CVC #5: Balance Sheet or Fund?
A question probably as "old" as Corporate Venture Capital itself - investing from corporate balance sheet or through a separate fund structure, single LP or multiple investor fund. As with many questions, the answer is "it depends", however there are some clear guiding principles and advantages of each structure. Below I summarize my point of view on advantages of both structures and its short-comings:
A) Balance Sheet Investing
Balance sheet investing refers to corporations making direct venture capital investments using their cash reserves on its balance sheet. As a result, the investments will sit on the balance sheet of the corporation. This strategy can provide several advantages and short-comings:
Flexibility: Balance sheet investing offers flexibility, allowing corporations to adjust their investment strategies based on changing market conditions and trends or shifts in their own business needs. Companies can choose when and how much to invest without being tied to a rigid fund structure.
Time-to-market and efficiency: When corporations start with investing in Venture Capital, balance sheet investing provides a time-to-market advantage. As there is no need to set-up a fund structure (or even external fundraising), investing from the balance sheet can be done without much extra burden, which can be costly and time-consuming.
Long-term strategic investor: Investing from the balance sheet offers the possibility to invest more longterm. Required exits after a certain time defined in fund terms is not required, which provides the CVC the possibility of being a stable longterm investor.
Accounting and financial impact: The financial impact of on-balance sheet investments and fund investments can vary quite substantially. Under most common accounting standards, the influence (shareholding, board seat sometimes even if you have 1 out of 5 board seats, voting right, etc) can trigger an accounting method for the investment, which is in most cases either at-cost or at-equity accounting. As most startups have negative profits in their seed & growth phase, the accounting method has a major impact on book-result for the corporation.
Corporate red-tape and regulation compliance: As CVCs are part of a corporation and investing from its balance sheet, it means as well that all the red-tape comes along with it. This could be policies, approvals, payment structures (carry structures are usually more challenging) as well as any corporate guidelines (travel, hiring guidelines, etc). In some jurisdictions, regulatory issues may make a separate fund structure more appealing. For instance, certain types of corporations, such as banks, may face regulatory constraints on balance sheet investing.
B) Fund Structure Investing
With a fund structure, a corporation establishes a separate legal entity for venture capital investments. This could be done as a single LP (the corporation is the only Limited Partner / investor in the fund) or pooling money from different external investors:
Open fund for other investors: Fund structures allow corporations to invite other investors to pool money into the fund. This allows for diversification of risk, external perspectives (external investors bring a range of perspectives, expertise, and contacts to the fund as well as opportunity for additional Business Development activities) as well as possibility to take larger tickets e.g. participating in later stages or having more follow-on tickets on your winning investments.
Independence: A separate fund structure can operate more independently from the parent corporation, potentially reducing the impact of corporate politics and policies on investment decisions. This independence can allow the fund to focus on financial returns and long-term value creation rather than shorter-term corporate objectives.
Commitment: Investing via a fund signals to the ecosystem a clear commitment as the capital is committed in the fund by a corporation for duration of the entire fund, which is usually ~10 years. This also allows for participation in follow-on rounds.
Talent: A fund structure might be more attractive to venture capital professionals because it resembles the familiar structure of independent venture capital funds and could offer more attractive incentive schemes. This can make it easier for corporations to attract and retain top talent in the competitive venture capital industry.
Fund terms & structure: Despite the costs of setting up a fund, such structures can be limiting as well. Examples of limitation are the fund duration, e.g. usually exit planning after 5-7 years independent from status of company or market conditions as well as investment terms of fund (opportunities outside these terms e.g. larger sizes are not possible).
So, Balance sheet or Fund investment?
Disclaimer: The views and opinions expressed in this post and under Corporate Venture Capital newsletter are solely mine as the author and do not necessarily reflect the official policy, position, or opinion of my employer. Any content provided are my personal views.