Something Old, Something New

Dec. 21, 2004
Manufacturing stalwarts chase entrepreneurial dreams -- and returns -- with venture-capital investments.

Even a 150-year-old German corporation can think like a Silicon Valley start-up. A handful of executives in California and Munich is proving it as they show off the speed and smarts of Siemens AG through a tiny unit that invests in young companies. Siemens started the unit and corporate venture-capital fund in 1998, and capitalized it at $100 million. Seeking to convey a touch of wildness, alacrity, but also an ability to build a relationship, executives named the group Mustang Ventures. "Most people in the U.S. see Siemens as this big, global, German company steeped in tradition and, as a result, a little slow," explains the venture's president, Bjoern Christensen. Mustang is galloping. In its first 18 months, the fund returned a 1,100% growth in value to $1.2 billion. It completed one deal in six days, cutting short financial due diligence to participate. Part of Siemens' Information and Communication Networks group, Mustang invests in start-ups involved in telecommunications, data, and Internet networks. Its holdings include two of 1999's stellar IPOs -- Extreme Networks Inc. and Inc. Hoping to grab a piece of technologies that may spark a whole new industry, start-up culture, and impressive returns generated by public offerings, Siemens is one of more than 200 corporations to launch a venture-capital fund in the last few years. In 1999 companies announced the creation of investment programs valued at $6.3 billion, reveals Corporate Venturing Report, a newsletter focusing on the explosive trend. In 1998 that figure was just $1.7 billion. European, Asian, and U.S. manufacturers have jumped into the game. Executives in charge of the funds list strategic reasons for them, such as expanding markets. But they don't mind the profits, and they trumpet the number of companies they've helped to take public. The returns in 1999 were breathtaking, but the market's recent distaste for dot.coms and other tough issues surrounding the integration of the old and new economies cause a few experts to wonder if profitability can last. Some corporations, like Siemens, start funds on their own. They develop informal networks with traditional venture-capital firms, and provide access to markets or manufacturing expertise, in exchange for leads on deals. Other companies new to venture capital arrange formal partnerships with established investment firms such as Advent International, Boston, and H&Q Venture Associates, San Francisco. Still others allocate money from units such as business development or mergers and acquisitions to make occasional investments when the right deal comes along. They find willing takers among young companies that see a life-or-death imperative in becoming large quickly. One way to bulk up is through the well-established distribution channel or production process of a mainline manufacturer. At first Silicon Valley served as a foothold -- both as a headquarters location and as a source of deals. Now corporations are advancing farther afield, to other parts of the U.S. as well as to Asia, Israel, and Europe. Telecommunications mammoth Nokia Corp., for instance, established its Nokia Ventures, a $100 million fund, in Menlo Park in 1998. It recently opened offices in London and Helsinki to grab a piece of Europe's telecom upstarts. Joining old-economy stalwarts are new-economy leaders. A number of firms that went public in 1999 have already made venture investments. Among them are Juniper Networks Inc. and Akami Technologies Inc. Investors flock to entrepreneurs who are innovating in health care and information technology. They're also specializing in types of financing, thanks to the intense competition to participate in the best deals. Some corporate venture funds, for instance, put money into very young companies seeking initial financing. Others won't consider such novices. No question, the Internet has driven the move by big business into venture capital. So have the booming economy, the wads of cash, and the healthy returns reported by traditional equity investment firms in the last few years. In 1999 alone venture-capital spending reached $40 billion. Fear likely pushed some old-line manufacturers into venture investing. They watched new companies emerge and grow into competitors, and they saw talented executives leave to join dot.coms. Industry stalwarts realized they could battle these surging rivals by investing in them. A venture-capital arm might also help a corporation hold onto employees seeking fresh challenges and retain the attention of Wall Street analysts interested in fast-moving stocks. "This is about companies trying to keep on top of the next enterprise that will eat their lunch," says David Barry, senior editor at Corporate Venturing Report. Executives running venture funds inside manufacturing firms pride themselves on their hands-off approach. "We don't want to be this big, ugly corporate animal that says you have to do it this way," insists Charles C. Wu, who runs Matsushita Electric Industrial Co. Ltd.'s venture program in Cupertino, Calif. At Matsushita's Panasonic Digital Concepts Center, a distinct division separates the old and new economies. Khaki-clad Wu strides by the offices of Satoshi Kabasawa and other longtime Matsushita employees who are stationed in the technology incubator and venture-capital operation to soak up Silicon Valley's culture. He slides a magnetic card across a locked door separating the Japanese expatriates and other deal makers from the incubator's inhabitants. Wu walks into the shelter for business start-ups. Inhabited by bright young entrepreneurs whose minds the Matsushita managers would like to read, the incubator bears no trace of a Japanese manufacturing corporation's culture. Groups of young techies cluster around computer screens and bellow at colleagues across the hall. Others sit on desks chatting with associates. No one wears a suit or looks as if he or she trusts anyone over 30. Jake Sullivan saunters up to Wu. A physicist by training and software engineer by trade, Sullivan serves as vice president of engineering for 2Roam Inc., which provides content for wireless devices. It was the second company to move into the Panasonic incubator. "We turned away some investors and places to stay. You want to choose the place that fits within your business plan," says the tall, lanky engineer in jeans and a T-shirt. "Panasonic has done a great job introducing us to people, not only to do business with, but also new hires," he says. A denizen of the new economy, Wu is not your typical Matsushita employee. For starters, he's probably paid better than most. The 39-year-old deal maker oversees the incubator -- home to eight hopeful enterprises. Panasonic provides desks, Internet access, and introductions to financiers. Inhabitants rent by the square foot at or below market rates. They plan to stay until scoring their first big round of financing, which can take less than a year. Wu also leads Panasonic Ventures, a $50 million fund concentrating on network technology. Originally Matsushita wanted to start a research-and-development organization in Silicon Valley, but quickly understood the model wouldn't work in the new economy. Executives realized they wouldn't be able to attract the top engineers or match local pay scales. Wu learned about Silicon Valley's culture when he helped transform Vertex Management Inc., a venture-capital firm with $60 million in holdings, into one with investments worth $450 million in Europe, Singapore, China, and Israel. Before that he worked for Raytheon Co. The MIT-trained engineer recalls stories of friends who worked in manufacturing describing how they would slave for years on a project, only to be told the results were interesting but inappropriate for commercial development. He sees Matsushita's approach in Silicon Valley as much more efficient. "I could have a bunch of engineers working for me, which would cost an enormous amount of money. We'd be lucky if we got one commercial project out a year," he explains. "Instead I have a bunch of engineers working for themselves, for other financiers, and for us. We try to match appropriate people," says Wu, who travels to Japan every two months to build connections and interest in the Digital Concepts Center's companies. He also relies on Matsushita expatriate VIPs stationed in Silicon Valley to build bridges between units in Japan and start-ups in the Valley. Wu likes the incubator's door to revolve. Already businesses are moving out, and that's good. One entrepreneur involved in his second start-up set up an office at the Digital Concepts Center, brought in financiers, and raised $10 million for a Web-based accounting company. He moved out after three months with plans to go public. The entrepreneur now sits on Wu's board, and Matsushita is considering his accounting services for internal use. Corporations are late in becoming venture capitalists. In the 1960s a forefather of venture capital, Benno C. Schmidt, collaborated with another, John Hay Whitney, to back promising young companies in exchange for equity. It wasn't until 1979, after a fresh interpretation of the Employee Retirement Income Security Act, that pension funds began pouring sums into venture-capital firms. Among manufacturers Intel Corp. was a pioneer when it established a venture arm in 1991. Today the giant chipmaker's fund, Intel Capital, is so large it outpaces funds of equity firms devoted only to investing. In the fourth quarter of 1999 it held investments worth $8 billion in more than 350 companies. Stakes in overnight IPO successes such as eToys Inc. and Copper Mountain Networks Inc. led to profits of $327 million in the fourth quarter. The Internet anchors Intel's investment strategy. The company seeks to finance established entrepreneurs with a certain attitude. "Two key traits that I look for are impatience and flexibility," says Les Vadasz, a 30-year veteran of the Santa Clara manufacturer, who runs Intel Capital. Intel doesn't take board seats, and it refuses requests from seed companies. Increasingly, it looks overseas for the best deals. "We want to see the Internet grow all over the world, so we'll invest in a lot of different countries where the growth of the Internet infrastructure and content could use some assistance," explains Vadasz. In 1998 less than 5% of Intel's investments fell outside the U.S. Last year more than a third of them went into foreign companies including a portal enterprise in Poland. Intel hasn't always bet on the Internet. Before launching Intel Capital, the company put venture cash into products that would improve microprocessors, such as software that promised faster ways of designing them. Not all of its bets return what executives want. "There were a few -- very few -- dry holes," admits Vadasz. "We had great financial success investing in broadband technology. Yet if I take a critical look at where we are, broadband connectivity is still at an extremely early phase. This is disappointing," he observes. Dry holes are hard to avoid. Adobe Ventures, a $60 million fund managed by H&Q Venture Associates for software firm Adobe Systems Inc., hit a few in its early days. The two firms linked up in 1994 to invest in innovations in publishing and design. H&Q manages the fund's day-to-day operations, takes board seats in portfolio companies, and develops and executes exit strategies -- acquisitions or preferably a public offering. The investments that disappointed were those in which one firm strong-armed the other into a deal. "We either made the investment because the financiers at H&Q wanted it, and Adobe didn't support it, or we made an investment that Adobe really wanted, but we didn't think was a great financial deal," explains Christopher B. Hollenbeck, an investment manager for the fund at H&Q Venture Associates. Most investments, however, returned healthy rewards. Impressed by the bond between the two enterprises, Texas Instruments Inc. managers established their own fund with H&Q based on the Adobe model. Cash abounds for upstarts with promise. As a result, sought-out entrepreneurs develop strategies for eliminating moneylenders that don't offer special value. Large corporations such as Texas Instruments, Matsushita, and Siemens offer well-trod routes into markets around the world, and experienced guides to take small companies to them. Siemens employs 63,000 people in 192 markets. Members of the nine-person Mustang group act as ambassadors of sorts, generating enthusiasm for the fund's portfolio of entrepreneurs. Already Siemens salespeople sell's hardware and software to European distributors of cellular phones. Competition for the best deals has sparked other changes. Like Matsushita, Siemens opened an incubator to host start-ups under construction, often just far-out ideas still in the heads of professors. The plan is to ready these potential businesspeople to compete. Then the most promising will be funneled to Mustang's deal makers or one of Siemens' three other venture-capital funds. Located within walking distance of the University of California, Berkeley, the Siemens Technology-to-Business Center incubator hosts a handful of fledgling entrepreneurs. It employs four "venture technologists" -- professionals who scour the country's top engineering schools in search of exciting projects that might one day become marketable. Since the incubator's inhabitants often lack the nuts and bolts of business, its professionals offer help on marketing and management plans, and coach entrepreneurs on attracting financiers. Every two weeks the Center hosts afternoon sessions taught by professors from Berkeley's Haas School of Business in basics such as sales and accounting. "The biggest challenge for venture capital operations is how to get high-quality deals. We're trying to go to the top of the food chain, and instead of waiting for people to come to us, we're looking for them," explains Arding Hsu, president and CEO of the Technology-to-Business Center. When Hsu, Christensen, or Matsushita's Wu does find the engineer with a market-changing notion the payoff can be tremendous. At most venture-capital firms brokers are richly rewarded when they take a cut of the profits on successful companies that they helped to start. Corporations are struggling with how to keep internal venture capitalists happily compensated without causing resentment among faithful company veterans. At the Panasonic Digital Concepts Center deal makers are rewarded when companies succeed, but Siemens has chosen another approach. It compensates Mustang employees in a "fair" manner, says Christensen, focusing on long-term opportunities such as one day becoming the CEO of a portfolio company or an operating officer of a Siemens global unit. Already one of Mustang's vice presidents left to start a venture arm for one the organization's portfolio companies. Mustang also is establishing a separate company to give it more flexibility in both business development and compensation of top performers. Other conflicts emerge when companies try to integrate the old economy with the new. Corporate decision makers like the idea of investing in start-ups, but occasionally fail to give new venture funds adequate cash, staff, or attention. "In this environment it's a minimum commitment of $50 million," believes Hollenbeck. "Beyond that, you've got to have support from senior levels in the corporation. That's how you get the deal flow, and help from operating people on the diligence process." A bigger problem may be the stock market's gyrations. Nasdaq's wild swings in April had venture capitalists inside and outside corporations wondering how long the rich returns would continue. One thing is certain. If the markets continue to tumble, venture capital, also known as risk capital, will slow. Start-ups have postponed IPOs and tied up equity investments. What's more, last year's stellar performers such as eToys, Copper Mountain, and Extreme Networks -- companies that turned profits for Intel and Siemens -- lost chunks of value with the market's downturn in April. In conservative corporations, the strength of venture arms will surely be tested. "Recently the market has been so good and the exits so quick for some of these corporate funds. It will be interesting to see how a bear market will affect them," observes Hollenbeck.

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