The Wrong Move?

As corporations shut their venture capital arms, they may do themselves damage

Sure, you can blame Comdisco Inc.'s (CDO ) dizzying spiral into bankruptcy on a multitude of management faux pas. But the last straw was the red ink flowing from the company's investment arm, Comdisco Ventures. The unit, which halted its investments in January, lost $149 million in the first half of this year, largely because of stakes in struggling tech startups. Says Morningstar Inc. analyst Terrence K. MacKay: "They were trying to grab hold of the tech gold rush, and it bit them."

More like swallowed them whole. And Comdisco, which filed for Chapter 11 in July, isn't the only company sporting teeth marks on its venture unit. Thanks to the tech downturn, a near-shutdown of the initial public offering market, and now increased economic worries because of the terrorist attacks, scores of corporations that set up venture-capital arms are slamming the brakes on investments. KPMG Consulting folded its venture unit after the firm went public this year. Internet consultant Scient Corp. (SCNT ) shut down its venture arm and wrote off all its investments in December.

And many more have done the same, says Darrell Rigby, a director at management consultancy Bain & Co. He says a survey of 245 execs with venture funds found that 45% had abandoned those efforts this year. "These are silent shutterings rather than loud proclamations," Rigby says.


  Corporate cash may be disappearing with a whisper, but its impact is loud and clear. Granted, overall venture-capital investment is down: It dropped 63% in the first half of this year from the same period in 2000. But investments by corporate venture units in the first half of 2001 plummeted 91% from last year's levels, according to a PricewaterhouseCoopers study. Last year, corporate venture funding totaled $6 billion. This year "we're getting close to the vanishing point," says Kirk Walden, director of venture capital research at PWC.

That's tough news for both startups and corporations with venture funds. The pullout of corporate cash will make it that much harder for new businesses to get off the ground. But it also can hurt the funders themselves: Many corporate venture-capital units act as adjuncts to companies' research and development departments, helping fill the pipeline of new technology.

"We really look to these tech startups to bring us ideas," says Warren Holtsberg, director of venture investing at Motorola Inc. (MOT ) Last year, Motorola pumped $3.5 million into Centerpost Corp. to get its hands on the Chicago startup's messaging technology. This year, Holtsberg expects to do 40% fewer deals--a potential blow to innovation.


  While corporations have been willing to forgo this source of ideas in past tech downturns, the stakes may be higher this time. Given the current pace of technological evolution, "you can get left behind a lot faster now," says Tim Rohner, a partner at Chicago consultancy DiamondCluster International Inc. who advises companies seeking to set up venture units. Even if it means skimping elsewhere, he says, corporate VCs should try harder to keep their funds active in this downturn than they have in the past.

That's advice Chevron Corp. (CHV ) is heeding. After investing $60 million in 2000, Chevron Technology Ventures is having a tougher time unearthing deals for the $100 million it has earmarked this year. "Finding new technology to help the business is too important to give up on," says Don C. Riley, chief of the unit. So far this year, he has invested in two startups with technology that Chevron can use. That's off the pace he had hoped for, but he says Chevron will keep looking.

As the tempo slows, those still in the dance can be more choosy about their partners. So much money was flying around tech startups over the past two years that investors felt pressured to act fast and skimp on due diligence, says Julian A. Brodsky, vice-chairman of cable TV operator Comcast Corp. "Now, you have time to do the job right," says Brodsky. So far this year, Comcast (CMCSK ) has made just two investments. Although he won't discuss details of either one, Brodsky says both should pay off better than anything he got last year. "The pace is slower, but the quality of the deals is higher," he says.

Many more companies have closed the spigot on VC investing without completely shutting down their venture units. Autodesk Inc. (ADSK ), a software maker based in San Rafael, Calif., has made no new investments in 2001, saying it just wants to focus on managing its current portfolio. Same goes for the venture arms of software maker Vignette (VIGN ), wireless upstart Aether Systems, and TV giant NBC, although they declined to discuss their reasons.


  Few corporate funds have fared worse than Comdisco's. The market value of Comdisco Ventures' public holdings plunged from $683 million on Sept. 30, 2000, to $5 million on June 30, 2001. Among Comdisco's losing Internet bets: furniture e-tailer, which filed for bankruptcy last August; the now-defunct real estate site; and hardware e-store Comdisco CEO Norman Blake acknowledges that the venture unit suffered from a lack of discipline.

"Some basic questions about each investment should have been asked but weren't," Blake says. That hit the bottom line: Comdisco Ventures contributed $110 million in profits in the quarter ended Dec. 31, 2000. By March, that had turned into a $30 million black hole.

The slowdown in funding is sure to hobble cash-starved startups. But if their erstwhile corporate patrons choke off an important source of innovation, they may suffer as well.

By Darnell Little

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