Structuring Corporate Venture Capital Deals

John Orbe

Kison sits down with John Orbe, Associate General Counsel - M&A at Emerson to talk about corporate VC deals, what the process looks like, and how to navigate challenges you may encounter.

Jeff Desroches
VP of Corporate Development at Atlas Copco
Ivan Golubic
Former VP Corporate Development at Goodyear
Erik Levy
Group Head Corp Dev and M&A at DMGT PLC
Kison Patel
CEO at DealRoom

Structuring Corporate Venture Capital Deals

10 Feb
John Orbe
Or Listen On:

Structuring Corporate Venture Capital Deals

Structuring Corporate Venture Capital Deals

“Any company, at the stage in their growth process, that is considering M&A, should also warrant looking at the VC initiative.”

Traditional venture capital versus corporate venture capital

On this episode of M&A Science, Kison interviews John Orbe, Associate General Counsel of M&A at Emerson, about corporate venture capital, what it is, why you should consider it for your organization, and the challenges you may face with it. John explains how to identify your strategic goal, setting objectives, and how to assemble your VC team. He then goes on to explain the deal structure of corporate venture capital transactions.

John and Kison briefly touch on the difference between LOIs and term sheets, negotiations during corporate VC, and convertible notes versus straight equity. They then go on to explain all the details of how corporate venture capital differs form traditional venture capital. John says the primary goal of a VC is to seek financial gain, unlike corporate VC which is strategy. Because of this, the exit scenario matters a lot to the VC and will be heavily negotiated. The interview ends with John's experience of the craziest thing he's seen in M&A.

special guests

John Orbe
Associate General Counsel - M&A at Emerson

special guests

John Orbe
Associate General Counsel - M&A at Emerson

Hosted by

Kison Patel

Episode Transcript


Today I'm here with John Orbe Associate General Counsel of M&A at Emerson. Today, we're going to talk about what the process of a corporate VC deal looks like and how to navigate challenges you may encounter. So becauseJohn's a lawyer. I'm going to get a brief disclaimer out of the way.

John, if you want to kick off, maybe tell us what you do at Emerson 

My role here is I am the attorney. I partner with our corporate development team and our other M&A functional lead. And really helped drive our M&A process here as far as doing our acquisitions our divestitures, and as well as our venture minority investments, which we're gonna talk about a little bit about today.

You have to be on the legal side, really hope to coordinate due diligence efforts, the actual document drafting, contract negotiation, really serving as the along with our corporate development, a quarterback for organizing our M&A efforts, and yet to the goal line of scope. 

What's the most interesting deal you've worked on?

Start to join Emerson, I was in a law firm for about a year. So this would be before my Emerson experience, but, we're here's the thing with Missouri and as any good St. Louis boy and Cardinals fan. 

So I had an opportunity actually at my old law firm to work on it in NatGeo and the Cardinals acquired their AAA affiliate, Memphis Redburn.So for a kid who grew up in Bush stadium written for the Cardinals. To get to combine that with my M&A practice. That was pretty special for me and is now the fun one.

Let's talk about corporate ventures. When do corporations or when should corporations think about investing?

What I mean by corporate venture and corporate VC, and people might be familiar with venture capital traditional firms that are investing in startups, seeking to return on their capital. 

When we talk about corporate venture capital, what we're really talking about is a strategic or a larger company/ larger firm making those minority investments and doing that from a company like Emerson, a big company who their focus isn't necessarily investing in little companies, but they do that as part of their strategy. 

And in terms of when people should think about investing, any company that, at the stage in their growth process, when they're considering M&A, if you're considering M&A, I think it should also warrant looking at the VC initiative. 

There are lots of advantages of getting involved in venture deals, minority investments. It really can push your company, especially with an older, long-established company by getting involved in the VC process. 

So we'll get a front seat at innovation from the new startups and from the new disruptive technologies that are coming out by engaging in a VC process and really puts you in the front seat of the innovation exposure there companies are always trying to adapt and evolve.

You want to see what the latest and greatest venture process that continued investment puts you there. 

And then there are other advantages of getting involved in venture investments and growing companies. You can look for a commercial synergy, partnering, looking at getting into a new market, combining your product with their products. 

You can develop a potential M&A pipeline by getting involved in a company early. One, you could potentially get it at discount down the road. You can test your hypothesis and see, make sure it is a good company. 

And you maybe get involved earlier. If you're not quite ready to acquire them, you can learn along with them.

But also with developing that pipeline, you might also block a competitor from acquiring something that could be potentially lucrative down the road. 

There are lots of reasons to get involved, but really help drive your growth and innovation are two main reasons to consider investing. 

Can you walk me through what shaping the strategy looks like?

Shaping the strategy, especially for a corporate VC is probably one of the most important things you need to do. You need to have an investment thesis and investment rationale and goals of what your corporate VC department group is looking like.

What did you want to do? What do you want to accomplish? Otherwise, you're just throwing money at shiny objects.You need to form your overall investment thesis of why you're doing this. 

You need to add the outset and decide why you're doing it. What your strategy is and what success would look like, and then stick to that strategy. You need to balance your strategic goals and your financial goals.

Obviously, it's great to get a financial return out of this investment. That's generally not the typical goal or main goal for a corporate VC deal. 

  • What kind of commercial partnerships are you hoping to get out of it? 
  • Are you just wanting to like a board seat, like a seat at the table to learn about this new technology?
  • Are you wanting to get a right of first refusal to potentially acquire this company down the road? 

What drives that? I feel like I would default to you're primarily looking for access to M&A?

That's actually a secondary goal for most of the deals. some of these ones you're making an investment in might not be a suitable full-on acquisition. It might be tangential to your space. 

And so you just want to be bottled to know what's going on. It's why you really need to form your actual goal because it could be other than just potential M&A targets.

You could see examples of a technology and it seems really interesting. 

Can you commercialize it in this partnering with a startup company can really be a way of learning and seeing if it can be commercialized. You can really gain access to innovation and learn what's going on.

So there are a lot of end goals other than just potentially acquiring them.

It's interesting because it's almost like you're looking at it where you can just enter a space. 

That’s a good reason to consider a venture deal and heavy minority investment goal or objective. If you're learning about these companies, if you're talking to these people mixing in the space, opportunities will arise. 

What other considerations and resources are needed?

First thing you want to do is you want to build your team. It's a different team and in my experience in your traditional M&A team, a company like Emerson has a strong M&A history and M&A team. We bring an army to deal sometimes and you look at the number of people in our working group. 

For a venture deal, I think you need a much smaller team. You need your lead development person, your lawyer, whether you have an in-house legal resource like we do, and myself, you really would need to make sure you have a good outside counsel and get outside counsel that knows venture deal is going to know what market is.

Don't just open up a phone book and get a lawyer. You get somebody that knows what they're doing and plays in the state. 

And then you need a couple of specialists, obviously doing your financial and tax due diligence. You want your legal doing your corporate due diligence. IT is a lot of this is around innovation and learning about new technologies.

You want to have an IT person on the team. You might want an employment person, especially if the target company has options or given certain things like that to their employees. 

You might want your employment specialist to look at that. You want to craft your specialized team for that. And then what's really important is defining your goals and your strategies.

You want to have a  playbook like this is what we're going to do, and this is how we're going to do it. Develop your company's approach to these. 

You also want to develop your own due diligence approach. Cause due diligence on these deals is a lot different than full-on due diligence for an acquisition.

If you're actually acquiring the company. Your concerns might not be the same thing. You also generally want to take a lighter touch with these. 

These are companies that you're not going to control and they need to still function, do their day-to-day, especially cause they're often pretty small. 

You have to be conscious about not completely diverting them off their business path.Develop a focus, lighter touch due diligence approach. 

Another resource or consideration is how are you going to fund these acquisitions for a big company? Sometimes you're meeting quarterly or yearly goals. 

And how is the venture investment usually has a five to seven-year time horizon? How does that play with any organization that has to meet quarterly and annual targets?

You can decide how you measure success. It's easier for a traditional VC where you measure success on your return on capital, how much money you get out of the deal.

If financial goal isn’t your primary goal, you need to decide what is going to be the measure of success. 

If you have a small team, how come your M&A folks, you don't want them to lead this effort?

It depends on every organization. You may have a very lean M&A team, to begin with. Your M&A team might be just what I described as a financial person, that business lead lawyer IT, and that's your entire M&A team there's nothing wrong with using the same team.

If you have a large team of 40 people, I'm turning every rock and identifying every single potential issue, that type of massive working group list. I don't think is needed here. 

It’s a smaller focus team and if that's your full M&A team, then run with it. The people on your VC team will most likely be on the M&A team as well. But some on the M&A team might not be on the VC team.

How do you set objectives for the corporate venture organization and how do you measure results?

It could really be talking to the businesses. Ultimately you're going to have buy-in from a business as to why you're doing this deal. You really need to discuss with them.

I think it's really driven by the business. I know every company development is different, but the development person really needs to work hand in hand with the actual business and see how  do we want it to interplay with our company 

It's important to outline at the beginning of the deal, what it is that you want to accomplish. So you can say we wanted a board seat to learn about the new technology. 

And in three years, you can just say, because of this deal and this board seat, we were able to learn X Y and Z. Or you can say our goal of bringing around these investments is we want to acquire learn about three commercially viable companies and acquire them. 

Then you can say three, five years later, like these are the new companies in our portfolio that we were able to acquire because of our venture practice. It becomes a way to measure success outside of just the financial return. 

Can you generalize and describe the transaction structure? 

It's similar to an M&A deal. The first step is obviously deal sourcing and that can come through a variety of ways can come from your business.

  • They know about new technology. 
  • They're in plush with a new company that's coming up.
  • You can also come from bankers. 
  • A company has hired a financial advisor to actually go out and fundraise for a round. And because of your involvement departments, you're able to leverage that and get connections. 

Once there was actually a thesis, you do initial high-level due diligence. You want to understand the

  • Cap table 
  • Governing documents
  • How would you fit in 
  • What rights you might have
  • What are the current lay of the land of the company? 

Once you have a good understanding of that, you move on to either an LOI or a term sheet. 

Very often venture capital deals Don't do a term sheet where you came out the high-level issues negotiate those ahead of times when you go draft the documents, not that controversial, you'll go through the things like they've made deal points: 

  • What are you investing dollar-wise
  • What percentage of a company 
  • What kind of rights they're going to have as an investor? 
  • What are you going to veto right on? 
  • What are you going to have a board seat or like an actual director? You can get a board observer. 
  • If you are very interested in your financial return, what's your liquidation preference? Do you get paid out before other investors or where you sit in the waterfall. 
  • Are you going to have a preferred dividend return? Whereas you might get paid X on your investment before other people.

Lay out those big overarching terms in the LOI or a term sheet, and then what that signed up. You have a deal. Hopefully, they get some exclusivity in there as well. So you know they're not out shopping for other people at the same time. 

When you go into that due diligence that we discussed earlier, the focus is lighter touch due diligence to uncover any problematic areas, anything that needs to be addressed.There's kind of two levels:

  1. This is a red flag. We can't close this deal and post this draft 
  2. Okay they should probably do this differently. Let's just close the deal. And once we're involved, we'll bring our experience as a big corporation and say, you can do this X, Y, and Z better.

You go through the due diligence. Towards the due diligence, sometimes simultaneously, maybe after due diligence, you begin drafting the actual transaction document of your purchase agreement, but then you have to usually revise a lot of their org docs. 

Like any shareholder agreement. That's a certificate of incorporation to incorporate the terms that you had agreed to at the LOI term sheet stage.

These days, a lot of the negotiation of national documents is really been taken out by the NBCA form. The National Venture Capital Association, they have forms that are the agreed-to standard of how these deal docs and venture capital deals will look.

So there's not too much deviation. You just set out the main agreed principles in the term sheet.

You go through that phase of negotiating documents. And then you sign and you fund, then you run with the company, try to achieve those goals you set up the beginning. 

If you're taking a passive stance as the board observer, you're sitting back and learning, or is there a real partnership there?

Are you involved in this company and helping commercialize it? And that's where a lot of the fun starts after it leaves our M&A place. It goes to the business and how they can make the business grow. 

Is there a difference between a letter of intent and a term sheet? 

There is and in terms of at least in my experience the term sheet will really detail what the actual main terms are. 

They'll say these are the specifics,  I guess we can go different ways. You could say high-level in terms sheet, but often we'll say these are the specific detail rights we get.

These are the specific pre-emptive rights. These are the specific provisions that are going to be incorporated in documents with all been really spelled out in the term sheet. 

Other times, an LOI that might be more general or high level.

You still set out like the price and the percentage of your acquirer because you have to have that before you really move forward and make sure there's agreement there. 

Once that you say we'll have standard and typical detailed rights, preemptive rights, and then you work on that later. 

The way I've typically see it is that term sheets are more specific. LOI is not as specific. But they both achieve the goal of formalizing that we have an agreement to do a deal, and then let's go forward and make it happen.

You tend to use convertible notes or straight equity. You'd take a board seat. You use options right of first refusal?

More often than not. What I've dealt with is straight equity investment.Certainly have seen the convertible notes often when I've really seen it. 

Somebody will initially do an equity investment and then the convertible notes or later when more funding is needed to convertible notes are really coming from existing shareholders. 

Options, I haven't really seen that. Sometimes you can acquire a warrant as part of your investment.

There are all different strategies of how you get the deal. I think the main thing that I've seen is trading equity investments. 

So there are so many things you can do. You can do warrants, convertible notes. You can do a face agreement, which is a newer instrument. 

I wouldn't recommend it for a corporate VC, but there are different ways to get involved in these and get, and getting money from these companies.

What's a face agreement?

Essentially, we'll give you this money and you agree to what equity that's going to give you down the road. 

It is a little open-ended.That's why I don't necessarily agree to it for a strategic binding. 

It is a popular route to raise money, especially for really early-stage companies where it's hard to put a value on what the equity worth. 

It's like an alternative to convertible notes. And then are you using options or right of first refusal?

Sometimes the right of first refusal they're often desired by the company by the corporate VC. 

They're often resisted by the startup because the thought that if the investor has the right of first refusal, it could cool interests from other potential buyers because they're not going to approach you if that could be the work of somebody else, can you serve them and jump in the process?

The startups, the target companies often resist those but obviously if a company, a corporate VC can get a right of first refusal and that's great. 

That's one of the great additions, a great thing for venture capital to have, right at first refusal, if somebody wants to buy this company and you've grown with it and you like it now, you got an option to buy it as well.

Can you explain to me the difference between traditional VC deals and corporate venture deals? 

The number one difference is the traditional VC deal is all about the financial return. They're there to make money. Each one has different things. 

They might have a strategic rationale, but their rationale is to deploy capital, get up multiple on their investment, and make money further fund for their investors, for partners.

And whereas corporate deals, there's a lot more strategy and a lot more to it than just getting a multiple on your investment. 

It's much more strategic on traditional venture capital or a highly negotiated thing might be what your multiple is going to be an exit scenario that might not be as important for a corporate deal where they have more strategic goals. 

Traditional VC deals, they might do more deals. I think corporate VC by their nature are a little bit more cautious. Would they make it a little bit safer bet If you will? 

Whereas traditional VC can be a little more aggressive and take more risk in the hope of getting at that high exit. A VC will usually always try to have at least one board seat because they want to have a say in what the company is doing. Whereas a corporate VC might not necessarily take the board seat.

And another difference is the VC often takes a good large chunk of 15, 20%, maybe more corporate VC could get up to that high, but often was very, very low. 

So with a low amount, you might not have a board seat. Whereas the traditional VC usually takes a board seat, which reminds me.

What are the considerations for both types of deals? 

It’s just discussion of pure financial and I shouldn't say just financial because a lot of times VC will also bring expertise to a startup, especially if it's like a niche fee that they only invest in certain types of companies. But at the end of the day, they're really concerned with their exit. 

Corporate considerations are a lot different. It's all the strategic rationale, how it can help your business.

I haven't touched on this so far, but I kept talking about why you might get involved in what these companies can do for you as corporate venture capital. But you also, a big company also offers a lot to these venture companies,

One, it gives them credibility. Look, we have a fortune 500 company that has invested in ust. They believe in us. 

They lend credibility with customers, potential other fundraising. There's a lot of benefit for them there. 

With their fortune 500 company, you have people that are experts in their fields and they know how to drive this business.How to grow a business. 

And you can bring some of your own expertise to the startup company. Who's just maybe making their way in the world. 

You guys probably have great ideas, but they combine your business expertise with great innovation. There's really a two-way street benefit in the relationship.

What are some of the challenges of doing a VC deal with startups?

I'd say one of the biggest challenges is the nature of a startup company versus the large big public fortune 500 is they can be unsophisticated.

  • They might be in full-out growth mode that they're just churning and burning
  • They're not really paying attention to some of the corporate formalities the lawyers might obsess over
  • They might not have checked their cap table
  • They might have given away things in their documents that they just didn't care about or think about

One reason that due diligence is so important. You need to dig in and make sure everything's on the up and up. And if it's not, figure out a way to solve it. 

There can be some complications with unsophisticated people there. I've also seen that they might be brilliant engineers or would have brilliant ideas, but they're not M&A people.

They don't know how to do a venture deals that these terms and things that are being negotiated. They might not understand them, so it can be a challenge there.

And also with different cultures, startup culture can be very different than a big company, especially where you're trying to do a partnership. And work together and maybe even embed in each other. 

There can be a clashing of cultures. That's something to consider. And then often a startup smaller company might only be a couple of people, a couple of employees at this point. 

They may not have the resources to fully devote their attention to your venture capital deal.

Whereas the corporate VC, you have a deal team. You have that small team I talked about whose job is to do this deal. 

Well, the startup, their job is to grow their business and go out and win customers and develop their technology sometimes to take them away from that and to try to negotiate a deal and to have an answer to your due diligence questions in a timely manner, that can be a challenge.

You need to balance out, getting the deal done in a quick and effective manner with the right amount of diligence, but not overwhelming your guy, taking them off the business plan and you inadvertently interrupted business for four or five months and set it back a year or two. You'll need to get a real balance there.

On the other side, is it going to limit my exit opportunities down the road that maybe one of your competitors would be put off by the fact that you're an investor?

One thing is on the traditional VC side. They're a little bit more aggressive. They might be willing to get in bed with an earlier company earlier in the process than a corporate. 

They might provide access to capital. At a certain stage of your company that you're not going to get from a corporate yet, you might not be at that stage.

They might be willing to give you more money and they might have had a history of you do that initial investment when you need more money, like year or two down the line.

They have a demonstrated history of putting in the additional capital and really knowing and having commitment to startups in the VC because they're driving for that exit in a few years.

Whereas maybe a corporate, they might do their initial investment. And if you go south, they're going to walk away. That's something that needs to be evaluated on a case-by-case basis. 

But while I think there's a great advantage for a corporate partner, there are clearly scenarios where a regular traditional VC is the right avenue for a company pursuing partnering.

How do you value these early-stage companies? 

It all comes down to forecast what their sales cas is. They need to demonstrate to you what they think their company's worth and why they're going to do it? Why are they going to hit these numbers, how are sales going to grow. 

Pretty much every one of them says sales are going to grow exponentially. They need to demonstrate why that is the case. 

You need to look at their burn, the burn rate, and figure out where you think, where you take, what they've given you in their forecast and kind of run in reality, and your own experience in what your financial team thinks.

And that's really a place where to have good financial diligence. Good financial team. A good development team to really crunch those numbers, something they don't always trust the lawyers with. 

We were promised no math, but if you're involved in this world though, as a lawyer, like you fully need to be aware of all that and how to handle all that, but having a good financial team to crunch those numbers.

What is your internal deal approval process? Is there an executive committee task to review and approve these?

It depends on sometimes there's investment thresholds, like an investment under X dollars. The head of the venture group can do it for over X dollars. It needs to go off the chain probably all the way up to the CEO. 

It's really case-by-case different companies, different approaches do it differently.  Typically we'll probably run-up to an executive, a high up executive, but sometimes if a well developed venture group will have authority to just do deals on X dollar.

What is your view on the employee option pool? How hard do you push for a high percentage before you make your investment? 

If it's just a straightforward cap table without employee options, it's much easier to deal with. than if you've given away a large percentage of the company already, or reserved a large percentage of equity for options.

That said dealing with options is pretty standard when you're looking at startups because that's often how they improvise and retain talent when they don't have the cash.

So,  it's obviously easier if it's not there but it's something you just have to learn to figure out how you're gonna do it.

How do you go about ROI and IRR calculations, factoring revenue from partnerships? 

You make a forecast on the information you have and what you think that you're going to be able to bring to the partnership and where you set goals, almost like any M&A deal.

You say your IRR based on your forecast and what you think this company can do. And you try to ground that in reality. 

You have different business cases and doing it with a startup is no different. That might be a little wider delta on the different cases and it might be more of an educated guess than anything without a strong track record, but that is something that you need to do when you're deciding your investments.

There are different strategic reasons but at the end of the day, there is a certain IRR that you're aiming for. And if it's not there, there better be a day in good strategic rationale to do it without achieving a certain IRR. 

Do you tend to couple the equity investment with a commercial agreement or other strategic collaboration, day distribution agreement, or joint development? 

I can bring it down a percentage of deals that do that or don't but that is a very often component and presence. And a corporate venture deal often there'll be a commercial synergy that real commercial reason to do this deal. 

A distribution agreement, buy agreement, some kind of commercial arrangement will also be part of the deal. 

So aside from the street M&A venture investment transaction at the same time, you'll also be negotiating a commercial agreement. That is very common. 

Does the investment go directly into the operation?

Typically, yes. It's one of the things you've set up is the use of proceeds. And one thing you don't want them to do is to take your proceeds and dividend them out to themselves right away. 

You often want to set the parameters of this is our investment, and it's going to be used for X, Y, and Z in future growth, corporate purposes.

Or you might even include veto rights on what they can do with dividends and things like that. But it should generally go into helping the operation and hoping to grow. 

How does the exit strategy match our acquisition strategy? 

It's a case-by-case scenario. Are they looking to do an exit in five to seven years often they are. And then they way to weigh in on what they're willing to give away as far as preferred dividend, things like that. 

But like I said, often, that's not as much of a concern to a corporate VC. It's hard to give a straight answer to it because it depends deal to deal on which one of these parties’ goals are. 

What's the craziest thing you've seen in M&A? 

I mean honestly, I think the craziest thing, and everybody as M&A professionals can relate to it, but the craziest thing in M&A is the hours. 

Especially being formerly on the wall from outside counsel. They're really married to the job and I've seen people working around the clock, missing kids’ graduation never really fully on vacation you’re always checking your phone and things like that.

And probably not we're looking forward to the craziest thing by the hours that M&A professional needs to dedicate to the craft. It can get pretty crazy. 

But at the same time, it's fun. That's why we do it. It's a highly rewarding field to be in when the deal comes together when it is finalized. Especially in the last couple of days and we'll rush to get it all dotted. It's a really fun industry to be in. 

The lawyers really do that? They really tense up. They feel like they're always laid back. Half the battle is getting the different law firms to talk to each other. 

They tense up. Their work part of the deal is you'd come off as cool, common collective, right? They put in amazing hours and not on the in-house counsel. I can really appreciate what some of the outside people go through and try to respect their time. At the end of day, the outside of the client service business. So you're always at the demand of your clients. I've seen some pretty extraordinary things, responding to those clients.

I know one of the other side projects you're working on is doing an Academy course with us. The goal is you're going to teach deal terms in an upcoming course. 

I wanted something like that when I started my career. Law school doesn't teach you how to do M&A deals. It's just something you learn by getting thrown into the fire, making mistakes, learning from your mistakes. 

I wish there was something like this back when I started. We were talking about deal terms that he believes at least the first one may be more, but I'm talking about typically indemnification terms, the areas that get negotiated with the buy-side one, qualified one, go through the category of those, and hopefully, it'll be informative and we can get something out of it. 

Ending Credits

Thank you for taking the time to explore the world of M&A with our podcast, please subscribe for more content conversations with industry leaders. If you like our podcast, please support us by leaving a five-star review and sharing it. I enjoy hearing feedback and connecting with our listeners. You can reach me by my email.

It's kison@dealroom.net. M&A science is sponsored by Deal Room, a project management solution for mergers and acquisitions. Additional educational content is available on Deal Room's, blog at dealroom.net/blog. Thank you again for listening to M&A science. See you next time.

Views and opinions expressed on M&A science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.

Show Full Transcript
Collapse Transcript
Join our M&A community
Get weekly updates about our upcoming podcasts, webinars and events!
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.