Venturing forwards: CVC and strategic minority investments in 2023 and 2024

Challenges to the VC market and opportunities for CVC investors

The high interest rates and increased inflation across the globe in 2023 have broadly reduced the risk appetites of venture capital firms and their investors. A cautious temperament has led to slower deal-making as VC funds rely on expanded due diligence with a focus on clear routes to profit-generation.¹  With global fundraising at its lowest level since 2015, prior to releasing their dry powder, VC investors are taking time to observe how existing investments perform.²³   This cautious approach has created an opportunity for CVC investors, as investee companies have had to cast a wider net for sources of funding and to familiarise themselves and get comfortable with CVC requirements with regards to additional regulatory compliance requirements and the investment terms required to satisfy corporate investment committees and regulatory teams. 

During 2023, the global value for exits (M&A and IPOs) in the VC market declined year-on-year. The decrease of exit opportunities has particularly impacted VC investor sentiment towards late-stage investments, which experienced a global decline.⁴ The late-2023 listings of Arm (a UK chip designer), Instacart (a grocery delivery company) and Klaviyo (a marketing automation platform) have not resulted in a recovery of the IPO market.  Seed and early-stage investment activity remained consistent year-on-year.⁵ Given the capital and strategic expertise offered by CVC investors, these market conditions have created a further opportunity for investors to secure investments on favourable terms and with reduced valuations. As CVC investors often value strategic as well as financial, returns, they are often more resilient to shorter-term fluctuations in exit viability, and, instead, invest with a longer-term time horizon.

The increasing cost of venture debt has impacted private and public valuations of unprofitable start-ups, which are often valued based on future cash flows. The combination of falling valuations and a liquidity crunch has enabled CVC investors to capitalise on: (i) insider-led rounds featuring investor-friendly terms and (ii) bridge financing structures (i.e. convertible promissory notes and SAFEs) that offer CVC investors a discounted rate on equity conversion.⁶⁷While down rounds and flat rounds have increased in prevalence, these have secondary benefits in enabling investment by new CVC investors at lower prices, and forcing start-ups to increase their operational efficiencies and cut burn rates for the short- and long-term. We note that a decline in start-up valuation is not necessarily indicative of a decline in the quality of a target company’s business operations, but is a result of investment market sentiment.  CVC investors have leveraged this opportunity to obtain ownership stakes in investees whose valuations have been reduced by market sentiment while their fundamental business remains strong.

Indeed, it is now common to see not just one, but a number of CVC investors on the cap table of growth equity and start-up ventures, particularly as CVC investors seek out co-investment opportunities with each other to increase efficiencies.  

CVC market developments and increasing efficiencies

The CVC ecosystem continued to evolve through 2023 and a number of new entrants appeared in the investment pool. One of the key trends was that the CVC market saw a number of investment arms established by large corporate entities. Such new entrants included venture arms formed by inDrive⁹ (the ride-hailing services company), ADP¹⁰  (the human resources management software and services company), Generali¹¹  (the Italian global insurer) and Posco Group¹² (the South Korean steel manufacturer). The range of sectors represented by these market entrants serves as a testament to the diversity and depth of opportunity in the sector, with each market entrant having their own strategic goals. 

The CVC ecosystem has responded to the arrival of new entrants and work has been done to accommodate heightened regulatory, compliance and investment committee criteria to which such new investors may be subject and the accommodation of such requirements in standard form documents. Similarly, the increasing use of side letters to fulfil regulatory requirements without reopening the main constitutional documents has allowed for fast transaction timelines. As such new entrants in the investment pool are increasingly able to compete as agile partners in the venture world. 

There have also been a number of improvements to deal frameworks and processes that have enabled deals to close on more efficient timelines. This efficiency gain in deal-making is owed to both: (i) the professionalisation of CVC units staffed by investors experienced in both the VC and M&A markets; (ii) the increasing familiarity with typical investment documentation structures and key terms; and (iii) the increasing familiarity of investees and co-investors with typical CVC investment approaches and any additional regulatory and compliance requirements.

Further supporting the trend towards increasing transactional efficiency in the VC market, in February 2023, the British Venture Capital Association (BVCA) published updated model documents, including articles of association, subscription agreement and shareholders’ agreement.¹³ In October 2023, the US National Venture Capital Association (NVCA) also published new industry standard model forms, including the stock purchase agreement, certificate of incorporation, investors’ rights agreement, voting agreement, and right of first refusal and co-sale agreement.¹⁴ While a number of terms in such model documents continue to be negotiated on a transaction-by-transaction basis, they have been seen by the market as a welcome update to align the documents with recent market practice. 

Another CVC trend that continued without abatement in 2023 was the “pairing” of investment with a commercial arrangement to utilise the products and services offered by the investee company in the CVC investor’s own broader business. While the combination of investment and commercial partnership brings its own potential challenges, for example with regards to conflicts policies, there are mutual benefits for CVC investor and investee and it helps to further signify the CVC investor’s commitment and engagement in the investee company’s future. This trend is likely to continue into 2024.

Key growth sectors: AI and cleantech

AI dominated VC activity during 2023, with start-up companies developing new AI technology and applying AI to a wide range of industries, including financial services, insurance, HR and legal services. AI-driven deals include Microsoft’s USD 10 billion investment into OpenAI, Amazon’s USD 4 billion investment into Anthropic¹⁵¹⁶  and Citigroup’s venture arm’s participation in a Series C funding round for Virtualitics, an AI platform which helps users explore complex financial services derived datasets and identify intelligent data insights therein.¹⁷ Accenture also made a strategic investment into generative AI as part of Writer’s Series B funding round. Accenture has been using Writer to produce and synthesize content since 2021, and its recent investment is aimed at further leveraging the platform’s capabilities and enhancing its client offering.¹⁸

In 2023, the Russia-Ukraine conflict, the resulting global energy crisis, speculation on future energy demands of the AI industry and a general focus on climate change and the energy transition, also prompted further interest in start-ups in decarbonisation, and the sustainability space. For example, the battery recycling start-up, Redwood Materials, raised USD 1 billion, securing funding from Microsoft’s climate investment arm.¹⁹  VC-backed deals in the nuclear fusion vertical have also accelerated with a record number of fusion startups raising funding rounds in 2023. CVC investors are uniquely placed to help accelerate the success of fusion start-ups by helping source required equipment and helping to overcome engineering challenges. Simultaneously, the CVC investors also benefit from exposure to a disruptive technology and insights which help inform their future role in the sector.²⁰  For example, TDK Ventures (the venture arm of TDK Corporation) invested in Type One Energy during 2023, with the strategic drivers being: (i) alignment between TDK and Type One vis-à-vis transformative energy goals; and (ii) Type One’s use of magnetic components and power electronics, similar to those manufactured by TDK Corporation, in their Stellarator technology.²¹

Forecasting ahead: 2024 and beyond

Looking ahead to 2024, there are positive indications that inflation may decline, and interest rates may be cut. Combined with signs of market stabilisation, this may contribute to a recovery in start-up valuations and increased general market activity, in which we believe CVC investors will play an increasingly important role. 

A final trend that may gain traction in a low-liquidity environment is that of VC continuation funds, such as those set up by New Enterprise Associates and Insight Partners. These funds are secondary investment vehicles that allow VC funds to sell assets (including equity shareholdings) to a new fund, also under their control.²² This allows VC funds to return capital to their existing investors, and reset the clock on providing returns on the transferred assets to any new, or rolling investors. CVC investors may benefit from such continuation funds, as the funds will help avoid circumstances where VC funds are forced to pursue less attractive exits in investee companies due to a lack of short-term ROI, thereby improving valuations and allowing the investee to adopt a longer-term approach to operations, strategy and profit-generation.

While 2023 represented a challenging year for the VC market as a whole, it has presented a number of strategic opportunities which CVC investors are uniquely positioned to capitalise on. The evolution in the CVC ecosystem and the increasing efficiencies in the investment process also mean that CVC deal-making is more agile than ever, as exemplified by the continued prominence of corporate investment across sectors, making CVC’s well placed to compete in an anticipated upturn in the market.