).

The Roemer Capital view

If a strategic investor shows interest in a Series A to C, Roemer Capital separates the investment from the commercial agreement in the negotiation and assesses the two separately. This keeps it clear which part of the offer is capital and which part is revenue that could also be negotiated without an investment.

Because Roemer Capital also accompanies companies through a later sale, it examines a group's rights of first refusal, first offer and information from the perspective of that process. The question is which bidders would become more cautious as a result and how this affects the achievable price. The contracts are drafted by the company's law firm; Roemer Capital contributes the calculation of their economic consequences.