June 23, 2009
By Laurence Cruz
Corporations are continuing to cut back their seed money for startups this year way back. But not Cisco Systems.
The number of deals involving corporate venture capital direct investments in startups by corporations is on pace to hit its lowest point in 12 years, according to the National Venture Capital Association.
But Cisco is holding steady in its investments despite the roiling economy. Buoyed by more than $30 billion in cash reserves and helmed by a team that has weathered stormy waters before, the networking giant continues to be an active investor, company executives say.
In January alone, Cisco invested in Xobni, a San Francisco-based startup that makes sorting tools for Microsoft's Outlook e-mail program; and in Digitalsmiths, a North Carolina-based pioneer in video indexing, analysis and publishing. The deals are a small part of Cisco's total cash investment, whether direct or via third-party venture capital firms, of about $1.3 billion, company executives say.
"We're very much looking for companies that have an opportunity to be disruptive to existing markets and create transitions that we can capitalize on," says Cisco's Charles Carmel, vice president, corporate development. "And we're fortunate enough to be able to maintain a consistent approach in our venture capital activity, whether the economy is strong or weak."
Types of Investments
Like Cisco's legendary acquisitions engine, the company's venture capital efforts fall under the umbrella of corporate development and are guided by an overarching mandate: to help drive Cisco's growth strategy.
To that end, Carmel says, Cisco's corporate venture capital investments fall into three broad categories. Some help the company learn about new markets. Cisco's stake in Digitalsmiths, for example, is providing key insights into the fledgling market of video search tools and analytics.
Other investments help Cisco influence the direction of new and potentially disruptive technologies for which it may later become a customer, Carmel says. Case in point: The company invested in BroadLogic, which in recent years has rolled out breakthrough video processor technologies to help boost cable operators' network capacity.
And still other investments are designed to solidify Cisco's existing partnerships, Carmel says. He points to Cisco's investment in virtualization software leader VMWare, which is intended to boost collaboration between the companies, thus speeding the adoption of VMWare's virtualization products with Cisco's networking infrastructure.
Greg Foster, a general partner at Noro-Moseley Partners and chairman of the National Venture Capital Association's corporate venture group, says a major benefit of such direct investments is the "eyes and ears" perspective it provides the investor. "It opens a window into the external world, which may or may not be disrupting your core business," he says.
A Global Approach
About half of Cisco's $1.3 billion venture capital investment is in international markets, where the company's strategy is a little different from its stateside approach, says Hilton Romanski, vice president in charge of Cisco's investments and acquisitions in the four major hubs of London, Shanghai, Israel and Bangalore, India.
In international markets, Romanski says Cisco initially favors indirect investment through locally based venture capital funds. Once it has learned more about a given market, the company may then move to direct investments and finally acquisitions, he says.
"We're fortunate enough to be able to maintain a consistent approach in our venture capital activity, whether the economy is strong or weak."
Cisco took an active interest in the Israeli market about a decade ago because of the country's innovations in communications, VoIP, and core routing and switching, among other technologies. Initially, Cisco partnered with three local venture capital firms, then moved on to direct investments and made nearly 10 acquisitions, Romanski says.
"Israel has been more active by volume than any other market except the United States," he says, adding that Cisco is in various stages of this same cycle in Central and Eastern Europe, India and China.
In seeking potential corporate venture capital opportunities, Carmel says Cisco looks for a rare combination of factors, from the quality of a startup's management team to the nature of the market it's targeting and the viability of its strategy.
Another key consideration: Will a deal provide both strategic and financial returns? While many corporations focus more on strategic than financial returns, Cisco considers both essential, Carmel says. After all, without financial health, a promising startup could vanish, along with any potential strategic benefit it may have held, he says.
Initial public offering activity is at a standstill in the current economy, but in 2008 Cisco's head of corporate development, Ned Hooper, racked up two big exits chip startup PA Semiconductor, which was acquired by Apple for $278 million; and address book manager Plaxo, which was bought by Comcast for $175 million. The sales earned Hooper the No. 63 spot on Forbes' Midas List this year.
Cisco's Venture Capital Roots
Cisco's relationship with venture capital dates back to the company's infancy. After landing its first venture capital investment of $2.5 million from Sequoia Capital in 1987, the then three-year-old company shot from scrappy startup to networking colossus at warp speed. In exchange for their $2.5 million, Sequoia and Valentine received a 32 percent stake in Cisco, which was worth about $225 million when it went public in 1990.
In the mid-1990s, Cisco fired up its own prolific venture capital engine, which has hummed along ever since, riding the venture capital boom of the late 1990s and weathering the last economic downturn in 2001-2003. Those years of experience and the track record of savvy investments that came with it have earned the company a sterling reputation in the venture capital community.
"The venture capital team at Cisco has great insights and knowledge of the entire ecosystem," says the venture capital association's Foster. "There's also a general belief that Cisco is a fair player, which allows it to be very active across the ecosystem. People welcome them in."
Foster says Cisco's approach to the corporate venture capital market is "somewhat typical," especially among technology companies or companies whose core business is tightly linked to technology.
What's not at all typical, he says, is Cisco's exceptionally healthy balance sheet and the ability it gives the company to continue its venture capital and other corporate development efforts through an economic downturn, with only a slight dip in its portfolio. For companies with less capital, that dip tends to look more like a "V" and goes deeper, sooner, he says.
"Any company with a healthy balance sheet that enables them to be very active in a down market has a huge advantage," Foster says.
Furthermore, he says, it's a great time for corporations to start thinking about venture capital investing. Startup valuations are in the low range, and many startups are seeking not just funding, but also strategic partnerships something that strategic investors are well positioned to provide, he says.
And what does the future hold in this time of economic uncertainty?
Foster says he believes the corporate venture capital market has already bottomed out and will level off for the rest of 2009. In 2010, he predicts it will return to a level of activity close to that of 2008, when about 750, or one in five, venture capital deals involved a corporate venture capital component. And after that, he says he expects it to continue the upward trend that began in 2003. (See Chart)
"This downturn is not a death knell by any means," Foster says. "And with Cisco's ability to continue to invest through it, they will come out the other end of it with several good deals they wouldn't otherwise have gotten."
Laurence Cruz is a freelance writer in Los Angeles.