Google Venture Capital: The Challenges

The news this morning is that Google is seriously considering entering the venture capital business. They bring a lot to the table, for sure.

But as Jessica Vascellaro points out in her WSJ piece: 

Their [corporations who invest directly in venture deals] track records have been mixed. Corporate venture-capital arms have been hampered by challenges that traditional venture-capital businesses don't face. Venture capitalists invest in private start-ups at an early stage, usually in hopes of a big payout if the company is sold or if its stock goes public.

Many start-ups fear that taking corporate money limits their options and comes with strings that could turn away other potential investors -- such as a right to buy the company at a later date. Some funds with less competitive compensation have struggled to retain managers, and corporate venture funds often don't allow senior employees to invest personal money in their funds, while other venture funds typically do.

Corporate venture capitalists' share of overall venture-capital dollars invested in U.S. companies fell to 7% in the first half of 2008 from 8.4% in 2007, according to PricewaterhouseCoopers and the National Venture Capital Association. Corporate venture capitalists were involved in roughly 20% of the venture-capital deals signed during the first half of 2008, compared with 21% in 2007.

All businesses are about talent, and the best talent in the venture industry doesn't work in large companies and won't work in large companies. So corporate venture investors start with a big talent handicap and eventually face employee churn in their venture groups.

And to make matters worse, corporate investors don't really share the profit motive with the entrepreneurs. Let's say Google (or any other corporate VC) invests in a startup and buys 20% of it for $3mm. Let's say that startup is a huge success, sells for $1bn and Google (or any corporate VC) makes $200mm on the deal. None of the employees who made that investment get rich. The founders of Google and the CEO of Google don't get rich (they are already but that's not my point). The company "gets rich". But Google makes $1.5bn of pre-tax profits every quarter. So this big win generates another 12-13% to the bottom line, but just once. It's not a recurring gain.

And that's the big problem with corporate structures for venture investing. One-time gains in corporations don't make anyone rich. Wall Street ignores the gain. The company can't put the gain into the pocket of its management. So it just doesn't matter very much.

Corporations have other motives for doing venture capital. But those motives aren't particularly well aligned with the founders, managers, and financial investors. So there's always tension in a corporate venture investment and it's not always healthy.

Please don't get me wrong. There are corporate investors in many of our portfolio companies. Six of our eighteen active and announced portfolio investments have corporate investors in their capital structures. That's one in three, well above the 20% number cited in the quote from Jessica's WSJ piece above. We like working with corporate investors in the right situations and we'd certainly love to work with Google considering all that they bring to the table.

But I do think that venture investing is not the best use of a corporation's capital and that it is inevitable that it will produce sub-par returns at best and significant losses at worst. And as a Google shareholder, I'd prefer to see them do something else with all that money they are making.

Disclosure: Long GOOG

Comments

[alpha24seven:]

Well they need to pick the right companies and management teams.

The problem you are addressing is one of "venture overlap". There are traditional VC shops such as yours and then their are traditional corporate VC funds. But now there are many more ways of doing venture coming from hedge funds and private equity. (I can testify to this directly) I can see your trepidation regarding an 800lb gorilla jumping in to the venture game. Good ideas and management teams are not infinite but competition is.

2008 Jul 31 02:58 PM

[NW Tech:]

The problem here is that Google has been unable to generate meaningful revenue from companies they have aquired. To date, YouTube hasn't produced expected target revenue. Google has ransacked Postini's $100M revenue stream to less than $50M today.

If Google isn't able to make good for companies they have purchased, what makes anyone believe they will accomplish more with companies they just invest in?

Google is a one trick pony...period!

I purchased my GOOG 2 weeks after the IPO and sold in December 2007. I won't buy Google stock unless and until I see better marketing of already existing services as well as much better customer service.

Google's customer service sucks!

2008 Jul 31 03:59 PM

[Chandler Lutz:]

I have to wonder weather Google is investing for strictly financial returns like most VCs or looking to gain access to certain developing technologies. If I were to guess, I'd have to say the latter. Obviously Google knows that a few small investments won't move the needle, but if you integrate these technologies into a larger net like Google's you could generate tremendous. As BayAreaGoogleGuy said above, google has not seen much success in acquisitions...we'll have to see if anything comes out of this new venture...

2008 Jul 31 10:17 PM