Most of the corporate venture capital funds investing in new energy ... energy funds, also generalist VCs have started to invest in the clean energy technologies.
Corporate Venture Capital in the European Energy Sector: A key driver for commercializing sustainable technologies? Corresponding author
Tarja Teppo Department of Industrial Management and Engineering Helsinki University of Technology PL 9500, 02015 TKK, Finland tarja.teppo@hut.fi Co-author
Dr. Rolf Wüstenhagen Institute for Economy and the Environment (IWÖ-HSG) University of St. Gallen Tigerbergstrasse 2 CH-9000 St. Gallen rolf.wuestenhagen@unisg.ch Keywords: Corporate Venture Capital, Sustainable Energy, Technological Change, Innovation Draft version: Do not quote without authors permission
Abstract With annual revenues of more than $1’500 billion, the energy industry is one of the largest sectors of the economy. It also contributes significantly to a number of environmental problems, such as climate change due to greenhouse gas emissions. With strong differences in per-capita energy consumption between industrialized and developing nations, the energy issue also is a social challenge. Therefore, commercializing new technologies in this sector is an important factor for sustainable development. One way for large corporations to commercialize innovative new technologies is corporate venture capital (CVC). Corporate venture capital has received a fair amount of attention from academic researchers in the recent years. Among other things, previous research has compared the main differences of venture capitalists (VCs) and corporate venture capitalists (CVCs) and the main advantages CVCs may have over the VCs. Sector specific studies on corporate venture capital and the effect of CVC on the emergence of new industries has received much less attention from the academic community. Most of the previous
empirical work is concerned with IT and biotechnology investments. Energy sector corporate venture capital investments, especially into the sustainable energy solutions of the future, have been the focus of only a few previous studies. However, corporate venturing programs in the energy sector are no new invention. First attempts were demonstrated by oil companies during the first big wave of corporate venturing programs that took place in the 1960s and 1970s. Lately many European and North American energy companies have participated in the third wave of corporate venture programs that started during the boom years in the late 1990s. These energy company corporate venture programs have aimed at creating a presence in the sustainable energy solutions of tomorrow. The investments have fuelled the growth of start-ups in areas such as fuel cells, biogas, wave energy and energy efficiency solutions. The goal of this paper can be divided into three parts. The first goal is to investigate the motivation and implementation strategies of energy companies that have launched their own corporate venture capital programs investing into sustainable energy ventures. Second, the relative strengths of VCs and CVCs in the energy sector are compared. Finally, we analyze whether the interaction between VCs and CVCs can accelerate the commercialization of sustainable energy technologies.
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Introduction New energy technologies, leading to a more sustainable energy infrastructure in environmental, security-of-supply and economic terms, have been marketed as the next big thing to emerge on the radar screen of venture capitalists. The market opportunity in clean energy has been estimated to grow from $9.5 billion in 2002 to $89 billion in 2012 (Makower et al 2004)1. For European energy companies one the most significant environmental drivers has been the Renewables Directive of European Union which promotes increasing the proportion of electricity generated from renewable energy sources across European Union to 22.1% by 20102. Concern for the security of energy supply has also emerged as a driver for more sustainable energy solutions in the European market. It has been estimated that by 2030 the dependence on imported sources of energy will reach 70% in the European Union (EU 2002). Having more internal control over the price of energy supplies also provides greater economic stability. The emerging field of more sustainable energy solutions has attracted energy companies to set up dedicated corporate venturing activities. These corporate venturing activities have consisted of direct investments into internal and external ventures, as well as fundof-fund investments into independent venture capital funds. The focus of this paper is the corporate venture capital activities, also referred to as indirect-external investments (McMillan 1998), where the company sponsored venture capital fund invests directly into ventures external to the parent company. Most of the corporate venture capital funds investing in new energy technologies were established during the boom years of the late 1990s. These CVC funds have been established by three main groups: oil and gas companies, electric utilities and energy technology manufacturers. These three groups will be later in this paper referred to collectively as the “energy companies” unless otherwise specified. In addition to corporate venture capitalists of energy companies and independent VC energy funds, also generalist VCs have started to invest in the clean energy technologies making it the 6th largest venture capital category (Henig 2003). Morgan and Tierney (1998) have stated that the attention of electric utilities is focused on short-term issues of efficiency and cost control, where the energy technology manufacturers are concerned principally with the enormous current demand to build traditional power systems all over the industrializing world. However, we have identified
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The estimate uses as the market growth rate for each renewable energy technology the annual global growth rates reached in 2003. 2 http://europa.eu.int/comm/energy/
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that the largest four European electric utilities3 EdF, RWE, E.On and Vattenfall, all have launched a corporate venture capital fund in the late 1990s. Compared to the capital investments going into infrastructure maintenance and power capacity additions, the sizes of the corporate venture capital funds set up by the largest European companies in the energy sector are still modest. In all of the European energy sector corporate venture capital funds we analyzed, strategic goals were the main reason for starting up the fund. An additional feature which makes the study of energy sector corporate venture capital funds in Europe interesting is that the corporate VCs entered the market prior to the independent VCs. As the time of founding for most of the European energy CVC funds dates back to the internet bubble of the late 1990s, these funds provide a 5-year record of investing in the sustainable energy technologies. The study of the European energy CVC funds revealed that many of the funds follow the same cyclic activity identified in the North American market. According to Gompers and Lerner (1999) US corporate venture capital programs started their 3rd cycle in the late 1990s. If these funds will follow the path of the preceding cycles, downturn in the amount funds is soon to follow. We identified this trend among many of the European energy companies that launched their own corporate venture capital funds during the 3rd cycle. Some of the funds we studies have reached the peak of their activity and are currently either not actively making new investments or have even closed down. Most of the funds had faced a battle for existence in the hands of new management at the parent company. The most stable funds indicated a growing activity and expressed plans for launching additional funds in the near future. In this paper, our goal is to present a typology of CVC funds making investments in the energy sector. In addition, we analyze the organizational models of these funds and their level of autonomy from the parent company. We also study the advantages and disadvantages a corporate venture capital fund in the energy sector has compared to independent venture capital funds. Finally we analyze the balance between the strategic and financial goals of corporate venture capital programs active in the energy sector. To obtain a reference level, we compare the energy sector corporate VCs to those independent venture capital funds that have made investments into sustainable energy.
Methodology Sustainable energy venture capital is an emerging field and thus quantitative data is insufficient both in volume and quality. For example, we studied the energy venture deal flow provided by the Venture Economics database and found a large mismatch with the database and what we could identify by analyzing the portfolios of the European CVCs and VCs active in the energy sector. Currently the total amount of funds active in the energy sector is 30-40 in the European market. This figure contains both the independent and corporate venture capitalists, when 3
Ranked by market share, measured by the electricity sales
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being active in the sector means having at least one investment in the area of sustainable energy. The more active funds, having three or more investments into sustainable energy ventures in their portfolio, bring the number down to around 15 funds in Europe. Due to these limitations, we have carried out face-to-face interviews with the representatives of European independent and corporate venture capital funds investing in the energy sector. Most of these interviews lasted 2 hours each and were carried out with a partner or a managing director of a fund. All together 20 in-depth interviews were carried out in France, Germany, Denmark, Sweden, Norway, Finland and Switzerland during 2003 and 2004, half of which were interviews with corporate venture capital funds. In addition to this data we utilize the data available from the Venture Economics database and the survey we carried out at the European Energy Venture Fair 2003. Since the operating history of most of the CVC funds in the energy sector was four years or less, very few exits have yet taken place. Thus comparing the financial success of the energy sector CVCs and independent VCs was not yet possible.
Literature review on corporate venture capital During the past decade academic research has produced several studies on corporate venture capital concentrating on issues such as compensation, organizational structure and conflicts with the parent company. Corporate venture capital programs have been referred to in the media as short-lived phenomena (Business Week 1999) and several previous studies have reported the failures of CVC programs (Baird and Rasmussen 2002; Fast 1978; Rind 1981; Sykes 1990, Gompers 2002). The reasons given for failure have ranged from incompetent management to conflicting goals. After four decades of corporate venture capital programs, recent studies (Gompers 2002) have shown that CVC programs have gained in experience and become more successful as they have developed in tandem with the independent VCs. The same study shows that CVC investments have been at least as successful as independent VC investments in financial terms and the probability of success is substantially higher for CVC investments in industries related to the parent company business. The better success ratio is due to the venture’s strategic overlap with the parent company. However, conflicting results to the benefit of having close strategic overlap has been shown by other studies (Rind 1981). If the venture serves a market served by the parent company, this may constrain the venture’s marketing options, potentially leading to lower rate of success. The counter-argument provided by Gompers and Lerner (1999) states that by lacking strategic focus with their investments, the corporate venture capital fund is likely to be short-lived, frequently ceasing after only a few investments especially during periods of financial pressure. Most corporate venture capital funds are organized as corporate subsidiaries (Gompers and Lerner 1999). However, when the corporate venture capital fund had a clear strategic focus, these funds were at least as successful as independent venture capital funds, despite of the very different structure compared to independent VCs. From this study it
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was unclear what level of autonomy and form of compensation these well performing corporate venture capital funds, some of them structured as corporate subsidiaries, enjoyed. One of the most fundamental questions in establishing a corporate venture capital unit is if this form of corporate venturing is a suitable for the company. A managerial decision framework has been suggested (Miles and Covin 2002) to analyze the suitability, taking the venturing objectives and corporate circumstances into account. A simplified version of the framework is shown Figure 1.
Corporate venturing objectives of the parent company:
X = Corporate venture
Organizational development & Cultural change
capital model is suitable
Parent company need to control the CVC activity
Strategic benefits
Quick financial returns
High
X X X X X
Low Parent company ability and willingness to commit to the CVC activity
High
Parent company entrepreneurial risk acceptance propensity
High
Low
Low
X X X X X
Figure 1 Framework for analyzing the suitability of corporate venture capital as a form of corporate venturing (Miles and Covin 2002)
Indirect-external venturing model, essentially identical to our definition of corporate venture capital fund, is recommended by Miles and Covin in cases when the corporate management’s need to control the venture is low, whether or not the corporate venturing objectives are to obtain strategic benefits or quick financial returns. When the purpose of venturing is to produce strategic benefits, they recommend pursuing both a venture capital fund and a suitable form of corporate internal venturing. When the corporate venturing objectives are organizational development and cultural change corporate venture capital model is not recommended. As the Figure 1 shows, corporate venture capital model can be applied with varying ability and willingness to commit resources to venturing and with different levels of acceptance of entrepreneurial risk by the corporate management. The only key determinant is to allow the corporate venture capital fund with a high level of autonomy and a low level of parent company control. Goals related to financial returns are easier to define and measure than goals related to strategic benefits. Previous literature on corporate venture capital (Gompers and Lerner 6
1999; Miles and Covin 2002; Maula, Autio and Murray 2002; Siegel, Siegel and MacMillan 1988) introduced at least three terms related to corporate venturing and nonfinancial goals: strategic goals, strategic focus, strategic benefits and strategic interests. None of these terms are specifically defined in the studies, but are used somewhat interchangeably when analyzing the non-financial goals and gains. Figure 2 shows the linkages between the parent company and the corporate venture capital fund and it can be used to illustrate some of findings of previous studies.
Company
Company core activities
2.
1.
CVC unit
External world Ventures Independent VCs
3.
Figure 2 Linkages of CVC unit, the parent company and the external world (Poser 2003)
Linkage number one shows the generation of deal flow. A corporate venture capital fund can utilize complementary resources available from the parent company to carry out the due diligence process, which in turn may result in strategic benefits to the parent company as the technical experts from the parent company learn from outside ventures. Previous studies (Gompers and Lerner 1999) have mentioned the possibility of using information from the related lines-of-business in selecting better performing ventures. Corporate venture capital fund can also build relationships with independent venture capitalists. According to Gompers (2002) good relationships with independent venture capital firms are essential but it takes time for corporations to build credibility in the eyes of independent VCs. Corporate venture capital funds may seek to syndicate their investments with independent VCs, contributing to the learning process of the CVC fund managers. An additional benefit of the company-sponsored venture capital fund is the ability of the parent company to use its lobbying power in industrial sectors where the regulatory measures are of great importance. The second linkage demonstrates the financial commitment of the parent company to the CVC activity and the degree of autonomy that the corporate venture capital fund enjoys. A previous study (Siegel, Siegel and MacMillan 1988) has shown that a close relationship with the parent company was a direct cause for four obstacles in corporate venture capital fund management: (1) lack of clear mission, (2) lack of patience, (3) lack of flexibility and (4) inability to relinquish control to the CVC. The main result of the study was that those CVCs that enjoyed organizational independence were generally more effective. According to Siegel et al (1988) organizational independence enables the 7
corporate venture capitalists to respond more aggressively to investment opportunities. Greater autonomy in investment decision making may also enable the CVC fund to pursue alternative business models in the ventures they fund, the benefit which has usually been credited as the advantage of independent venture capitalists (Chesbrough 2000). Linkage number three illustrates the strategic and financial benefits that the parent company can realize from the corporate venture capital activity and the resources it can provide to the portfolio ventures. Previous studies have shown (Siegel, Siegel and MacMillan 1988) that if the CVC fund suffered from the obstacles described above due to the close relationship with the parent company, having a primary emphasis on strategic benefits increased the problems resulting from these obstacles. Those CVC funds that enjoyed greater autonomy in investment decision-making and longer-term financial commitment to the venturing activity reached higher financial return on investment and reached at least as good strategic benefits as the funds with less autonomy and corporate commitment. In the study by Siegel et al (1998) the performance on strategic benefits was rated by the respondents themselves and thus there may be subjectivity involved in rating one’s own performance. Similar findings on the importance of high degree of autonomy have been reported by Gompers and Lerner (1999). They conclude that greater autonomy combined with long-term commitment prevents the current corporate management from viewing the corporate venture capital fund as the pet project of the predecessors (Gompers and Lerner 1999). A study by Maula and Murray (2001) studied the value-added that corporate VCs and independent VCs bring to the ventures they fund. They found that independent venture capitalists were more skillful in nurturing the ventures into viable companies contributing mainly in strategy development, additional fund raising and recruitment of key executives. Corporate VCs contributed in increasing the credibility of ventures and technology development. The CVCs were found to be more helpful in building a network with customers, suppliers and partners. In conclusion of the previous studies, the results show that a CVC fund with a clear strategic focus, long-term financial commitment from the parent company, autonomous position in decision making and emphasis on financial benefits is most likely to succeed in both acquiring financial and strategic benefits, independent of whether the fund is organized as a subsidiary or as an external company. In order to run a successful corporate venture capital fund that enjoys a high degree of autonomy and at the same time follow closely the strategic focus set by the parent company requires corporate venture capital fund manager to: -
handle ambiguities and trade-offs be willing and able to act in the best interest of the parent company bridge the gap between innovative entrepreneurs and inherent conservatism of the parent company
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-
make sense and communicate trends that may appear threatening to the parent company traditional business
In the light of the findings from previous studies on corporate venture capital, the next chapter will analyze the corporate venture capital funds active in the European sustainable energy market.
Corporate venture capital in sustainable energy sector Leading industrial corporations across sectors have been encountering strong competition from start-ups, despite of their heavy investments into internal R&D (Chesbrough 2002). However, until recently, the energy sector has not perceived innovation and quality to be the main competitive factors but have mainly concentrated on market power and price as the key factors, obtained by the economies of scale. European electric utilities are the prime example of leaving innovation and quality with less attention. During the past decade the European electric utilities have concentrated on growth through acquisitions and scaled down further their internal R&D budgets. The average R&D intensity of European electric utility currently lies under 1%4. Despite of not emphasizing the power of innovation in achieving competitive advantage in their traditional operations some of the biggest European energy companies have been setting up their corporate venture capital programs since late 1990s. These large energy companies consist of electric utilities, energy technology manufacturers and oil and gas companies. In the Table 1 are shown those European corporate venture capital programs investing in the energy sector that were active in the end of 2003.
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Source: Thomson analytics
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Table 1 European corporate venture capital funds active end of 2003 Name of the corporate venture capital fund Norsk Hydro Technology ventures Shell Technology Ventures Suez Nov Invest Schneider Electric Ventures Siemens Venture Capital BASF Venture Capital GmbH RWE dynamics MVV / Accera Eon Venture Partners
Type of parent company
Name of parent company
Location (country)
Fund size
Oil & gas
Norsk Hydro AS
Norway
Oil & gas Utility Technology Manufacturer
Shell Suez Schneider Electricite SA
Netherlands n/a France 300 mEUR
No Yes
France
50 mEUR
Yes
Germany
500 mEUR
No
BASF RWE MVV Eon
Germany Germany Germany Germany
100 mEUR 50 mEUR 40 mEUR 25 mEUR
Yes Yes Yes Yes
Vattenfall
Germany
n/a
Yes
EdF Endesa
France Spain
n/a 400 mEUR
Yes No
Technology Manufacturer Other Utility Utility Utility
Vattenfall Europe venture Utility EdF Venture capital including EdF Business Innovation and EdF Capital Partnaires Utility Endesa Netfactory Utility
45 mEUR
Interviewed Yes
Most of the energy sector investments made by the corporate venture capital funds exhibited in Table 1 can be classified under sustainable energy technologies. An exception is Shell Technology Ventures which concentrates solely on investments into oil and gas technologies. Some of the funds shown in Table 1, such as Siemens Venture Capital, BASF and Schneider-Electric Ventures, have their main investment focus on other industrial sectors than energy but have made investments into ventures that operate in the cross-section energy and other industrial sectors, such as electronics and chemical industry. Examples of these cross-industrial investments are ventures offering energy storage solutions. Most of the European corporate venture capital funds investing in the energy sector have an electric utility as the parent company. Some of the funds shown in Table 1 are not currently in active investment mode. Due to the confidentiality agreements with the interviewed CVC managers we do not distinguish which funds are about to cease in operation. In general, the parent company commitment to the corporate venture capital fund fluctuates much more than in an independent venture capital fund. The activity may be dismissed as the new CEO wants to set his own mark on the company structure or when the company needs its cash for other purposes as was also pointed out in earlier studies. The cyclical nature of the CVC funds was also acknowledged in our interviews. We already think that with the crash of the bubble it is not end of the innovation and end of the start-ups, it will be a permanent way of developing innovation…But what will be not permanent is the cycle of investment in the companies. Despite the changing levels of commitment to the corporate venture capital activity in the energy sector, the hope and belief lingers for new revival of the CVC activities in those
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funds that have been closed down or are currently not investing due to management reconsiderations of the corporate venture capital activity. This hope is shown by the maintenance of the established relationships with independent venture capitalists. This relationship with the venture capitalists… We want to keep these relationships. We are now in the low point of the curve for investment in the company but we still produce a very high cash flow in the company and so the priorities are now to consolidate and reduce debt, but in two years, the situation will change and we will come back to the investment period. And we want to keep the contacts so that when the investment will start again, we want to be ready. Table 2 summarizes the analysis of the European corporate venture capital funds investing in the energy sector. Drivers for investment, benefits and disadvantages for corporate venture capital funds in the energy sector compared to independent venture capitalists, organizational structure and the benefits to be gained by the parent company from corporate venture capital activities in the energy sector are discussed in more detail below. In order to ease the reading, each one of the topics is discussed individually under its own sub-chapter, using quotes from the interviews with the corporate venture capital funds exhibited in Table 1. Drivers for investment For most of the interviewed corporate venture capital funds investing in energy sector, the founding of the CVC fund took place after other corporate venturing approaches had been tried out. For many of the interviewed companies, the corporate venture capital activity is just one of the corporate venturing approaches that the company is currently pursuing. Sometimes the trigger for founding a dedicated CVC fund had been obstacles countered in internal corporate venturing. We had this internal incubator... In fact, to have this incubator, we saw that there were much more interesting projects outside [of our company] than inside In addition to the more interesting deal flow from external ventures, also the human resources with the parent company were not credited for being the source for innovation. It is always a question of people. And if you have a research center with 100 people or 200 people, they can gather all the information available in the world about technologies and trends and so on. But they are not thinking in terms of business, they are just thinking in terms of a department that delivers information. Two main factors, the deregulation of the electricity sector and the technological achievements in the area of distributed energy systems, have made especially the electric utilities aware of corporate renewal through innovation. Since the energy sector is not famous for spurring radical innovations, the CVCs focusing on the energy sector seemed in some cases to have a need to emphasize that also energy sector was worth while venture capital investments.
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So you can no longer say it [energy] is not an innovative business. If you are looking deep inside, you will definitely find innovative businesses. The European electricity market has been going through large changes due to deregulation of the electricity market. The deregulation introduces competition in the areas of generation and supply of electricity leading into more diversified industry structure. Removal of vertically integrated monopoly suppliers and tight regulation will provide opportunities for new entrants in a similar manner that has taken place in telecommunications sector. Despite of the changes, governmental involvement will still remain in the energy sector. As other researchers (Morgan, Tierney 1998) have noted, although these changes are often termed "deregulation," what is actually occurring is not so much a removal of regulation as a substitution of regulated competitive markets for regulated monopolies. Independent VCs investing in the energy sector that were interviewed for this study identified deregulation as one of the drivers for investment. In comparison, some of the corporate VCs approached deregulation from a more skeptical perspective. Deregulation in energy in Europe is a two-edged sword I think. If you take UK for instance, deregulation has freed up all the stand-by capacity, it has driven prices down. By driving down prices of electricity, doesn’t make it more attractive for investors. That is a negative impact for an energy VC Other factors included market confusion which was believed to lead into slower adoption of new technologies. On the other hand, without deregulation business opportunities for new entrants in the electricity generation would be much more limited. When you have deregulated markets then [bringing new radical technologies to the market] is difficult... I’d say deregulation and confusion created with deregulation creates opportunities but it also slowing market adoption of some technologies. Electric utilities have a strong hold of their customers, but not on energy technologies. Electric utilities can be compared to fixed line telecom operators of the past. They are in the business of generating and supplying the service, but they are not in charge of bringing new technological innovation to the energy sector. During the past decades, many electric utilities worked in close co-operation with energy technology manufacturers, operating as pilot customers for new technologies, usually incremental in nature. As the potentially radical innovations in the area of distributed energy systems enter the market place, the strong hold of the customer base is in danger to weaken as generation moves away from the centralized paradigm. Distributed energy solutions, in the form of solar cells, steam cells, fuel cells, wind turbines and other so-called micro-generation technologies, can be installed directly in the customer premises potentially breaking the link to the electric utility. For telecommunications operators the technology that broke the link to the customers was the introduction of wireless telephony.
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Some of the CVCs also compared the momentum they saw in the energy sector to what was experienced when telecommunications sector was deregulated. I would say there is the common feeling that after telecom the energy will be the new field for venture capital. The comparison of telecommunications and energy sectors has been critically addressed by a study that analyzed the research and development efforts in both sectors (Morgan and Tierney 1998). The authors note that “although a change in regulatory and economic philosophy has played an important part in initiating both, the role played by technology and by organizations that perform basic technology research has been and will likely continue to be very different in the two sectors”. The main obstacle in the power sector according to Morgan and Tierney is the absence of organizations, such as Bell Labs in the telecom sector, capable of providing the intellectual building blocks for the power industry renewal. However, it may be that the intelligent building blocks that Morgan and Tierney call for are present outside of the energy sector still allowing for their innovations to be adapted for the usage of power industry. Innovations such as fuel cells and photovoltaic cells do not have their origins in the energy sector but were developed in the defense research labs. The need for change in the energy industry has not been fully accepted by the parent company personnel, leading the corporate venture capital units to argue for the legitimacy of their presence. This industry is moving slowly, driving is not technology but market power. So we are not really in the battle, even if they claim that we are in a battle. In the mind of a manager, we are not in a battle. So we are anticipating here and it is not easy to anticipate in big companies. Based on the interviews carried out with the corporate venture capital units of European energy companies, there is no large scale concern that their dominant position in the power sector is under a threat. I think the degree the established corporations like [our company] are ready to accept innovation and invest in new business models largely depends on the regulatory frame. Because it is relatively stable they do not have any urgency to change their business model. Just do nothing and do nothing new, is the best strategy. I’m definitely convinced that this is the best strategy. Distributed energy systems are widely believed, both among corporate VCs and independent VCs, to be one of the biggest drivers for innovation and new ventures. Many of the CVCs saw the momentum for distributed energy technology taking place now. In
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some cases the customers of electricity may become the suppliers of electricity as the microgeneration technologies purchased by households are linked to the electric grid. One of the most important drivers for companies to establish a corporate venture capital unit is the notion that innovation takes place everywhere except in their premises. For many large energy companies, the internet boom of the late 1990s served as a reminder that innovation was taking place in external start-ups. At this time it was very hype to speak about ecommerce and internet and so on, and we were thinking, let’s do this game in the energy sector, why not Many of the interviewed CVCs acknowledged that the “hype factor” was present also in investments into new energy technologies. Examples of the hype are the investments made into fuel cell technologies in the late 1990s. Several independent VC funds invested in fuel cell technologies in the late 1990s. In comparison, only one of the European CVCs we interviewed had made an investment into fuel cells technologies. Rest of the CVCs expressed interest into the technology but remained cautious. We are looking actively for fuel cell investments. But I think they will still require quite a lot of money and you will not be punished not to invest right now. They have so many financing rounds lying ahead. To get fixed on one technology right now is very dangerous and you will not be rewarded by taking this risk right now. There is consolidation taking place right now. Some guys are running out of money and they will not be funded anymore. If you see [how many] funds are going for the fuel cells, it is like UMTS, you can never get this money back. Many of the corporate venture capital managers that were interviewed had a long career working for the parent company and an extensive career in the energy sector. Most of them had been working with either business development or corporate finance related activities prior to their appointment with the CVC fund. They were familiar with the problems of pushing through new radical innovations within the operational units. But these disruptive innovations were not taken up by the operative branches of [our company]… They could handle the incremental R&D, like improvements for the nuclear plant or some other existing business. But if you had a disruptive innovation for new activities and business, they didn’t know how to do it. It was not in [our company] culture to create companies and new activities…The only movement that is done is to reduce the personnel and the budget by 3-5% Problems and disadvantages of corporate VCs compared to independent VCs in the field of sustainable energy The conclusion of the literature review on corporate venture capital stated that a CVC fund with a clear strategic focus, long-term financial commitment from the parent company, autonomous position in decision making and emphasis on financial benefits is
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most likely to succeed in both acquiring financial and strategic benefits, independent of whether the fund is organized as a subsidiary or as an external holding company. We start the analysis by looking at the problems for energy sector CVCs that stem from execution of the strategic goals set by the parent company. As suggested by the theory, CVC funds are more likely to have problems with their strategic focus when their level of autonomy is low. We have identified six problems that may lead to disadvantages in comparison to independent VCs, mainly faced by funds that possess a low degree of autonomy in investment decision making. Three of these challenges are caused by having dual objectives of strategic and financial benefits:
1. Difficulty in finding a balance between strategic and financial objectives And I’m definitely limiting potential. Sometimes you cannot do a deal that is financially very attractive because of strategic reasons. 2. Not clear how strategic benefits are measured and compensated I’m now concentrating on delivering strategic benefits and maybe I’m suffering on the return side, because I cannot invest so many resources to making financially really attractive deals. 3. Clash with investment that are substitute to the core business Then we have had deals that have been very convincing. And [corporate HQ] says “people are great, as a technology it seems to be very, very interesting”. Then came: ”If these guys become a success, they will cannibalize our business. We cannot invest in a company that is cannibalizing our own business”. Additional three challenges are caused by lack of autonomy: 1. Parent company board not convinced that corporate venture capital model is the best vehicle to achieve strategic goals. If you have a board of [our company] for example, three people are on your side and two are definitely against you. And if they have the time and the interest, they will definitely fight against you. And it is not a fair fight. 2. Corporate headquarters interfering on all issues determined strategic, making the investment decision an organizational battle. The problem was the corporate headquarter (HQ). The people who were deciding about the investments, they were corporate people from corporate HQ,
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they didn’t have any knowledge of the technical things and the market things. So they were very insecure. 3. Time spent on internal lobbying work for acceptance of VC model in the middle management level So you have to convince people about the venture capital idea, who have not ever thought about venture capital. And maybe you get 50% of them if you are really convincing. So it was pretty much fighting against the organization. And at the end, not everybody was in favor of this investment. Financial commitment by the parent company management was identified as one of the key success factors in the literature review. Especially the funds initiated by the electric utilities were more likely than others to face a lack of financial commitment among the funds we interviewed. CVC funds initiated by electric utilities also seemed to suffer most from the problems described above stemming from the execution of strategic goals. This may be due to the fact that electric utilities are fundamentally service companies and have a more difficult time taking forward innovations that are technological in nature. Energy technology manufacturers appear to have a stronger in-house acceptance for venturing activity. This is due to two factors: (1) venturing activity is more acceptable for a company that is used to growth through innovation and (2) strategic it of technology ventures is better for technology companies than service companies. Clash of cultures, not just in valuing innovation, was evident also in other areas. The organizational culture in a large company, especially an electric utility, attracts different personalities than in a small start-up. You always have to ask why are people working with a big conglomerate or a big energy company and not working as an entrepreneur. They have a different spirit. And I asked a board member, very close relationship with the board of [our company]. And he said: “Look at these people. They are not entrepreneurs. So you are trying to do something that is impossible, to move these people to your side”. Most of the deals made by corporate venture capital funds we interviewed were syndicated investments. The funds found arguing for strategic benefits challenging when competitor company CVC fund was a co-investor. It was odd to have so many other companies in there. It is very hard to argue for this investment from a strategic point of view. If you go to your investment committee they say “ok, it is an interesting case and you have these risks and benefits.” But then they also notice that [our competitor company] is inside and then they say “Hey what is here the competitive advantage. Maybe it is a disadvantage if they invest and we don’t”. But it is not so convincing. It is always more convincing when you say “We have this exclusive deal and if it is a big hit we have the advantage to acquire rest of the shares and make a huge business out of it”. That is really convincing.
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In the midst of balancing the strategic and financial benefits, the corporate venture capital fund needs to constantly defend its right to exist. What I see now is that all the CVCs are in a more defensive position. All of them, I cannot tell you one exception, are struggling with their own company. And everybody is looking at his competitor. And they say: “If they are closing their business, why should I be in this business? There are only risks and if I do nothing, I will not be punished. If I don’t do the decision other people have already done, maybe I’m proven wrong and I’m fired in two years”. So, it is very, very difficult. The struggle the energy company CVC funds are experiencing with the parent companies is providing opportunities for independent VCs. Several CVCs we interviewed felt that independent venture capitalists were starting to move into the market at the same time as the parent companies of corporate venture capital funds were reconsidering their venturing mode. What I see is that some independent VCs are entering the markets for energy, they are interested in it but they are a little bit hesitant of course because they don’t know too much about the business. So they really try to link with these [CVC] guys over their funds… That is definitely a trend. Others are of course going in a secondary market…they can make great deals right now with the [energy companies]. Defining the success of a corporate venture capital fund is one of the most difficult issues based on our interviews. On the individual venture level, the success may harm the existing core business. In general, losing market share in the traditional sector or an operating unit is valued more than chances in the new growth area. Most of the corporate venture capital funds in the energy sector are small compared to the annual turnover of the parent company. This leads to a situation where failure gets punished but success goes without noticing. So we have only risk and even if you are very, very successful it’ll never be so successful that it will be reported at the quarterly report. So we as a supervising team can only lose. So if the money is away the shareholders are asking what happened to our money, is it really necessary to do these kinds of investments. And if you’re successful it is “so what”. Also, the parent company seems to quickly forget why the corporate venture capital fund was set up in the first place. [Our company] is very core-areas focused and lots of companies are these days. That means it is not obvious why you need a corporate venture capital unit. You still need it to spot migration opportunities.
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Some of the corporate venture capital funds in the energy sector have solved the conflict with strategic goals by following the optimum model determined by the literature review. In this model they operate autonomously and emphasize financial benefits. So basically it means we go after profits. If you don’t go after the profits, how do you know what you’re finding? Is it going to be the market leader in the future? So by definition if you can’t spot the best deals and get the best returns, you cannot spot what the market is doing. The importance of high degree of CVC fund autonomy from the parent company was identified as a key factor both by the literature review and the interviews we carried out with the energy sector CVCs. In order to review this issue in more detail, the next step in our analysis is the review of organizational structures of CVC funds in the energy sector. Organizational structure Organizational structures of venture capital funds active in the sustainable energy sector are exhibited in Figure 3. Only the interviewed CVC funds are included in the figure.
Classical CVCs
Eon Venture Partners Schneider Electric Ventures Vattenfall Europe Ventures
CVC-VC Hybrids
Theme funds
Emerging Industry Funds
Independent VCs
Norsk Hydro Technology Ventures EdF venture capital Suez Nov Invest BASF Venture Capital
RWE Dynamics MVV / Accera
Conduit Chrysalix
Nth Power SAM Group
Capman Apax partners
Pure VC approach Pure CVC approach Figure 3
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Corporate venture capital funds listed in Table 1 belong to a category “Classical CVCs” or “CVC-VC hybrids”. Examples of classical CVC models are the corporate venture capital funds of E.On and Schneider-Electric. The general managers of the funds following the classical CVC model are most likely to have worked previously for the parent company. The investment committee of the classical CVC funds brings together members from the operational units in the organization. Examples of CVC funds in the “CVC-VC hybrids” category consist of funds that have a high degree of autonomy from the parent company. The managers of these funds may have a background in an independent venture capital company or are likely to have a carried-interest model similar to the independent VCs. The hybrid funds have more leeway to move to the right, towards the independent VC model, when the financial or strategic commitment of the parent company weakens by raising capital from sources external to the parent company. Benefits of corporate VCs over independent VCs in the field of sustainable energy The first and most obvious strength that the energy sector CVCs have over independent VCs is their experience in the energy sector. The corporate venture capitalists tended to emphasize the energy technology knowledge more in early stage deals. If you are investing in start-up companies, [the knowledge needed] is definitely more the technical side, definitely. The evaluation of the technology is really the core and very essential for calculating the risk and reward scheme. If companies are more grown up, I think it is more the market The corporate venture capitalists we interviewed generally felt that one of the reasons independent VCs had not entered the sector in larger quantities was the lower level of knowledge both in terms of energy markets and technologies. Despite of the access to inhouse experts in due diligence and knowledge of the markets, many energy sector CVCs had gone through a learning process themselves. We have gone through a learning curve ourselves. We’ll now avoid capital intensive deals. The other lesson is the market adoption time: just need to look at microturbines. Market adoption takes a lot of time. And people tend to be incredibly over-optimistic about that. And even when you have discussions with large suppliers, on how long it takes to take products to the market, they can also be far too optimistic than they should be. Despite of deregulation of electricity markets, energy markets are closely coupled with governmental intervention in terms of subsidies and regulations. Although CVCs we interviewed had their own reservations about governmental involvement, they had belief in the long-term commitments of European government with regard to regulation. Although the parent company financial commitment to a CVC fund may change over time, many of the interviewed CVCs emphasized the importance of understanding long-
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term commitments when investing into energy technologies. The CVC pointed out also the larger capital needs due to field testing and longer time-to-market. Some of the CVC also saw the possibility to turn regulations into long-term advantage. If we are able to find the most efficient technology in the market and to invest in this and to make this company really big and convincing, then [the parent company] can go to the regulator and say “you don’t need this huge amount of money to make this more efficient. We already have a very efficient alternative and you can lower the subsidies”. And that would be good for the start-up company because this would create a barrier to entry for others. And it would be good for [our company] when there are not so many subsidies in this area. Another asset that energy sector corporate venture capital funds are able to offer to the ventures in their portfolio is better access to parent company resources to be used in piloting and demonstration. When we talk to companies, [our company] is reasonably attractive because it has a good reputation that it is a fairly easy corporation to deal with. So they are not afraid that they’re going to get screwed. And then they know it is a fairly big company so there is potential help in marketing the products and that there is a potential technology help. The corporate venture capital funds also have an access to parent company resources in order to perform due diligence on the deals. For our investments, we have invested in very early stage companies. [The work we had to do] was really technical due diligence and we were working closely together with [our parent company] engineering unit. And they do have four or five hundred specialists. Every specialist has really a specific area that he is concentrating on so you really get the best of technical experiences. Syndicating investments with competitor sponsored corporate venture capital fund can also be used to achieve an industrial standard on a technological solution. If you for example have an investment in basic technology like fuel cell or steam cell, it is definitely an advantage because you can create something like an industry standard. But if you are creating something really close to the customer, I think it is getting more and more complicated to cooperate with a competitor. But if you want to create a standard and you have maybe 2-3 standards in the market it is good to syndicate and say “ok, if we feel comfortable with this standard, that is a win-win situation “And in these kind of cases you really prefer a partnership. Benefits for a energy company from a CVC activity
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The classical benefit to be quoted both by academics and the corporate venture capitalists we interviewed was to obtain a “window on technology”. In practical terms this means obtaining inside information about an emerging sector as an investor to a start-up. You don’t see the same things when you invest in a company and when you monitor from outside. If you check from the internet, you don’t get the same information. This is information that is available for everybody. If you invest you feel what the ecosystem of a sector is: all the relationships with the players and so on. Investing into an emerging sector also offers a better ability to react if long-term visions turn into short-term opportunities and threats. For example, consider the micro-generation in the houses. This was thought as a medium-to-long-term opportunity [within the company], because of the technology, fuel cells and so on, was not ready yet. But in the UK, because of the battle in the mass market, some competitors thought they were very strong in gas, and if they develop a concept that they produce the heat by the boiler but the boiler also produces the electricity, they would catch the customers. Although many of interviewed CVCs were skeptical about finding opportunities worth pursuing in internal ventures, innovations also take place in the parent company. Corporate venture capital fund can provide a more natural home for the innovations that the operational units are not able to pursue further. So we had projects that were not in the hands of anybody and there was a lacking chain between R&D and the market. So the board of company Y asked us to create this chain, [corporate venture capital fund].
Conclusion The variety of approaches observed in the corporate venture capital programs of European energy companies is surprising given the clear conclusions of previous research on suitable management approaches for CVC funds. Either the lessons learned and reported in academic journals have not reached the practitioners in the energy sector or there is a need for further academic research that studies how the industrial sector and parent company type affects the organizational form of a CVC fund. Volatility and vulnerability during times of management change at the parent company suggests that the value of CVCs is not fully understood. Clearly better measures for success, especially for the success of strategic goals, need to be developed. We identify the measurement of strategic success as an important area for further academic research, both to study what methods do the parent companies currently deploy to measure the strategic success of a CVC fund and do strong strategic benefits make a CVC fund more stable in the case of a management change.
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We demonstrated in this research paper that most of the opportunities in the energy sector lie in radical innovations, such as in distributed energy systems. However, as the literature review showed, CVC activities are more successful when there is a strong strategic overlap with current activities and the CVC strategic focus. Combining these two conflicting results leads us to conclude that independent VCs are more likely to gain success in taking radical new energy technology innovations forward than energy company CVC funds, especially the CVC funds established by the electric utilities. Energy technology manufacturers show more promise in their ability to nurture radical innovations in the energy sector. To confirm this result, further research among energy technology manufacturer CVC funds is needed as the current sample is too small. Based on out study, energy technology CVCs add value particularly in technical due diligence and have a lower barrier to enter early stage deals since they feel more confident on the technological issues than the independent VCs. However, challenges due to strategic goals seem to override both financial and strategic benefits, especially with electric utilities. Some of the challenges are due to fears of cannibalizing existing business which outweighs the perceived benefits from new technologies. Energy companies tend to value reserving current competencies more than investing into new. Our former hypothesis on the deeper pockets of energy company CVCs compared to independent VCs does not hold. Electric utility CVC funds are also more likely to be terminated early due to CEO changes or during times when other energy companies are reassessing their venturing activities. In short, the value of having a corporate venture capital unit within an electric utility is not always well understood among the parent company personnel. The message is that it is really difficult to make a corporate venture capital unit exist in a big group, when there are a lot competing branches and when you are not convinced that innovation will be the key in competition. In the corporate level they don’t think that innovation will be the key in winning the competition. They think it is the price or classical services. From the perspective of an energy technology venture, electric utility sponsored CVC funds do not appear to be a long-term partner. To confirm this finding, further research is needed among those energy technology ventures that have received financing from both corporate VCs and independent VCs.
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Appendix 1 Table 2 Analysis of European corporate venture capital programs active in sustainable energy
Topic Drivers for investment
Factors • Low level of parent company internal innovation • Deregulation of electricity markets • Strong hold on customers but not technologies (Electric utilities) • Analysis of the change in other industrial sectors previously operated as monopolies • Technological development in distributed energy systems • Pressure from regulatory bodies • Increasing competition from start-ups (Electric utilities) • Internet boom
Benefits of CVCs over independent VCs
• • • •
Disadvantages of CVCs compared to independent VCs
• •
•
Benefits to be gained from corporate venture capital activity to an energy company
• • • • •
Used to governmental involvement and regulation in the energy sector Knowledge about the energy markets and technologies o Lower barrier to enter early stage deals o Ability to tap on parent company resources in due diligence Value-add to portfolio companies using the parent company resources: piloting, new energy technology demonstration Lobbying power Limited autonomy of CVC funds in most cases Struggle with strategic goals (electric utilities) o Parent company not convinced that CVC is the best vehicle to achieve strategic goals o Corporate HQ interference with all issues determined strategic o Measure of strategic success unclear Difficulty in finding balance between strategic and financial objectives o Conflicts due to compensation o Clash with investments that are a substitute with core business Inside information about an emerging sector as an investor Organizational learning leading to strategic benefits o Learning about competitors by observing the activity of their CVC funds Securing positions, affecting the direction of development Better ability to react if long-term visions turn into short-term opportunities and threats Internal innovations find a more natural home
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