Investment at the core: the evolving centrality of captive funds

The consumer sector looks set for a flurry of investment and acquisition activity. As we move into the next phase of Covid-19, large businesses across the consumer sectors will re-evaluate their portfolios, and begin tailoring their brands and subsidiaries for the new normal – acquiring businesses and technologies that help them cater to newly-emerging consumer trends. At the same time, smaller businesses and startups hard-hit by the economic impact and uncertainty of Covid-19 will be increasingly open to the financial security of corporate multinational investment.

As part of this movement, it is interesting to examine the role that captive funds – a business’ internal fund – have to play. Indeed, in the last decade we have seen captive funds evolve from a ‘nice to have’ to a core vehicle. Where once businesses used captives to invest in adjacencies and potentially make a good return, now they are used to ensure sustainable long-term growth and accelerate transformation. These days, an effective captive fund sits at the centre of an organisation, utilised to acquire technology, IP and even human capital for the main part of the business.

This isn’t to say that internal R&D departments are a thing of the past – just that they occupy a different position in corporate life. A business’ R&D activities are often focused on the development of incremental technologies that prolong the life of existing business models and revenue streams. While this is positive in the short to medium term, the inward-looking nature of R&D can result in organisations failing to adopt a long-term, industry-wide outlook that is set up to truly disrupt the market – or to bring in new ideas, approaches or skills. Especially in the current climate, with the consumer-facing sector experiencing an overhaul and customer behaviour changing fast, it’s vital that businesses think holistically and creatively about their position in the sector.

“Especially in the current climate, with the consumer-facing sector experiencing an overhaul and customer behaviour changing fast, it’s vital that businesses think holistically and creatively about their position in the sector.”

In order to address future long-term challenges, then, more and more businesses are establishing – and optimising the use of – captive funds.

This strategy has a number of benefits. Perhaps most predominantly, utilising a captive fund to acquire or invest in technology businesses allows established organisations to immediately be at the forefront of digital innovation and burgeoning consumer trends, acquiring ready-made technology and bypassing years of internal development. This can take the form of a sideline venture, or by integrating the tools and IP of the newly-acquired organisation into the core of the business.

Here, R&D departments and captive funds can work side by side, informing and enhancing the other’s operations in a number of different ways. On the one hand, captive funds can bring in a startup which accelerates the work of an R&D department and becomes part of the business’ overall proposition. On the other, new ideas, tools or visions can be introduced to a business via a captive fund, adding an element of competition between the two entities and driving innovation.

Captive funds also allow for product differentiation and for businesses to reach new target demographics. A prime example is beer giant AB Inbev’s captive fund, ZX Ventures, which has invested in everything from canned wine to wellness products. Or indeed, the largest tobacco business in the world, Philip Morris International, and their aggressive captive investment into new adjacencies such as IOT with Bow Group and bio-chemical agriculture with CometBio. With consumer habits changing rapidly, businesses may want to diversify their customer base, enter new categories or expand their portfolio of brands. Using a captive fund may be a good way to do this.

Captive fund activity can also be integrated into a corporate’s talent strategy. Alongside establishing training programmes and hiring the best graduates, acquiring startups gives businesses access to best-in-class founder talent.

If appropriately championed within a business, and sufficiently supported, captive funds can introduce new revenue streams, help companies to achieve long-term sustainable growth and pivot towards the new normal. In the consumer-facing sector, FMCG and telco are leading the way: Unilever Ventures scales promising companies and gives them access to its network of assets; Distill Ventures provides support for drinks startups in emerging markets, such as the non-alcoholic spirits brand Seedlip; and in telco, Samsung Ventures’ $2bn fund is aimed at driving innovation in AI.

Conversations with senior leaders in this space have brought to light the complexity of captive funds in the consumer-facing sector. For example, there is no set precedent for how captive funds work, nor who should be leading them. Right across the sector, from fintech to FMCG, funds operate in different ways, providing different measures of value.

“As captives increasingly gravitate towards the business’ core strategy, navigating the talent challenges will be key.”

From a talent perspective, we are also seeing a number of different types of profile occupying leadership roles at captive funds. Firstly, some come up through the company, providing a deep understanding of the business, the sector and its context. These leaders are well-equipped to guide captive fund activity and ensure that any ventures align with the goals of the corporate entity.

Alternatively, senior captive leaders can have an R&D background, and possess the technical ability to sit alongside founders of an acquired start-up and guide the product road map from a position of strength. The third talent profile within captive funds is venture capital talent. Leaders from this background are well-suited to deal-making, are aggressive and are able to think strategically about the market. The latter has proved to be potent in the success and prestige of a corporation’s captive.

However, captive funds face a challenge when it comes to attracting the best VC talent, due to the viewpoint from the VC community that captive funds are risk-averse, or else mere play things of the corporations behind them. Rightly or wrongly held, this view prevents many captives from headhunting the very best from VC. Added to the equation is the matter of financial remuneration, which is structured very differently between captives and VC, where carried interest plays a major role.

As captives increasingly gravitate towards the business’ core strategy, navigating the talent challenges will be key. Building a diverse team of the above profiles has plenty of merit and those who are innovative enough to offer carried interest as opposed to usual corporate packages will have a distinct advantage. As the impact of Covid-19 continues and acquisition activity intensifies as organisations seek to pivot, having the right captive team will be more important than ever.

Where have you seen captive teams work best? Let us know your thoughts. |  | @TheMBSGroup