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Smaller companies in search of cash have a new source: big companies.
Alix Stuart, CFO Magazine
October 1, 2011
When finance executive Ane Ohm joined Harqen, an early-stage company that makes tools to index and analyze recorded phone conversations, one of her reasons for taking the job was, in a sense, lofty: she hoped to meet angels. While the ones she was targeting are not quite as rare as the heavenly variety, angel investors are not as commonplace as smaller companies would like.
With bank financing still uncertain, small and midsize companies are looking to alternatives, with mixed results. Angel groups generally invest in only 1% to 10% of the opportunities that come before them, according to Marianne Hudson, executive director of Angel Capital Association. Those are slightly better odds than companies seeking venture funding or private-equity infusions will encounter, according to a recent survey by the Pepperdine Capital Markets Project, but just 13% of businesses that responded to that survey reported getting funding from any of those sources.
Small businesses on the hunt for cash may, however, benefit from the massive cash hoards that large companies possess. According to one recent study of more than 800 public companies, cash balances at the end of 2010 had more than quadrupled, on average, compared with 10 years earlier. Indirectly, these deep pockets may help growth companies by providing tired investors with renewed liquidity. "If the large corporates make more acquisitions and create more exits, they may get people excited about investing again," says Jeffrey Sohl, who tracks angel investing as director of the Center for Venture Research at the University of New Hampshire's business school.
More directly, many large companies are looking to sink money into companies that can possibly speed their own growth. An increasing number, including EMC, Google, and Juniper Networks, have established or renewed such efforts in the past two years. "Corporates see [such venture efforts] as outsourcing R&D," says Gerald Brady, managing director with Silicon Valley Bank's venture-capital group, who previously worked with Siemens's venture-investment arm.
No matter how the capital comes in the door, however, finance executives need to understand that by cashing the check they are also accepting a new and active partner. Experts say that both angel and large-company investors want to be intimately involved in the business. That involvement can take the form of board seats, coaching programs for top executives, and even business-plan revisions.
Angels at Work
For Ohm at Harqen, such intervention has been a benefit rather than a burden. "I can't say enough about how much value I've gotten from our angels," she says. As vice president of finance and operations, she has participated in coaching and strategy programs run by her angel investors. That has helped her track what's happening on the competitive landscape, and develop a vision for how the company should grow and evolve over time, so that when it's time for an exit, "it's a good transition," she says.
Ohm joined after Harqen had raised two rounds from angels. The company is currently seeking its third round to help launch a new product. In her time with the company, Ohm has learned that angels stick close. The same investor, Lauren Flanagan, has led all three rounds, and has helped introduce the company to others that could help, including angel groups that aim to invest in woman-led companies.
Such closeness has drawn a tight circle around the types of investors Ohm will approach in this latest round. "When you have a really good group, you want to think very critically before you go outside of it," she says. Her main goal is to make sure any additional investors contribute specialized expertise, a goal that could at some point extend to a corporate venture arm.
Angels typically look for high-growth firms with great market potential, even if they have no current revenues. Such firms are typically valued at $1.5 million to $2.5 million before the investment, with median deal size between $500,000 and $750,000, says Angel Capital Association's Hudson.
Larger sums, however, may be more readily available because angels are increasingly syndicating their deals. Jeff Gray, CEO of cloud-computing start-up Glue Networks, says that "more than $4 million appeared [practically] out of thin air," thanks to two angel groups that syndicated the deal with four others.
Here Come the Corporates
Corporate venture investors are also getting more involved in portfolio-company operations, in large part because they view such investments as a vital part of their own growth strategies. In the past, "they kind of stood back, and did not take board seats or an active role," says Mark Heesen, president of the National Venture Capital Association. "Now they want to be an integral part of helping that company grow to the next level."
"Our investment efforts are generally intended to be friendly; we're fairly straightforward in the terms we propose, and we try to add value to the companies and make them successful," says Jeff Lipton, a former engineer and VC who now heads up Juniper Networks's venture efforts. Juniper reviews more than 200 companies a year, and ends up investing in only 7 to 10, about a 5% hit rate. The firm is open to acquiring, and has done so in at least two cases recently, but its main aim is to help products come to market that complement its core platform, Lipton says.
While corporate venture funding tends to rise and fall with corporate fortunes, the volume of dollars coming from corporate venture arms is up to $1.4 billion in the first two quarters of 2011. That puts it on pace to be the best year in a decade (see chart, above).
Most deals involve a co-investment between traditional and corporate VCs. Traditional VCs are more open to getting help than in the past, particularly in capital-intensive industries like clean technology and semiconductors. "There's a sea change in how the corporate VCs are perceived; they are now the well-heeled, deep-pocketed investors that are also the likely acquirers," Gerald Brady says. For their part, corporates appreciate the deep deal experience they can gain from partnering. "We like to follow financial investors and have them set the financial valuation," says Lipton.
Each corporate fund has its own mandate, and it can vary greatly even within the same firm, as Juniper's funds demonstrate. While the bulk of the investments go toward a broad range of early- and late-stage software firms, the $4 billion maker of high-speed switching routers will also consider hardware and component makers at any stage. It is also willing to consider even younger companies, though its investment time horizon is generally one to four years.
The moral of the story? With a little creativity, high-growth companies may find ways to shake loose much-needed capital from investors both large and small. To do so successfully, CFOs should research what investment groups are looking for — their goals and rules can vary widely — and be patient and persistent in wooing them. It wouldn't hurt, of course, if the stock market were to make a spectacular recovery.
Alix Stuart is senior editor for small and midsize business at CFO.