Corporate venturing can nurture software success

Milwaukee, Wis. - You may have missed this: Web-software services provider Zywave Inc. recently announced it would be the anchor tenant in a new 165,000-square-foot building being constructed in the Milwaukee County Research Park.

The announcement was little noticed outside of commercial real estate development circles, but the news is more than a real estate story. It's a major technology success story playing out, and an example of how a powerful business development practice could bolster the regional economy, if it were not engaged so rarely.

That practice is called corporate venturing, a broad category of activities whereby an operating company deliberately and strategically develops and allocates funds and resources to new businesses.

The most well known strategies under the corporate venturing umbrella are acquisitions in early-stage companies and joint ventures. Lesser known, but with high potential, are internally focused business creation strategies, or “internal corporate venturing” initiatives. Some are conducted informally as “skunk works” projects, ad hoc idea creation, or the pursuit of opportunity-driven innovation. Other strategies such as corporate venture capital, corporate incubators, and support for corporate entrepreneurship are more formally structured.

Founders knew of Zywave's growth potential Zywave is an example of internal corporate venturing through its former parent, Frank F. Haack & Associates, an insurance brokerage firm. Haack internally formed and launched Zywave in 1995 to provide software-based reporting solutions to its insurance clients. However, from the beginning it was clear in the minds of the founders that Zywave was a software services company and could stand on its own after a planned incubation period supported by the parent founders.

Zywave now has more than 110 employees and its leaders anticipate annual growth of 25 to 30 percent the next three to five years, according to Bill Haack, Zywave's president and CEO. This region has other outstanding examples of corporate venturing successes — examples that will be explored in more detail in a follow-up column.

Let's first take a look at the strategy of corporate venturing, since the term is relatively unknown and unused in this region. Even though the term may be unfamiliar and the practice uncommon, the potential for new business development through formal or informal corporate venturing is high, particularly the development of software-centric businesses.

Jeff Covin, professor of entrepreneurship at the University of Indiana, has been researching and publishing works on corporate venturing for more than a decade. In recent discussions, he shed light on the many facets of corporate venturing and its role in strategy and innovation. His work can help navigate the maze of options and funding scenarios.

Corporate venturing can be funded directly through an operating budget or indirectly through a financial intermediary such as a corporate-sponsored fund or outside managed fund.

Corporate venture capital

A subset of corporate venturing is corporate venture capital (CVC), whereby a company makes direct external investments in other companies, exclusive of any investments made through a third-party managed venture fund. The National Venture Capital Association (NVCA) tracks CVC, providing this recent data:

• Although off the peak of the dot-com bubble years of 1999-01, 2006 was the best year since 2002 for CVC.

• CVC represents more than 20 percent of invested capital.

• During the first half of 2006, the top sector deals by CVCs were in software (23 percent).

Winslow Sargeant, currently a VC partner in Madison-based Venture Investors, was the recipient of a Cisco-funded direct investment in Aanetcom, an Allentown, Pa. company he co-founded in 1997.

“This was both a financially and strategically motivated investment,” Sargeant said. “Cisco knew the fabless semiconductor market very well, so it could do the due diligence internally. They also wanted cutting edge technology not available from current suppliers.”

Under a direct investment like that, Cisco takes a minority stake with the potential to acquire the company later. In Aanetcom's case, it got needed cash and an initial customer. Cisco ultimately did not acquire the company, but was financially rewarded when Aanetcom sold for $900 million to PMC Sierra.

After contacting several VCs in this area, it was clear that CVC activity in our region is rare. More encouraging is our region's activity categorized as “internal corporate venturing,” like the Zywave initiative. Through an informal survey, we identified several other such ventures, including software-centric managed services companies that were formed within existing businesses.

Those include stalwarts like Metavante, which was started internally by M&I Bank and which now employs 4,000 people, generating more than $1 billion in revenue. M&I in April reported it intends to spin off Metavante in a $4.25 billion deal. Another is Trisept Solutions, a travel technology outsourcer started as the internal data processing division of Mark Travel in Milwaukee. Trisept is now a global leader in vacation travel processing.

Why internal corporate venturing?

In larger companies, corporate venturing can provide strategic and financial value to the corporate entity. Strategically, companies see corporate venturing as a framework for inducing innovation and corporate renewal without the trappings of corporate bureaucracy. It can create a mechanism to exploit new markets or emerging technologies in a setting that will tolerate failure.

Covin says that if a corporation's sole access to new markets is through acquisition, the company may dull its innovative skills.

Some innovative firms built competencies in areas that provided a competitive advantage for the parent and the door was open to exploit that expertise with a new business. Without executive tolerance to pursue such opportunities outside the parent, Metavante and Trisept wouldn't exist today.

Another alternative is to extract value from technologies that are no longer core to the parent company's business strategy. Saab AB follows that path, according to Covin.

Advantages for the corporate entrepreneur

For those developing a new venture, there are many advantages to establishing operations with the support of a company, whether it assimilates into the core business or eventually spins out through divestment.

Pure start ups are challenged in the early years while attracting their first customers and capital. In contrast, a start up launched as an internal venture can benefit from relationships, corporate resources, infrastructure, know-how, and sales channels of the parent.

Further, the parent company, as a first customer, can provide regular revenue, critical and timely feedback, and endorsement. If the parent is perceived as an innovator and leader, its use of innovation can be leveraged to the next layer of early adopting customers. The corporate parent is likely to provide more time and patience to the development of an internal business.

On the downside, if the new venture meets its potential, it eventually needs to convince the market that it is independent. Some VCs won't fund a deal where there is undue influence by the corporation or a perceived challenge to acquire customers that compete with the parent. In addition, some of the early venture's customers may actually feel comforted by the parent company's support.

Corporate venturing has proved profitable for businesses and for the communities where those ventures are located. Those communities benefit from the creation and incubation of high-growth, entrepreneurial businesses and from the innovative culture of the new companies — a culture that could, in turn, spawn further innovations or new companies. Finally, great benefits are realized when the new companies move to their next stage.

"We see a lot of these `accidentally' formed companies resulting from a corporation's focused activities around improved customer service or value-added offerings", said George Roberts, a Wisconsin resident and venture partner for Boston-based OpenView Partners, a venture firm focused on software, Internet, and technology-enabled companies. "If they are non-core to the business, they can be spun-out to thrive on their own. The market is currently paying three to five times revenue for technology-enabled companies with decent growth and or profitability. Even more if they are strategic acquisitions."

You can bet the recipients of those payouts will invest in new ventures.

In light of all those benefits, what can be done to foster greater corporate venturing by companies in this region? We invite your insights on the topic. My next column will identify some of the common traits of the software-centric managed services companies created in our region via corporate venturing, and the market conditions in which those new companies were created.

In the meantime, the following are some additional resources on corporate venturing:

Google: Covin corporate venturing

Corporate Venture Capital on the Rise

Spin-out Business Model: A Strategic Tool for Innovative Growth, Entrepreneurship and Flexibility in the Service Sector

Previous articles by Geoff Bastow

• Geoff Bastow: Connecture's Maynard finds IT business opportunity in adversity

• Geoff Bastow: Web-centric entrepreneurs find models that attract investment

• Geoff Bastow: New Silicon Pastures director envisions more home cooking for Wisconsin angels

• Leadership insights from co-founder of Yesmail