“Nobody can do it alone” is one of my favorite quotes when it comes to describing the state of business today. We are all working in an environment where trends like hyper-specialization, the increasing speed of innovation and the growing pressure from legislation force companies to focus even more on their core business than before. Due to the increase of (specialized) suppliers taking care of (parts of) business processes, this leads to complex ecosystems where companies rely on each other in global supply chains. Something venture capital companies should take into account.
The three current drivers in venture capital
At the same time we see a booming market of mergers and acquisitions (M&A) pushed forward by three drivers. For one, there is a surplus of free cash flow. This cash needs to go somewhere where it can create value for its owners. The only way to do that at this time is by investing money and not by lending, which sometimes even requires providing loans at negative interest rates. Free cash combined with the desire for returns drives an ever growing demand for M&A or venture capital (VC) activities.
The second driver is the fact that companies realize that scaling is one of the strategies to take the hurdle of continuous rapid technology change. The overall opinion is that size does matter when it comes to dealing with innovation and disruption. I might have a different opinion on that, from my experience bigger is usually not faster and certainly not more agile, but I understand the rationale behind this.
After the pandemic we will see a lot of cancelled or temporized projects experiencing a reboot, adding the third driver for potential M&A activity.
Overseeing risks and opportunities in the complex venture capital investment ecosystem
First is that, as every organization is part of an ecosystem, the valuation of the organization depends also on its role in the ecosystem. This is not new. There has always been a lot of emphasis in data-rooms on the commercial contracts in both sales and procurement. The obligations give some insights in the risk profile of the company and also some ideas on future revenue.
However, what do you valuate? How do you know the current state and outlook of all the interactions with other parts of the ecosystem? This requires a legal analysis, a portfolio analysis, a risk analysis and all elements that relate to the ecosystem the target organization operates in. I believe, that in a due diligence situation this is sort of usual. However, I also see that it is not always done correctly. Embracing a spot-on standard actually helps to easily identify the risks and benefits and can create a more accurate valuation on both sides.
Improving data-room quality with contract management
For sellers of organizations there is a significant benefit to be in complete control of the interactions with other organizations in the ecosystem as that is what drives the total value. This can be achieved by implementing a contract management approach that does not only look at the obligations in the contract, but also proactively changes the contract when organizational goals require the relation with the counterpart to change. CATS CM® is a contract management methodology that always puts the organizational goals in pole position and focuses on realizing the corresponding contract goals to create the maximum business value from a contract.
Lately we at CATS CM® have seen companies implementing the methodology very rigorously in order to get themselves ready for a potential transaction. Benefits include that it is easier to prove the value of their contracts and show the way risks in the supply chain are controlled. Therefore it becomes more easy to sell, the data-room quality has increased significantly.
An often overlooked benefit is that the acquiring organization can leverage the portfolio of contracts (the ecosystem) better and can do that in the acquired as well as in the acquiring organization. This value multiplier (better purchasing volumes for instance) can be huge if found and implemented quickly.
Contract management is a key selection instrument for investment companies
Contract management is not only important in the buying phase. In our view venture capital should promote proper contract management execution in each of their investments. This creates trust in the likelihood of achieving the value of interactions with the surrounding ecosystem according due diligence. Another benefit is, that it becomes much easier to identify the contracts that contribute the most value as possible scaling advantages across investments.
Contract management therefore plays an important role in selecting the most promising investments and ensuring that the return on investment is achieved where contracts with ecosystem partners are involved. The contract management methodology CATS CM® is up for that challenge.