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In 2022, venture funds and private investors are putting investment activity on pause. Their place is taken by corporations that provide startups with funding and access to potential customers. What are the advantages here?
About the expert:
Elena Volotovskaya, Head of Softline Venture Partners Fund, Vice President for Investments at Softline Group of Companies.
On June 16, 2022, the Technology Focused Nasdaq Composite Index is fell to its lowest closing level since September 2020.
NASDAQ Composite Index is a composite index that includes more than 3 securities of high-tech and fast-growing companies from both the US and other countries. It is one of the key indicators of the state of the world economy, along with the S&P 500 index. Based on their dynamics, professional investors and analysts make forecasts for the most promising segments of the economy.
The list of technology companies in the US and Europe that are cutting staff is growing daily. Since the beginning of 2022, according to the layoffs.fyi tracker, this fate befell 483 companies around the world. This wave has affected start-ups in the financial sector, nutrition and healthcare most strongly. Following the recommendations of the largest investment companies, startups are changing course from rapid growth to survival in the hope of making it to the next round.
Against the backdrop of a general decline in the number of venture capital transactions, which is confirmed by both Russian and foreign analytics, corporations are increasing investment and M&A activity in various areas.
According to According to Bain & Company’s 2022 Global M&A Report, corporate venture capital (CVC) investment now accounts for more than a fifth of global venture capital investment. For comparison, ten years ago they accounted for 11%.
In the period from 2010 to Q2021 22, the total investment of venture funds grew at an average annual rate of 31%. For comparison, transactions secured by corporate capital are XNUMX%. According to CB Insights, the number of such deals in the first three months of 2022 set a quarterly record high of 1317. Funding volume decreased by 19% compared to the previous quarter, but remained at a high level compared to Q1 2021.
Traditionally, in difficult economic periods, it is corporations that are the first to slow down investment activities. What has changed? There are several reasons for this.
Corporate investment vehicles got stronger
In an effort to ensure continuous sustainable development, companies have begun to look more towards vertical integration and create investment units.
An open innovation strategy, when large companies invest in external ideas, and not only in internal experiments, allows us to solve many problems – from increasing profits and sales to strengthening the position of the business in the market and strengthening its influence.
Despite their size, corporations can be surprisingly flexible. Over the past decade, most of them have responded dynamically to changes in the tech landscape, adapting their strategy to keep pace with the startup ecosystem, thereby helping to raise the bar for investment in CVC. Usually this path looks like hackathons → accelerators → first investments → fund launch.
According to Dsight, in 2021, 54 corporate accelerators were held in our country, of which four were carried out by companies on their own, without the involvement of an external operator. Early investment provides more favorable conditions for the purchase of projects with in-demand technologies, which will allow you to stay ahead of competitors. This shift also explains why many corporations have started launching investment funds specifically for startups—just look at Mondelez International (formerly Kraft), Nike, Microsoft, American Express, and PepsiCo.
Niche expansion
Among Russian companies, the pioneers of corporate venture funds are telecom, IT and financial companies: MTS, Finam, Sistema, Softline. Today, however, virtually every corporation is involved in venture capital in one way or another and spans a number of niche sectors. This means more choice and more money for startups.
If for companies from industries with a traditional IT component, venture activity seems absolutely logical, then the interest, for example, of the agro-industrial complex in investing in innovation may, at first glance, seem strange. In fact, there is nothing surprising, since the breakthrough development of the agro-industrial complex requires the introduction of modern technologies, and those, in turn, require a sufficient amount of investment.
Hence the emergence of such programs as, for example, the RSHB DIGITAL digital platform from Rosselkhozbank. However, this does not mean that corporations invest only in strategic projects. So, Softline Venture Partners in 2019 invested 250 thousand dollars in a platform for monitoring cattle farms using video analytics systems. This suggests that despite the presence of a certain focus associated with the company’s core business, it can pay attention to a promising project with the aim of reselling it to a strategist in the future.
Why corporations will remain active
Increasing interest of corporate investors noted in Toronto at the Collision 2022 startup and venture investment conference. Growing deglobalization will force companies around the world to look for alternative products and solutions, including through breakthrough technologies. The latter, among other things, are able to reduce production costs, which is extremely important in the face of rising inflation.
As innovation becomes an imperative for corporations, venture capital investments provide them with an excellent way to minimize the associated risks. The fund can invest in 25 different start-ups, each with a promising idea and strong entrepreneurial intent to bring it to commercial viability. If just two of these ideas come to fruition, then the corporation can double down on these innovations, use its early access to create a competitive advantage, and more than justify portfolio investment. It would be difficult to launch the same 50 innovative projects in parallel within the company.
Thus, the CVC model offers higher potential at much lower risk. Together, all these factors provide the growing strength and sustainability of corporate venture.
There is another explanation for the expected surge of corporate interest in technology projects. In a situation of declining valuations, start-ups become extremely attractive objects for investment. Even the largest of them are forced to accept new market conditions in order to secure access to further financing.
A recent example is Swedish fintech giant Klarna. At the beginning of July the company confirmed the attraction of a new round of financing, as a result of which its valuation was reduced to $6,7 billion – about 1/7 of what the company was valued in June 2021.
The next factor is the appearance on the market of a certain amount of HNWI/UHNWI capital. The former include owners of liquid financial assets worth at least $1 million, the latter – at least $30 million. Being extremely limited in investment opportunities, they pay attention to actively growing businesses in our country. Early-stage investors, including corporations, understand that there is interest from large potential partners in technology projects and, accordingly, clear prospects for the next rounds. As a result, they are more active in transactions.
What are the benefits for technology innovators in raising corporate funding?
First of all, that it can help them survive the economic downturn and the limited choice of investors.
But this, of course, is not all. A significant criterion for a good investor has always been the opportunity to receive smart money: when, in addition to money, projects received a vision of the market, network, access to potential clients and other resources. Now this role has been taken over by corporations.
In addition, large companies can also be the first testers of startup products and services, which makes them both commercial clients and partners.
And, finally, many years of investment experience allows us to conclude profitable start-up deals and bring benefits to projects faster.