Differentiating between corporate spin-outs, carve outs and corporate venturing

With the relenting pressure from shareholders who want to see a bigger bang for their massive corporate research expenditures, large multi-nationals cannot simply rely on the number of patents filed as a measure of success. They must also show improved productivity in terms of number of projects that result in meaningful and measurable commercial gains, and sustainable, long term competitive advantage. In large multi-national organisations, it is quite common to see a large number of projects being abandoned mid-stream and collect dust, as new priorities emerge to take up limited available resources.

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The news that Philips Research is to partner with New Venture Partners to encourage and explore potential new spin-outs presents some interesting possibilities and challenges. First of all, it must be noted that the unit in question is the centralised corporate research entity which carries out pure and applied research for Philips’ operating divisions and business units, as opposed to the R & D units which are located within the operating product divisions such as semiconductors, lighting and consumer electronics.

Corporate spin-outs
Imagine a typical scenario which happens on a regular basis in large corporate labs. A group of research engineers come across a novel innovation, material or method, and become so excited about it that they want to pursue it further; they go to their line managers and request more resources (read funding).

A vast majority of these will be rejected due to the departmental focus on its core projects which must be finished on time and on budget. There is very little flexibility for carrying out additional non-core projects. As technology makes more advances, there is more pressure on R & D personnel to keep abreast of new developments in their spare time, let alone have the time to do additional work.

The engineers get turned down so often that they soon develop a habit of not submitting new ideas or projects, for fear of being rejected. This will create one of two possible outcomes:

- the idea will be stillborn and sit on the shelf
- the engineers are so convinced about the possibilities of their new findings that they muster enough supporters and quit the company, so they can venture out on their own

Responsible corporate entities might be sympathetic to new ideas and even encourage the engineers with support and guidance for their new venture. They may even take a small equity position in return for the IP, which theoretically belongs to them.

Fairchild is a very good example of this (more about Fairchild later on). Other examples include Cambridge Consultants Ltd, The Technology Partnership and PA Consulting in England, UK.

A bad corporate entity will resist such spin-outs and even threaten their potential spin-outs with legal sanctions and unenforceable restrictive employment terms. This is short-sighted, as working with spin-outs can have numerous mutual benefits later on. The bad feelings created at the onset can be damaging for both sides, as more employees leave to join the new start-up, and the two parties avoid doing business with each other.

Large multi-nationals have a choice of setting up an internal tech transfer office (TTO), similar to some universities, or sub-contract the work out to an external organisation – as was the case with British Telecom and Lucent/Bell Labs. Blueprint Ventures in the USA specialises in spinning out corporate technologies. An internal TTO close to the product divisions presents some challenges as product managers and divisional chiefs attempt to protect their turf, internal resources and crown jewels from walking out of the door and creating potential new competition.

Corporate carve outs
On the other hand, a complete free-for-all can hollow out an organisation and might make it unviable in the future. The solution in this case may be a corporate carve out, where a sizeable portion of the corporation is carved out – as was the case with IBM/Lexmark Printers, ATT/Lucent, HP/Agilent, Motorola/Freescale and Siemens/Infineon.

The motivation may appear to be noble at the beginning, as the new carve out will be able to (at least in theory) withstand normal commercial pressures. This is due to the carve out carrying its own IP, products, customers, revenues and cash flow. It may be carved out with a concurrent IPO or a leveraged private equity buyout, which can bring in a large dose of fresh capital.

But sometimes, carve outs occur for the wrong reasons, and the carved divisions may require an extraordinary amount of capital and time to stand out on their own feet – especially for carve outs from large integrated semiconductor manufacturers. Sometimes, whole divisions are carved out due to the cyclic/volatile nature of the business, which unnecessarily brings the share price of the whole enterprise down, as was the case with the Infineon and Agilent semiconductor divisions.

The new carve outs require a whole new set of clothes and dressing in terms of corporate and board structure, governance, treasury and corporate finance services, before they are able to stand on their own. But, as most astute corporate planners know, that is someone else’s problem. By the time the lock in period is expired and the initial backlog and goodwill is burned off, the original corporation would have received a fair amount for their original shareholdings.

Corporate venturing
Corporate venturing units are designed to offer external entities, usually technology start-ups, with access to the company’s infrastructure, markets, customers and partners, as well as access to financial capital. Corporate venturing is different to traditional venture capital, in that it requires an internal sponsor, who will mentor, support and nurture the start-up with all the internal corporate nuances before a corporate venture investment is agreed.

So why go through all the trouble?
Corporate venturing is done for various strategic reasons.

a. To make use of and leverage existing corporate assets, such as channels, partners, customers
b. Develop a wider user base for its core technology platform
c. To fulfil R and D deficit
d. To fill in gaps in the product line
e. To enter a new market sector
f. As a pre-emptive defensive move to stop a competitor getting hold of key technology
g. A strategic fit for future potential acquisition, if milestones have been met

Cisco has been very good at cultivating such a strategy. In the long run, it could potentially be cheaper to acquire a technology once it is proven, rather than undertake speculative research internally. The motto here is, “Let somebody else take the first risk”.

It is therefore unlikely that a start-up, which is pre-Chilli R1 (see definitions) will see much interest from corporate venturing outfits.

Some start-ups go through rigorous due diligence, only to find out that the corporate venture partner has pulled out at the last minute. This is sometimes wrongly perceived by start-ups as a fishing expedition by a large corporate company who wants to ensure it is on top of all the latest trends. Large multi-nationals have too much at stake, versus their potential equity stake, to knowingly get involved in such an exercise, as sooner or later the misdeed, if any, would be found out.

Some companies do not have a formal corporate venture unit or make direct financial investments, but instead have venture relationship managers who assist larger VCs with assistance in speciality due diligence and market assessment. They can also provide the start-up with access to their channel partners or even become their first blue chip customers.

Sometimes, internal corporate sponsors view start-ups as competition –especially when one considers the stock options and exit opportunities given to the founders and staff.

Other than a few blue-chip corporate ventures funds, many corporate ventures have come unstuck with a limited portfolio and poor returns. They have in turn decided that managing and growing start-ups is not part of their core expertise and delegated these activities to professional VC firms. Examples include HP and Applied Materials.

Fairchild went through corporate venturing, spin-outs and carve out
Fairchild was founded by Bob Noyce, Gordon Moore and six others, who left Shockley Laboratories in 1957 and its autocratic management style when they were (read corporate venturing) backed by Fairchild Camera and Instrument. Later on (read corporate spin-outs) Fairchild spawned famous companies like Intel, founded by Bob Noyce and Gordon Moore; another spin-out, National Semiconductor, was started by manufacturing expert Dr Charlie Sporck; Jerry Sanders, who was a sales and marketing guy from Fairchild, started AMD.

Another spin-out was Signetics, which was later acquired by Philips. In turn, these spin-out companies carried the same philosophy and spun out numerous other companies, resulting in what we now know as Silicon Valley, with its spirit of entrepreneurship.

Fairchild, as it happens, went through some troubled times and was bought by Schlumberger, who wanted its very high speed measurement and instrument technology for the oil exploration sector. The rest of its technology was superfluous, so it was separated out and sold. In a great irony, it was sold to one of it previous spin-out companies, National Semiconductor in 1987. It then went through a management buyout and operated as a separate company (read, corporate carve out). It now employs 8,000 and has revenues exceeding $1.7 billion.

Understanding these basic differences between corporate spin-outs, carve outs and corporate venturing, can be used for maximum benefit in a start-up’s strategic plans.

© Chilli Publishing Ltd 2005

06SEP2005