Sometimes technology rollouts are a headache for First Union Corp. senior vice president Peter Browne: Project managers are not obligated to use his choice of vendor and the top brass may have to sign off too.
But when Mr. Browne, who works in First Union's information security division, wanted to introduce a software system that digitally authenticates people's identity, he had no problem persuading his colleagues to use his vendor of choice - after all, the bank had bought an equity stake in the vendor in August. First Union's $21 million investment in Arcot Systems Inc. "makes it easier for us to get the software deployed," Mr. Browne said. "It's just a better thing to say - 'Our bank has a stake in this.' "
Welcome to the latest wrinkle in technology procurement: An increasing number of banks are making capital investments in companies whose software they also use. The initiatives bring together a desire to take advantage of the huge windfalls that are possible through early investments in start-up software companies, and a need to plug technology holes at the bank.
Groups responsible for making these so-called strategic investments are popping up with increasing frequency at the biggest banks. Their mission is entirely separate from that of banks' venture capital groups, because they cannot merely invest in a company that looks like a good risk - they must also ensure that the bank could use the company's products or services in a way that gives it a strategic advantage.
The synergies extend far further than alleviating system installation headaches. Banks with early stakes in emerging-growth technology companies are positioned to reap the benefits of initial public offerings or rising stock prices.
Plus, with a paper profit hanging in the balance, banks have extra incentive to help their chosen technology companies succeed. Both vendor and bank become that much more motivated to refine a system that can be sold in massive quantities elsewhere.
Often, just the announcement of a bank's relationship with a tech company sets the company's stock price on an upward course. Investors are hip to a technology company's ability to benefit from a close relationship with a bank that has a huge customer base and a built-in sales force.
Bank of America Corp. has equity investments in a number of companies, including the wireless provider 724 Solutions Inc.; the electronic marketplace operator Ariba Inc.; the electronic billing company CheckFree Corp.; and the small-business-services provider Biztro Inc.
Bank of America also licenses software and services from these companies, and the full relationship pays dividends. "When companies announce partnerships with Bank of America, they see an improvement in their stock prices," said Mark Argosh, senior vice president of consumer and small-business e-commerce at bankofamerica.- com. "It's more than just theory, it has been proven time and again."
The nature of the relationship shows why. In addition to capital, Bank of America's partners on the consumer side gain access to the bank's 2.7 million online banking customers. On the corporate side, they can take advantage of a nationwide sales force.
"Versus being passive venture capital investors, we bring to the table instant success," said Pam E. West, senior vice president of corporate e-commerce at bankofamerica.com. For that type of assistance, "why not participate in the upside" of a stock price lift?
Meanwhile, investments by Bank of America's Strategic Alliance and Investment group have helped the bank's Internet business group, bankofamerica.com, ease the burden of its heavy research and development expenditures. Bankofamerica.com is devoted to working with the bank's business groups to develop and bring to market capital-intensive, Internet-related services such as digital marketplaces and bill payment/presentment.
Capital gains from equity investments in the companies that Bank of America works with can cover a large part of its technology development bill, Mr. Argosh said. So far, returns have enabled its dot-com unit "to be virtually self-funding," he said.
"That's important, because growing revenues is not an overnight proposition."
Banks that use the software of a company they have helped fund clearly can expect to get a little back. "We use the leverage of our investment to get the best deal we can when negotiating on the service side," said Don MacLeod, executive vice president of First Union's eVentures group, which has invested in about 16 companies since its formation in early 2000.
It works the other way around, too. Banks are better positioned to insist on favorable terms and warrants in an investment if they are using that company's software. They can also throw their weight around in pursuing hotly contested investment opportunities. Technology companies are more likely to carve out a piece of the action for investors that can provide software licensing agreements, not to mention millions of customers as potential users.
When Corillian Corp. went public April 12, it took advantage of a practice that lets four entities purchase shares at the initial public offering price. Two of the firms it let in on the opportunity were Bank One Corp. and Huntington Bancshares, said Matt Cone, chief marketing officer of Corillian.
The reason? "They're big customers," Mr. Cone said. "You want them to have a vested interest in seeing your company be successful."
Bank have "tremendous influence as investors because they are also customers," said Scott Wu, general manager of San Francisco-based FT Ventures, a fund that has carried the strategic investing concept a step further by gathering up investments from several banks and putting them in financial technology companies.
Many of the institutions that run their own strategic investment groups also participate in the FT Ventures fund. Whether banks make investments on their own or as part of a larger group, "each is extraordinarily powerful," Mr. Wu said.
Strategic investing has gone from being relatively obscure a few years ago to being something that practically every large institution engages in. The unrelenting advance of the Internet and the many business opportunities it offers have erased any skepticism about the technology; more pervasive now is a sense of paranoia about falling behind.
A strategic investment unit can help institute a regular flow of much-needed information about competitive technology among a bank's information technology department, its business lines, and its top executives.
The process by which Arcot came to receive an investment from First Union shows how various groups in a bank have come to interact in new, fruitful ways. During a sales presentation to Mr. Brown's corporate information and security group, Arcot mentioned that it was seeking investments for a second round of funding.
That disclosure led to meetings between First Union's eVentures group and its security group, and eventually a trip to Arcot's Santa Clara, Calif., offices by Mr. MacLeod, Mr. Browne, and David Carroll, First Union's executive vice president and chief e-commerce officer.
Mr. Browne's information security group played a crucial role in proving Arcot's technology. It spent about six weeks trying to poke holes in the system before deciding that it was valid, Mr. Browne said.
Unlike other banks that may have looser requirements, First Union requires formal sponsorship of a technology company by one of its business units before it will put any money into a company, Mr. MacLeod said. "The reality is that if our experts in the field see something they like, it suggests that the company will be a success," he said.
Since the Arcot investment, the security group has begun to perform due diligence on three other companies in which eVentures is considering investing, Mr. Browne said. The highest levels of management have shown a heightened interest in information security, which has been a positive experience, he said.
Employees that make up banks' strategic investing units come from a number of backgrounds. The three people in Washington Mutual's Strategic Capital Fund, in operation since January, have experience in mergers and acquisitions, investment management, and technology, said Jim Fitzgerald, senior vice president of corporate development and venture capital.
The seven staff members of First Union's eVentures group include an investment professional with a law degree, some former portfolio managers, an executive from the bank's wealth management unit, and a former payments system consultant. Mr. MacLeod's 14 years of experience at First Union include global cash management and running a bank in Tennessee.
Banks typically examine hundreds of companies before making investments in perhaps a dozen. Wamu had looked at about 300 before putting money into about 10, Mr. Fitzgerald said. He described Wamu's $1 million to $5 million investments as "on the low side."
After fielding requests from more than 250 companies in about eight months, First Union allocated sums of $1 million to $25 million each to those 16-odd companies. The ideal size of an investment is between $5 million and $7 million, Mr. MacLeod said.
Though banks did not reveal the returns on their investments, they were unanimous in saying that financial gain was not the sole goal of strategic investments. "The financial returns have been good, but we wouldn't be making the investments in the first place if they weren't strategic," said Daniel Friel, senior vice president of Bank of America's strategic alliance and investment group.
Most banks' strategic investment groups are still fairly young, and there seems to be plenty of money to go around. Wamu, for example, has spent only a fraction of the $150 million it has allocated for strategic investments. First Union has not put a cap on the amount it will spend.
"The only question I don't have an answer to is how much bandwidth the company has to integrate these things," Mr. MacLeod said.