Corporate Venture Capital: Variations on a Theme (5 Key Terms)

We have seen increasing interest in venture capital investments by corporate investors (as compared to traditional investment funds) in recent years, especially as new technologies appear poised to dramatically impact, or are already reshaping, traditional industries. For traditional investment funds and the companies in which they invest, this trend both presents opportunities and creates challenges. The ability to recognize the key issues up front can determine the success of a potential investment.

Corporate Venture Capital:  Variations on a Theme (5 Key Terms)

On the opportunity side, corporate venture capital investors (or “corporate VCs”) often are able to provide added value to portfolio companies through introductions to potential vendors and customers. With respect to potential challenges, corporate VCs often have motivations in addition to the financial return sought by fund investors, including an ‘inside track’ on potential acquisition of the investment target and/or supporting vendors, technical and joint venture partners.
As a result of these additional motivations, corporate VCs often seek financing terms that differ from, or are in addition to, those sought by purely financial investors. Those terms can include the following:

  • Right of First Refusal (or Negotiation) – Usually the most controversial request of a corporate VC, this provides the investor with a right to negotiate to buy the investment target or to match another acquirer’s offer to buy the target, which could make a sale of the target more difficult.
  • Board/Observer Rights – While financial investors may also often request the right to designate a director, a corporate VC’s designated director’s fiduciary duties can be somewhat more complicated given the differing interests of corporate and fund investors, and information sharing between the designated director and the corporate shareholder can be tricky.
  • Competitor Restrictions – Venture-backed company governing documents may include restrictions on disclosure of information to, or transfers of equity by or to, competitors of the target (which may or may not be clearly defined) and corporate VCs often require comfort that they and their affiliates do not constitute competitors.
  • Pre-emptive Rights – Preferred equity investors typically receive the right to invest in future financing rounds of the target, but that right is often waivable by some percentage of the preferred holders and may be technically waived despite some preferred investors still investing in the financing. Given greater sensitivity around relative corporate VC ownership, corporate VCs may try to ensure that pre-emptive rights are not waived without their consent or, if they are waived but some investors are allowed to invest, that the corporate VC is also allowed to invest.
  • Consents/Amendments – While issues around consent/amendment thresholds are not specific to corporate VCs, as the corporate VC’s long-term goals with respect to the investment may not be entirely aligned with fund investors, consent thresholds for a sale of the target and/or drag-along provisions, and amendment thresholds generally, especially with respect to the rights described above, often are the subject of greater focus.

Traditional investment funds and the companies in which they invest should consider these issues early in negotiating investment terms to ensure the parties are aligned on expectations. Doing so can help avoid confusion and delay, and can facilitate a smooth and successful closing among corporate VCs and traditional investment fund investors.

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