Consortium deals – a surer route to digital transformation?
Something is afoot in the world of trade finance. Traditionally a paper-based business, and long resistant to innovation, players all along the value chain have started to come together to explore platform-based solutions and new technologies like blockchain to drive greater efficiency and more transparency in their operations.
Some of the larger consortia currently active include we.trade, Marco Polo, Voltron, Forcefield, Komgo and VAKT.
These groups are each targeting slightly different aspects of the trade finance life cycle. we.trade, for example, aims to help SMEs manage, track and protect open account trade transactions, whereas Voltron is more focused on letters of credit. Meanwhile another recently announced example, Trado, is exploring a new supply chain finance structure in which blockchain and smart contracts are used to collect and record social and ecological data on suppliers.
And the trade finance industry is not the only one looking at consortia as a means of speeding up industry-wide uptake of new technologies. There is a growing number of organisations opting to set up consortium deals to bring about digital transformation. Power in numbers
Power in numbers
So why are consortium deals on the rise, particularly where developing highly innovative and market-changing technologies is concerned? The simplest answer is that it is all about spreading risk and cost in an area which, by its nature, is highly experimental and requires significant investment.
Companies looking to accelerate digital transformation have one of three basic options – buy, build or collaborate. They can buy the technology and the people who have created it, invest (at potentially high cost) in building it themselves, or collaborate with partners that bring crucial technologies and skills to the table.
Traditional M&A and joint venture deals play a significant role in this process, but they can both carry high levels of risk in areas where innovative solutions are being explored for the first time. Indeed, if a technology is highly experimental or less developed, M&A buying could be one of the riskiest ways to go.
When looking for solutions that can disrupt entire marketplaces or sectors, many companies are now recognising that consortium deals offer the fastest and best way to bring about enduring change, while dispersing the risks involved among multiple players.
Only the very largest companies will have the market power or resources to bring about change by going it alone. Not only can such an approach be a heavy burden on an organisation but it also requires considerable confidence in the proposed product (often a challenge in untested or new technology).
For most, therefore, it is better to find a solution that has the backing of players right across the marketplace, bringing together people with a common vested interest in creating a successful solution and who, together, can validate it in the wider marketplace, speeding up the process of adoption.
Complexity of the unknown
Most consortia are structured as a distinct private limited company. Shares will be issued in return for what is often a relatively small initial investment and with the rights of individual investors carefully and equally protected. Usually, it will be important that no one player is perceived to be in the driving seat or likely to benefit most.
But creating such shared structures to bring a market-changing technology to life is fraught with complexity.
First, there is the issue of trying to balance a wide range of potentially conflicting interests. For example, one company – already working on a system that tries to address the issue at hand – may be concerned that its own business will be cannibalised by the new technology.
Trickier still is handling the complexity of the unknown. Since the technology may only be at the very earliest stages of conception, how do you legislate for what might happen three or four years down the line when you don’t yet know what the system can or should do? This degree of uncertainty is in clear contrast to many conventional joint ventures, where a project usually will have a defined objective and the parties, often with different levels of interest in the venture, will have a pretty clear idea of when and how they will exit.
Where consortium deals are concerned, it is important to create bodies within the consortium’s governance structure that are charged with not only managing the immediate challenges of the company but also to think ahead to what new rules or support might be needed by the consortium as the project develops. Adaptability is the key.
The corporate structure also needs to remain flexible to take account not just of changes in the market but changes in ownership over time. A total lock-up of the parties’ interests is often counterproductive and thought should be given as to how ownership may need to change as time goes by. Some investors may want to build their stake but, equally, some may want to exit early, while others may want to join as the platform builds momentum and is able to attract greater interest in the market. The terms for each need to be clear from the off so that the parties know the rules by which they hold their investment. As the need for funding increases, the consortium may want to seek additional investment or to stage an IPO to raise necessary finance. These issues should be carefully taken into account from the outset.
Careful structuring is also important to protect intellectual property and the goodwill flowing from it. Investors will want to be sure they are investing in a clearly defined structure where the IP is locked up in the entity, for the benefit of the company as a whole as well as the individual parties.
As with any tech-driven business, a clear understanding of treatment, protection and monetisation of data will also be a point to consider from the outset.
Overall, the process of building a successful consortium is painstaking work. It is not unlike designing a constitution for a country or a society, a system of governance that anticipates change in future and can stand the test of time.
More deals to come?
It is already clear that consortium deals are an increasingly important weapon in the armoury of companies looking to use technology to disrupt outdated and inefficient marketplaces, alongside traditional M&A and joint venturing.
We have already seen them deployed in a range of settings, including huge infrastructure projects, such as pipeline building, and in pharmaceuticals, often with a crossover between the public and private sectors.
As digital technology disrupts more and more sectors there is every reason to believe we will see deals, increasingly innovative in their structure, multiply and we might even expect some consolidation between existing consortia.
With the stakes so high, consortium deals not only provide a way to spread risk among multiple stakeholders with a common interest, but increase the chances of new technologies being validated and adopted right across the supply chain – ensuring that effective and lasting digital transformation can take place.
Consortium deals are an increasingly important weapon in the armoury of companies looking to use technology to disrupt outdated and inefficient marketplaces, alongside traditional M&A and joint venturing. There is every reason to believe we will see deals, increasingly innovative in their structure, multiply.
Consortium deals – some key considerations
Scope and purpose
Investors must agree on the objectives of the collaboration, backed by a clear business plan and early identification of any red lines for participants. This often means a more lengthy term sheet negotiation so that parties are as clear as possible on what is being built. Close participation between the legal and business teams in helping to identify potential issues often yields a more informed and robust structure.
Ownership and financing
Care should be taken in considering the rules by which investors may hold and transfer their interests in the consortium and the process by which the consortium raises additional funds or welcomes new stakeholders. There are many important issues to consider; from whether a lock-up is appropriate (eg when the business is preparing to launch its product), to change-of-control mechanics, to what, if any, veto participants have on raising debt or new investors joining the consortium.
Expertise and governance
It takes time to attract the right members who fully represent the marketplace and have an appropriate spread of skills, but is vital. Governance issues such as voting and veto rights and selecting the right management team (as well as how to incentivise that team) require detailed consideration from early days and must be kept under review. Developing an appropriate committee system to help nurture the young business and draw the best from the consortium members is also an important consideration.
Loss of background IP rights is often one of the main concerns of organisations joining a consortium and, in general, IP risk issues are more complex in this sort of collaboration than those in a traditional strategic investment or M&A. Issues need to be carefully covered off by clearly defined agreements at the pre-contract and formation stages, during the life of the deal and potentially on termination.
Data is increasingly recognised as a valuable asset of any collaboration. Frequently, it is addressed as an asset class as part of the commercial agreement, alongside intellectual property rights and other assets.
The level of regulation that the consortium will attract will be driven by its proposed products, the markets in which it operates and the share of those markets it captures over time. It is a point that needs to be considered not only at the planning stage but throughout the life of the consortium.