Some interesting insights into Corporate VCs and how they are attracting and retaining talent

MM&K, jointly with its fellow US GECN member firm, Farient, has recently conducted a survey of approaches to pay policies in Corporate owned Venture Capital (“CVC”) businesses.

We see CVC firms breaking down into three categories, as follows:

(1) integrated unit;

(2) strategic accelerant;

(3) standalone VC.

Integrated units are typically staffed almost entirely by individuals seconded from the parent organisation.  They invest only in businesses and technologies that have some strategic interest or relevance to the parent company’s business.  Their main raison d‘etre is not to make financial gains from realising investments, but to find technologies that will improve their parent’s existing business or that will enable the parent to branch out into new (but connected) business areas.  The businesses that they invest in, if successful, tend to become subsumed into the corporate structure, and if not successful, tend to be sold back to management or wound up.

Strategic accelerants also 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. In addition, 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 realise the value of its investments by a sale to a third party (including via an IPO) or back to management (i.e. probably with the backing of another VC or PE investor) rather than to their parent organisation.

Standalone VC firms invest their parent company’s money in venture capital opportunities with a 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 latter two types of CVC (the Standalone and the Strategic Accelerant) 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 interesting internal discussions about how to pay and incentivise the individuals that are working in the CVC.

Out of the eleven CVCs that we surveyed, almost all of them said that 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 that they report in our annual compensation survey, would suggest otherwise.  The reality is that most CVCs tend to be required to keep their salary and bonus levels closely aligned to equivalent grades in the parent organisation and this often means that while the salaries may be competitive, bonus levels are not.

There is though one important area where the CVC’s compensation policy is usually more attractive and that is in their 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 whole area of employee wellbeing, e.g. job security, holiday entitlement, maternity/paternity leave, etc..

But at the end of the day, perhaps the most important factor in determining whether a CVC can attract and/or retain talent when competing with an independent VC is whether it has a carried interest plan for its investment professionals or not.  And if it does, whether the terms of the carried interest plan are attractive.

Out of the eleven CVCs that we surveyed, seven had a “private equity style” carry plan and four did not.  Of the four that did not, we would say that three of these were in reality integrated units, so perhaps it was not surprising that they did not have a carry plan.

The one that did not have a carry plan (and which was not an integrated unit) was considering putting a carry plan in.

One of the concerns for a parent organisation with having a carry plan in its CVC is that it can encourage some undesirable behaviours.  The way that 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% or 6% annual irr hurdle rate.  Seemingly, this is what the LPs are still wanting to see, although we are beginning to see a few VCs moving over to a money multiple hurdle for the carry on their latest funds.

In our view this type of carry structure is a win win opportunity for CVCs to help ensure that the right behaviours are being encouraged among their carry participants and to make the carry plan more attractive to potential new hires.  Having a money multiple hurdle (of say 1.33 x or 1.25 x, 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.  To us 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), it takes the pressure off having to make (bad) 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 ten year closed end VC fund.

One senior executive from a CVC that we interviewed said “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, relationships, etc.”

We do acknowledge that there needs to be a really supportive culture amongst the parent company organisation for there to be a successful CVC business.

And one area, we believe, where 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.  It can do this by having a money multiple based hurdle and a relatively short vintage carry structure.

In this year’s annual European PE and VC Compensation Survey Report that we will be publishing in October, we are planning to include a special report on CVCs and how they are compensating their teams.

This Report is only available to participating firms (last year we had circa 50 participating houses) and is produced based on the responses we receive from our annual PE and VC Compensation Survey which we are currently conducting, and which is supported by PEI.

For further information about the issues raised in this article or on how to participate in the MM&K/Holt 2020 Survey, please contact Nigel Mills or Margarita Skripina.

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