Downturn could pare appetite of corporate venture capitalists

Singapore

THE recently-crowded field of corporate venture capital (CVC) could face a reckoning if global economic conditions sour, industry watchers caution.

A business downturn - an increasing concern amid softening sentiment - could test the appetite of companies to absorb investment losses on their balance sheets, and challenge corporate investors who adopt a "dual mandate" of financial returns and strategic gains.

Jake Robson, a partner at law firm Morrison & Foerster, said: "The risk is that as soon as there's a downturn in the economy, the company sees that nine out of its 10 investments will fail. That's the nature of venture capital. It's very high risk...

"Some of these investments will look like they are now becoming a problem, as far as the balance sheet is concerned.

"They need to be very clear what they're trying to achieve; they need to be very clear that they can't take a short-term, dip-your-toes-in kind of approach ... They have to understand the nature of venture capital, the risks... and they have to be in it for the long term."

The note of caution comes amid an influx of corporate capital into the regional startup landscape. Corporate investors took part in seven of the top 10 deals in South-east Asia in 2017, going by a May 2018 report by the Singapore Venture Capital and Private Equity Association.

Joongshik Wang, EY Asean digital strategy and mergers and acquisitions leader, said: "Driving this has been the availability of undeployed capital, aligned with CVC investors looking for growth into strategies aligning with their innovation horizons and their openness to longer-term opportunities."

The "real turning point" in the CVC boom came when tech giants and later, unicorns including Grab and Razer, set up their own venture funds to scale quickly in the quest for market share, noted Chia Tek Yew, head of financial services advisory at KPMG Singapore.

But an identity crisis of sorts can manifest when the issue of objective is broached. Is the CVC unit trying to maximise financial returns, or is it making investments that are a strategic fit? Or both?

Tan Yinglan, founding managing partner of Insignia Ventures Partners, said: "CVCs are rarely successful when both objectives are mingled, because it is rare that an investment would be able to perfectly satisfy both objectives. Even if they do, the universe of startups that the CVC can invest in is very small."

A dual mandate may also mask underperformance, said Finian Tan, chairman of Vickers Venture Partners. "Many corporate VCs have the dual mandate of returns and strategic development. This may cause companies to choose the mandate they want to suit their result or lack of it. For example, they can say that the reason they didn't achieve a good return was because it was strategic, or vice versa."

He expects that the harsh realities of venture investing may eventually lead to some consolidation among CVCs. "Only the truly good ones will continue," he said. "Venture capital is not as easy as most people think or hope. Although the average return is high, the median loses money because the top quartile makes all the returns."

In an economic downturn, corporations that do not prioritise the strategic objective may find it hard to stomach losses from their CVC units.

Corporates certainly should not be eyeballing financial gains as a sole objective, said Lim Kuo-Yi, managing partner at Monk's Hill Ventures. "The risk profile of the venture asset class might be too much of a disjoint from that of the corporate," he said.

Mr Chia of KPMG agreed, saying: "If a company sets up a CVC purely for financial gains and doesn't use it to drive synergy, adoption and culture change, they might as well just invest their funds in best-in-class VCs as venture partners."

For its part, Japanese financial giant Mitsubishi UFJ Financial Group (MUFG), which recently launched a CVC fund, says that it is cognisant of the risks of venture investing, but stays resilient by taking a long-term view.

Rather than focusing solely on near-term strategic gains, MUFG's fund looks to invest in emerging technologies that may produce synergies further down the road, said Makoto Shibata, executive fellow of Japan Digital Design, an MUFG subsidiary promoting fintech and innovation within the group.

"It's definitely difficult and we understand that. We are not saying that just having CVC would lead to success in innovation, but I think it's part of a necessary effort," he said in an interview last month at the RISE Corporate Innovation Summit in Bangkok, Thailand.

Despite the challenges, MUFG saw value in setting up its 20 billion yen (S$243.7 million) CVC fund in January because of the efficiency it brings. "After making investments into startups in several (ad-hoc) cases, we decided that setting up a fund and hiring a professional to make investment decisions would be a better way," he said.

Similarly, tech unicorn Grab's CVC unit is committed to long-term relationships with startups, by functioning both as a venture investor and venture builder. It runs an accelerator programme, Grab Ventures Velocity, for growth-stage companies to scale up and access Grab's capabilities.

Chris Yeo, head of Grab Ventures, said: "We are not financial investors. Instead, every investment we make is strategic - to both us and the investee startup. We look for strong synergies and immediate value creation for our strategic investments. With this approach, the success of every investee startup will contribute back to Grab's own growth."

Mr Shibata of MUFG also acknowledged that it can be challenging for CVCs to balance both financial and strategic returns. Long-term strategic aims will often have to take precedence, he said.

"Typically, if you focus too much on synergy, you might end up with a lot of failure in terms of (financial) returns. And if you just focus on returns, you might end up investing in a company which has no synergies with your own company... We're having a difficult challenge, that's for sure."