Corporate venture capital and strategic partnerships: what do investee companies need to consider?
Published on 1st Jul 2024
Additional considerations to factor in when taking on equity investment via CVC as opposed to traditional independent VC funds
Against a backdrop of a tougher fundraising environment for start-ups and scale-ups, companies are increasingly taking on investment via corporate venture capital (CVC) deals. Corporate venture capital can present a great opportunity for companies, but there are factors that need to be borne in mind by investees.
What is corporate venture capital?
Venture capital investment into companies has slowed from the highs of 2021 and 2022, especially into later-stage companies. This has led to an increase in corporate venture capital (CVC) – strategic investment arms of large corporate groups investing in start-ups, sometimes in parallel to a new or ongoing commercial partnership. Often, CVCs will be part of trading businesses that operate in a similar or parallel commercial space to the investee company and may also be making investments into other, potentially competitive, businesses.
Therefore, while CVC investors can contribute a huge amount of industry expertise, commercial opportunities and sector know-how in addition to capital, there are also potential pitfalls to taking on investment from a CVC which is also connected to a trading business.
In particular, the CVC may not be purely motivated by making a financial return on their investment but also by its connected trading business' commercial interests, which creates the risk of misalignment between the CVC's interest in the company and its other interests.
There are a range of considerations for companies seeking to mitigate some of this risk in their shareholder documentation when negotiating an investment from a CVC. Companies should be particularly cognisant of protections that may be necessary around rights to information, board representations rights and an exit process..
Information rights
Most shareholders' agreements will provide that investors receive certain standard information rights, such as the provision of periodic management accounts, annual accounts and more tailored forms of reporting. Companies should consider if this information could be used by the CVC for wider purposes than purely the monitoring of the investment or prejudice the company's interests in the hands of competitor. If so, companies should seek to limit these rights for CVCs and/or have an ability to redact information which may be considered commercially sensitive.
Board director and observer rights
It may be agreed that a CVC will have a director or observer appointment right, meaning a right to attend board meetings and receive board papers. This will likely give the CVC access to commercially sensitive information and discussions which the company would not want divulged to other market participants or competitors. Companies should therefore consider caveating any CVC's board appointment rights with the ability to exclude their representative from meetings and/or withhold board papers should the board think it necessary or appropriate to do so in order to protect their commercial interests.
Exit rights
Companies should carefully consider the level of influence that a CVC should have over an exit process. Veto rights over an exit will likely put off potential trade buyers who are in competition with the CVC from making an approach and could deny the company a potentially lucrative exit opportunity.
Other types of exit rights can have a similar effect. For example, granting the CVC a right to match an offer from a third party will also likely have a deterrent effect on prospective purchasers, as they will not want to commit resource to an acquisition if there is the possibility of the CVC stepping in late in the process. Furthermore, if the CVC has a board appointment right, then companies may also want to consider requiring the ability to exclude their representative from the negotiation of the terms of an exit until such time as there is a final offer for approval.
Osborne Clarke comment
Taking on CVC investment can bring a wealth of benefits for a company. However, companies should also be alive to the risks involved and seek to mitigate them from the outset.
Understanding the differences between a CVC and a traditional venture capital investor and the commercial rationale for the CVC's investment is key, and we would recommend that advice is taken at the outset to ensure that appropriate protections are provided for in the term sheet and the legal documents that follow.
