Why defense giants tie in with start-ups. `Partnering' gives high-tech access or paths apart from Pentagon

America's giant defense contractors are in the forefront of corporations relearning the fine art of ``partnering'' with small, fast-growing companies. Westinghouse, Raytheon, General Electric, and others have been experimenting with venture-capital units built into their corporate structures. McDonnell Douglas and Northrop are reported to be considering similar moves. Grumman is in the process of starting up its venture-capital group.

Why this interest?

The growth of available venture capital, from $2.5 billion in 1977 to an estimated $19 billion this year, has produced a swarm of new firms, many of them in high-tech. Their products and expertise are coveted by aerospace companies, either for defense applications or in the strategic drive to diversify away from heavy military orientation.

Like other big corporations, defense contractors want to take advantage of the entrepreneurial drive of smaller companies, and yet they realize the small companies need to be left relatively independent.

``I've noticed lately many defense companies jumping back on the bandwagon after being in it in the '60s,'' says Mark Radtke, a vice-president in charge of corporate strategies with Venture Economics, a Wellesley, Mass., consulting company. ``The whole idea is to get what you want without buying a controlling interest.''

There are now six defense companies with formal venture programs; 4 more are seriously considering them; and 12 others continue to make occasional venture investments, Mr. Radtke says. Analysts say that's a fair amount of involvement, considering that there were only 50 companies in the United States with formal venture programs last year.

Buying a minority stake is a more sophisticated method than outright acquisition. During the late '60s and early '70s, large companies practiced ``corporate partnering'' by simply snapping up small, fast-moving high-tech firms in order to gain the much-sought ``window on technology.''

But in the rush to bring a fledgling company into the fold, the giant organizations often squashed it with bureaucracy, heavy-handed reorganization, and even the switch to a different accounting system.

``What we don't set out to do is be a conduit for everything,'' says David Steadman, vice-president in charge of Raytheon Ventures. ``I don't sit in the middle of every piece of business that develops. Nor do we set out to administer the company. We are absolutely an investor, and a business partner, but we're not managing the company.''

At Raytheon Company, the $6.4 billion conglomerate, the biggest chunk (59.2 percent) of its sales last year came from missile, radar, and electronics contracts with the Defense Department. The Raytheon Ventures offshoot has minority investment positions worth $10 million with four firms, and $4 million in other commitments. Though just a speck in corporate operations, Mr. Steadman's venture unit chose each of the four investments with an eye toward learning new processes and techniques. Profits on the investment are important, but they aren't expected for four to seven years.

In return, Raytheon lends the confidence and stability of its name as well as some management advice and business contacts. It benefits because ``we obviously can't do everything; there are niche markets, innovative applications of technology, which we see in these young companies,'' Steadman says.

For example, Raytheon has expert systems and artificial-intelligence help for some of its defense work from LISP Machines Inc. of Cambridge, Mass. Raytheon Ventures owns less than 20 percent of LISP and three other small companies.

Although each of Raytheon's venture investments has technology that could be applied toward weapons systems, this is not usually the sole motivation for Raytheon or other corporations to do big business with the Pentagon. Investment money also goes into strategic partnerships that might help consumer operations.

The character of a corporate venture program varies, largely according to whether the aim is corporate profits or technological symbiosis. Strategic alliances can run the gamut from outright acquisition or a minority investment with a product development contract to an informal working agreement or an investment of research-and-development money tied in with a distribution agreement.

General Electric Company has remained in the venture-capital business since starting on it in 1969, and its roughly $200 million stake is aimed primarily at bringing in profits -- not at gaining strategic alliances with the companies in which it invests.

Westinghouse, on the other hand, began venture activities in earnest in 1983 and has invested about $60 million. Some funds have gone to direct and limited partnerships, some to other strategic investments outside the company (less than $10 million, according to analysts), and some to the company's own ``skunkworks'' (relatively independent research units).

For example, Westinghouse set up its own project to develop a voice synthesis system that takes the spoken word and puts it on paper. The effort grew out of speech synthesis research by one of the firms it sank venture money into, says Donald Tovegsil, a corporate planner at Westinghouse.

Nevertheless, the jury is still out on direct venture investment by corporations, analysts say. A crucial question is whether companies can provide management help and still refrain from running them -- or from pressing them for profits too soon. ``Five to seven years is a very unfamiliar time frame for corporate officers, who much prefer to work in quarterly installments,'' says Stanley E. Pratt, chairman of Venture Economics. ``It requires a commitment to longer-term building, and these days we have very few builders and a lot more traders.''

Second of two articles. Part 1 ran Tuesday.

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