Corporate-owned venture capital businesses break down into three categories:
Integrated units are typically staffed by individuals seconded from the parent organization and invest only in companies and technologies with some strategic interest or relevance to the parent organization’s business. The companies they invest in, if successful, tend to become subsumed into the corporate structure and, if not, tend to be sold back to management or wound up.
Strategic accelerants also focus on investments in businesses and technologies with some strategic interest or relevance to the parent company’s business. However, they also seek to achieve capital value enhancement opportunities while under the ownership of the parent business. In these types of businesses, the CVC will expect to realise the value of its investments by a sale to a third party (including via an initial public offering) or back to management.
Standalone VC firms invest their parent company’s money with the main purpose of realising financial gains. Whether any such investments may be of strategic value or interest to the parent company is a secondary consideration.
For the most part, the strategic and standalone businesses look to compete with independent VCs for talent, although they also second people from the parent entity’s business.
This dual recruitment and deployment strategy often leads to interesting internal discussions about how to pay and incentivise team members.
“A money multiple hurdle is a win-win opportunity for CVCs to help ensure the right behaviors“
Out of the 11 CVCs we surveyed, almost all believed their short-term comp was competitive and, in some cases, more attractive than is typically found in independent VC houses.
However, our own experience, from advising CVCs and seeing the data they report in our annual compensation survey, would suggest otherwise.
Most CVCs are 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, the bonus levels are not.
Yet big corporates tend to provide better benefits, such as pension provision and private medical insurance, and may offer more in terms of employee wellbeing.
Nevertheless, 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 with attractive terms.
Of those we surveyed, seven had a ‘private equity-style’ carry plan. Of the four that did not, we would say three of these were integrated units. The remaining firm was considering putting a carry plan in.
Parent organizations can be concerned that carry plans encourage undesirable behaviors, as they encourage participants to seek exits early to achieve an 8 percent or 6 percent annual internal rate of return hurdle rate.
Seemingly, this is what LPs are still wanting to see, although we are beginning to see a few VCs moving to a money multiple hurdle for the carry on their latest funds.
In our view, a money multiple hurdle is a win-win opportunity for CVCs to help ensure the right behaviors among carry participants and to make the carry plan more attractive to potential new hires, as it encourages a more long-term view from carry participants.
Another way is to base the carry on one- or two-year vintages rather than a five-year or whole fund structure. This can ensure the right people are in the carry plan for each vintage (by introducing new hires and rising stars quicker and phasing out sunset stars more easily). It also takes the pressure off having to make investments in a particular time period, and should mean carry distributions will start coming through earlier than in a more conventional 10-year closed-end VC fund.
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: firstname.lastname@example.org Tel: +44 20 7283 7200