Google's New Role: Venture Capitalist

The tech giant's startup investments are narrowing opportunities for VCs. Other corporations are upping their venture investing, too

Just as it has done to companies in the software, publishing, and advertising industries, Google is becoming a thorn in the side of venture capitalists. The owner of the world's largest Web search engine is scooping up young tech outfits for a relative pittance, giving itself first dibs on hot-growth technologies and in some cases boxing VC funds out of potential big-bang acquisitions and initial public offerings.

Google (GOOG) has begun making VC-style investments to the tune of about $500,000 or less in promising startups, often buying those companies afterward, according to partners at Silicon Valley VC firms who spoke on condition of anonymity. In an effort to keep spotting promising deals, Google has been hiring a stable of finance pros. And it has invested more than $1 million in a Mumbai-based investment firm called Seedfund to gain access to technology such as automatic translation software that could help spur growth in India.

"Google has easy money," says Pravin Gandhi, a managing partner at Seedfund, which also has raised some of its $15 million from Motorola (MOT) and VC firm Mayfield Fund. So far, Seedfund has taken $500,000 to $750,000 stakes in four companies, including an online news site. On the horizon could be investments that help Google add specialized channels, such as information about autos, to its Web site or cultivate technology that can translate Web content from English into Indian languages, Gandhi says. "It's a somewhat less risky way to participate in the Indian growth story," he says.

Beating VCs to the Punch

By staking startups, Google hopes to avoid paying the higher prices companies can fetch once they take funding from traditional VCs. It's possible that some of its investments are conditioned on Google having first-acquisition rights should a target opt to sell, some VCs speculate. Google didn't respond to calls requesting comment. Making investments in startups also can help Google use more of its $4.5 billion in cash to cultivate tools that complement existing products. Google recently started a program called Gadget Ventures to fund entrepreneurs who build online tools using Google's technology.

The zeal for dealmaking at Googleplex mirrors an increase in corporate venture investing to its highest level in years. "They're back, like the swallows returning to Capistrano," says Paul Maeder, a managing general partner at Highland Capital Partners. "We're in a wave now where corporate venturing is increasing again."

Companies that aren't full-time investors pumped $1.3 billion into 390 venture capital deals in the first half of 2007, up 30% from the $1 billion invested in about 350 deals a year earlier, according to an Aug. 30 report by PricewaterhouseCoopers and the National Venture Capital Assn. (NVCA), based on data from Thompson Financial (TOC). That's the most invested since 2001, just before the bottom fell out of the tech industry. The big spenders include Intel (INTC), which invested $112 million in U.S. startups in the first half of 2007, vs. $79 million a year earlier, and Motorola, which invested nearly $30 million in the first half of the year and says its overall 2007 investments should top the record set in 2006.

VCs Seek Alternative Sources

The incursions don't sit well with many VCs. Combined with the predilection on the part of many entrepreneurs to fund their own ventures, investments by Google and other corporations leave even fewer opportunities for VCs to take big, early stakes. That's especially problematic when venture firms have raised record amounts of cash and need to find places to invest it (see, 2/5/07, "Venture Capital's Growing Aspirations").

"There are a lot of entrepreneurs who aren't making the trip to Sand Hill Road," says Ray Rothrock, managing general partner at Venrock Associates, referring to the Menlo Park (Calif.) thoroughfare that is home to many venture capital firms. "They're going elsewhere." Venrock, which funds Web startups including women's blogging site BlogHer and search engine ZoomInfo, is considering launching a startup incubator as a way to counter corporations' ability to buy the same companies it wants to fund.

A partner at another large VC firm says a tendency by corporate venture arms to buy startups not long after investing in them is "very inconsistent with the venture community's strategy" of providing guidance and making several rounds of investments over the long haul.

Widespread Corporate Stakes

Among the reasons for the corporate-investing comeback: an upswing in research-and-development spending after the tech-stock crash; the need to spot promising startups in China, India, and Russia; and increased shareholder willingness to tolerate the quarterly vicissitudes of venture investing in order to create long-term value. Venture investments by pharmaceutical companies to fill their drug-development pipelines also helped boost the first-half numbers, according to the NVCA—Novartis (NVS) and Johnson & Johnson (JNJ) were among the biggest U.S. investors.

In the tech sector, Intel Capital invested $236 million worldwide through the first half, 62% of that overseas. Among its winning investments was a $218.5 million stake in virtualization software company VMware (VMW), now worth triple that amount after VMware's blockbuster Aug. 14 IPO (see, 8/14/07, "VMware Shrugs Off Shaky Markets"). In 2006, Intel took a $600 million stake in Craig McCaw's Clearwire (CLWR), which is building a long-range WiMAX network.

Intel has restructured its fund to emphasize financial returns and is investing in follow-up rounds in its portfolio companies—something it didn't do before. "There's no strategic value unless each individual investment is successful," says Intel Capital President Arvind Sodhani. "A bankrupt company is not very strategically valuable to Intel—or to anybody for that matter."

Nothing Ventured, Nothing Gained

Cisco Systems (CSCO), too, is parking more venture money in emerging markets. In 2005 the maker of computer-networking gear earmarked $100 million for investment in Indian startups, and since December, 2006, it has opened funds to invest in China and Russia. Closer to home, Cisco took a $150 million stake in VMware. The company averages 15 to 20 investments a year, a spokesman says.

In the wireless sector, Motorola Ventures invests about $100 million a year worldwide. Key 2007 deals include Vocel, which makes software for marketing ringtones and mobile applications, and VidSys, which provides video-surveillance technology to the military. And cell-phone chipmaker Qualcomm (QCOM) has been investing in startups that provide TV and payment services for mobile phones (see, 1/18/07, "Qualcomm's Crystal Ball").

Even Yahoo! (YHOO) is turning its attention to nurturing startups—both inside and outside its walls. The company has set up an in-house incubator called Brickhouse in downtown San Francisco, and in May, Yahoo hired noted dealmaker Blake Jorgensen as its chief financial officer, signaling an increased willingness to make acquisitions (see, 2/9/07, "Yahoo Taps Its Inner Startup").

Returning to the Fray

Corporate venturing can be risky. Amid the tech market crash, longtime investors such as Intel booked big investment losses, and some companies, including Dell (DELL) and Boeing (BA), exited the venture business entirely. "They got burned after the bubble, probably even more than the traditional VCs," says Mark Heesen, president of the NVCA. Other companies, such as Microsoft (MSFT), IBM (IBM), and Hewlett-Packard (HPQ), scaled way back. Microsoft and HP still make selective startup investments, though not through formal programs. IBM has stopped taking equity stakes entirely, though it works with VCs to strike technology deals with young companies that can help it generate revenue or spot acquisition targets, says Claudia Fan Munce, managing director of IBM's venture capital group.

Now the question is whether corporate investors and VCs can shepherd their investments to acquisitions or IPOs after a summer in which stock and credit markets took a beating (see BusinessWeek, 8/27/07, "Tech Stock Oasis: Can It Last?"). "Tech has been down for so long," says the NVCA's Heesen. "Now people are saying: 'Everything else is so bad, maybe tech is a good place to be.'"

Google and other corporate venture investors are betting that's true—and they're treading on VCs' turf to make sure they claim some prime acreage.

Check out the slide show to learn more about technology companies' venture investments.

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