Corporate-owned venture capital businesses break down into three categories, but two compete with the independent VC market for talent, leading to interesting discussions about compensation.
The first comprises integrated units typically staffed almost entirely by individuals seconded from the parent organization. They invest only in businesses and technologies that have some strategic interest or relevance to the parent company’s business.
Their raison d’être is not to make financial gains from realizing investments, but to find technologies that will improve the parent’s existing business or that will enable the parent to branch out into new, but connected, business areas.
The businesses they invest in, if successful, tend to be subsumed into the corporate structure.
The second category is strategic accelerants. These tend to focus on identifying and making investments in businesses and technologies that are expected to have some strategic interest or relevance to the parent company’s business.
An almost equally important requirement of these investments is to achieve, in some cases significant, capital value enhancement opportunities while under the ownership of the parent business.
In these types of businesses, for the most part, the CVC will expect to realize the value of its investments by a sale to a third party (including via an initial public offering) or back to management (ie, probably with the backing of another VC or PE investor) rather than to its parent.
Finally, standalone VC firms invest their parent company’s money in venture capital opportunities with the main purpose of realizing financial gains.
Whether any such investments may be of strategic value or interest to the parent is a secondary consideration.
For the most part, the standalone and strategic accelerant models look to compete with the independent VC market for talent, although in most cases they do also second people from the parent entity’s business. This dual recruitment and deployment strategy will then often lead to sometimes thorny internal talks about how to pay and incentivize the individuals who are working in the CVC.
“I’m not optimistic about companies having successful CVC businesses. There are too many mismatches with comp issues, people issues, reporting, investment committees, capital, ability to interact, and relationships”
Executive at CVC business
Of the 11 CVCs we surveyed, almost all said they believed their short-term comp was competitive and, in some cases, more attractive than is typically found in independent VC houses.
Our experience, from advising CVCs and from seeing the data they report in our annual compensation survey, suggests otherwise.
The reality is most CVCs tend to be required to keep their salary and bonus levels closely aligned to equivalent grades in the parent organization.
This often means that while the salaries may be competitive, bonus levels are not.
There is, however, one important area where the CVC’s compensation policy is usually more attractive, and that is in its provision of employee benefits.
Big corporates tend to provide better benefits, and this is particularly true in the case of pension provision, death-in-service, private medical insurance and permanent health insurance.
Other areas where the corporate HR policy may be more attractive in CVCs than in independent VC houses is in the area of employee wellbeing, such as job security, holiday entitlement, and maternity or paternity leave.
Perhaps the most important factor in determining whether a CVC can attract or retain talent when competing with an independent VC is whether it has a carried interest plan for its investment professionals and, if it does, whether the terms of the plan are attractive.
Of the 11 CVCs we surveyed, seven had a private equity-style carry plan and four did not. Of those four, we at MM&K would say that three of these were, in reality, integrated units. It is not surprising that they did not have carry plans. The remaining CVC was clearly not an integrated unit and it was considering putting such a plan in place.
“Most CVCs tend to be required to keep their salary and bonus levels closely aligned to equivalent grades in the parent … salaries may be competitive but bonus levels are not”
Nigel Mills, MMK
A concern for a parent organization with a carry plan in its CVC is that it can encourage some undesirable behaviors.
The way carry plans are structured at present in most independent VCs encourages participants to look for exits early in order to help the carry plan to achieve its 8 percent or 6 percent annual internal rate of return hurdle rate.
This appears to be what LPs still want to see, although we are starting to see a few VCs moving over to a money multiple hurdle for the carry on their latest funds.
This type of carry structure is a win-win for CVCs to help ensure that the right behaviors are being encouraged among their participants and to make the plan more attractive to potential new hires.
Having a money multiple hurdle of, say, 1.33x or 1.25x, rather than an IRR-based hurdle, should encourage a more long-term view from carry participants, which is typically what is needed in a CVC environment.
One other way in which some CVCs are making their carry plans more attractive to their investment professionals is by basing the carry on one- or two-year vintages rather than on a five-year or whole-fund type structure. This makes huge sense.
With a vintage carry structure, one can ensure that the right people are in the carry plan for each particular vintage by introducing new hires and rising stars quicker and by being able to phase out sunset stars more easily.
This takes the pressure off having to make (possibly poor) investments in a particular time period, and it should mean that carry distributions will start coming through earlier than they typically do in a more conventional 10-year closed-end
“I’m not optimistic about companies having successful CVC businesses,” a senior executive from a CVC told us. “There are too many mismatches with comp issues, people issues, reporting, investment committees, capital, ability to interact, and relationships.”
We acknowledge that there needs to be a really supportive culture among the parent company organization for there to be a successful CVC business.
And the one area where we think a CVC can steal a march on an independent competitor VC in the area of compensation is in having an attractive carry plan that will appeal to the sort of VC talent that the CVC is wanting to bring in and retain over the longer term. A money multiple-based hurdle and a relatively short vintage carry structure is the answer.
MM&K has launched its 25th annual Compensation Survey for the European Private Equity and Venture Capital Industry. If you believe your firm might like to participate, contact Nigel Mills:
Tel: +44 20 7283 7200