During the first week of this year, Microsoft quietly announced it was redesigning its startup investment strategy—again.
The corporate tech giant has gone through several iterations in its approach to founders already, all the way back to its foray into venture investing during the Dot Com boom and bust, when it was among the biggest corporate losers in the private markets, reporting billions of dollars in investment losses on its balance sheet. Nearly seven years ago, Microsoft made another big bet on startups, setting up its own independent fund called M12, scaling it to a team of currently 30 people and backing a host of software and A.I.-type startups from banking startup BlueVine to generative A.I. app Typeface.
But now, as the private markets spiral yet again, Microsoft has been changing direction, pivoting M12 from more of a financial corporate VC model to a strategic-focused venture arm. As Michelle Gonzalez, who has led M12 as its global head since the summer of 2021, wrote in a January blog post, the fund has “tightly aligned” its strategy to Microsoft in the last year, focusing more on connecting startups with the tech giant’s ecosystem of products, divisions, and network, compared to focusing primarily on financial returns. It’s prompted tough conversations inside the fund following the leadership change. And Fortune has learned that at least eight M12 employees have left their jobs between the summer of 2021 and the end of 2022, per interviews, their LinkedIn pages, and a review of M12’s team page accessed through the web archive.
M12’s move to cleave tighter to its mothership coincides with a turbulent time in the broader VC space. During past recessions, corporate VC arms have sometimes pulled back as current results trump investing in future growth. While it doesn’t appear Microsoft is in that boat thus far, the broader company is laying off employees across divisions.
But it’s clear that Microsoft’s highest ranks—specifically CEO Satya Nadella—are prioritizing betting on innovation. Microsoft as a corporation recently invested a whopping $10 billion in buzzy A.I. startup OpenAI as it angles to compete with rivals like Google amid the escalating A.I. war. Meanwhile Nadella appears interested in other startups, as well: Gonzalez told Fortune that Nadella will “sometimes” send notes to M12 about companies he thinks are interesting.
Historically M12 has frequently led rounds, as well enabled startups to do what's right for them if and when they exit: Several years ago, M12 stopped using “right of first,” or ROF terms, which give investors the option to be first in line to buy a startup—and which limits the startup’s options for exit. “We are financially focused, not strategic in that sense,” Priyanka Mitra, a then-principal and now partner at M12, told Crunchbase News in the fall of 2021. Now, according to some, M12’s internal changes are sending a different signal to startups.
“M12 was founded with Microsoft here to help entrepreneurs. That was the core ethos: 'We're here to support these founders, and to build great companies, and how can Microsoft help you?'” one former employee who had been at M12 for several years, and requested anonymity to speak freely, told Fortune. “Now it's the other way around: ‘How can these companies help Microsoft?’”
Venture the Microsoft way
Microsoft first launched its San Francisco-based venture arm, then called Microsoft Ventures, back in 2016, to invest in early stage software, A.I., and cybersecurity startups. Since its founding, M12 says the fund has invested in more than 100 companies, six of which went on to go public.
M12 was founded by Peggy Johnson, who since left Microsoft in 2020 to become CEO of Magic Leap, and ex-Qualcomm Ventures’ Nagraj Kashyap, who led M12 as its first global head until he left the top post in February of 2021 for SoftBank (per his LinkedIn, he has also since left SoftBank). In 2018, the company rebranded the arm to “M12” (M for Microsoft, and 12 for the number of letters in the word “entrepreneur”), which the company said was to resolve confusion among entrepreneurs with Microsoft’s startup accelerator (previously known as Microsoft Ventures).
The fund has written checks in the tens of millions, although Gonzalez believes check sizes will shrink as valuations en masse take a hit. M12 told Fortune the average check size ranges between $2 million and $10 million. M12 has been actively investing in rounds with other corporate VCs, including Google’s GV and Salesforce Ventures in recent years. Among the startups M12 has backed are crypto custody firm Bakkt (which since went public), A.I. compute platform d-Matrix, and, announced in February, generative A.I. startup Typeface.
View this interactive chart on Fortune.com
M12 had, for many years, emphasized that it was doing things differently. In 2018, Kashyap described the fund as a “different kind of corporate VC,” with a strategy of investing “in the best enterprise startups; we align with our founders by measuring ourselves on financial return; and we leverage some of the best enterprise assets in the world to add value above and beyond our invested capital.” And at an M12 event a year later, the fund was telegraphing its pro-founder focus: Kashyap was quoted in a GeekWire article chronicling the event saying that “If you do right by the company that you’re investing in, they will do well. And if they do well,...you get some mutual benefit to your parent company.”
But since the new leadership came on board, the former employee said that M12 has “changed dramatically.” They described that previously, financial return was “the true Northstar from which everything else kind of falls into place,” which meant focusing on things like maximizing ownership, leading rounds, and wanting to take board seats. Though M12 still cares about financial returns, and will still take board and board advisor seats, according to Gonzalez, the new direction is “a lot more strategically aligned to Microsoft—so, continuing to invest in early stage companies, but with more focus.”
She says that M12 continues to have autonomy from Microsoft, but while previously the fund was “primarily a financial VC with loose affiliation to Microsoft,” now they have closer connections with stakeholders. It’s something the former employee felt as well: “There was a desire to say, 'Okay, great financial return, [but] we want to see more strategic value.' And that's always the tension with a corporate VC,” they said.
Johnson’s successor, Chris Young, who joined Microsoft in 2020 as its new executive vice president of business development, strategy, and ventures, inherited the oversight of M12 (Gonzalez reports to Young, who in turn reports to Nadella). He told Fortune that at the time, while he thought the existing M12 team did a “phenomenal” job of getting the fund set up and building a portfolio, he believed it wasn’t focused enough. Gonzalez, one of his first hires, was brought on in 2021 to begin making that shift in strategy—one he envisioned would enable M12 to “go deeper” in investment categories that would help better serve their companies by building stronger connections with Microsoft through information sharing, integration, customer connections, and joint go-to-market, while growing their businesses.
Gonzalez says that while in the past M12 was a “bit more reactive—something would come in, [a] hot deal, right? And then you’d have to build out that thesis,” under the fund’s new strategy, M12 has set theses to proactively look for deals that match. For M12, those are A.I., cloud infrastructure, cybersecurity, developer tools, and vertical software-as-a-service (SaaS). Several months ago, the company also announced the GitHub Fund, which will be managed by M12 and focused on funding open source startups using Microsoft-owned GitHub’s platform (M12 told Fortune that fund invests smaller checks, between $500,000 and $1.5 million).
Young also said that the fund helps those inside Microsoft learn from the M12 portfolio companies. That could be particularly important in areas like A.I., where Microsoft as a whole is striving to get an edge over competition.
Not ‘for everybody’
Once Kashyap left M12, the fund was without a leader for several months. When Gonzalez joined in July, she says there was some adjusting internally.
“There hadn't been leadership for some time, for several months. And so, you know, that's always tough, right?” she said. The new strategy was communicated on an ongoing basis, Gonzalez and the former employee told Fortune.
Gonzalez says she initially spent time speaking with “about 60” portfolio company founders, as well as Microsoft CEO Nadella and CFO Amy Hood, and other leadership, “doing a lot of listening and learning.” Gonzalez said that M12 also sent out a “very long” survey to the fund’s roughly 99 portfolio companies seeking feedback on what they needed and wanted from Microsoft.
She says a top response was that companies wanted more help with their customers, and that M12 could be “differentiated” by having a team focused on revenue growth for portfolio companies through Microsoft’s distribution or connections the company can make for the startups. “One of the things that they were wanting, craving, was those connections and...meeting the right people at Microsoft,” she said. That’s where that other half of the M12 team is focused: On “concierge-like service for the portfolio.”
The incorporation of the portfolio development team—and assessments of how Microsoft could support customer connections—is now a data point in M12’s investment process. “That was not the case before,” Gonzalez said.
M12 also meets with CEO Nadella and his leads at least twice a year, Gonzalez said, and they’ve been bringing startups to meet with them. “We're starting to do more of that,” she said.
But apparently not everyone was excited about the new strategy. According to the former employee, some people inside M12 felt like the new mission was not what they had signed up for. “When you have a big strategy shift,” the former employee said, “you can either embrace it or it can alienate you or you're still along for the ride. And I think it certainly played out for many folks that way.” The former employee described “tension” as changes were being rolled out.
When asked about the turnover at M12, Gonzalez says they’ve had some “tough conversations” as they’ve made the changes, and that “the new strategy wasn’t for everybody” in terms of being more focused versus “generalist” and the tighter ties with Microsoft. M12 says over the last year they’ve added 15 people to the team.
M12 has always been keen on its portfolio using Microsoft’s products, like Azure, but that seems front and center now. She told Fortune that there's no requirement that companies be on the platform, and that “most of our companies aren't, but there are a lot of things that we can do” if “they do have some of their workloads on Azure.” Or, as Young described it, it’s more of a focus on help us help you: He said M12 isn’t asking portfolio companies to “do anything unnatural,” but that they want them to work with Microsoft “to help us give you leverage in places where it matters.”
According to the former employee, the two biggest changes at the fund are needing the “nod blessing” from Microsoft management, and a much “narrower” opportunity to lead deals.
The former employee said Microsoft management would pass along startup names to M12 to look into, and claimed that since the leadership change, M12 was more receptive to Microsoft-sourced deals. Gonzalez said that sometimes “Satya [Nadella] will send notes and say, 'Hey, this is an interesting company,’” and that “it is important for us also to have those conversations with Microsoft execs.” But she says M12 also sources through their own networks and the approval process is theirs. In response to a further request for comment, M12 later said “this is not correct” and that “we invest independently of Microsoft’s business and product groups,” adding that while they “engage a lot of Microsoft experts and stakeholders about our thesis areas and the companies we talk to, we do this for product truth and insight—not permission.” Meanwhile, acquiring startups that M12 is investing in hasn’t been and still isn’t a priority for the fund, Gonzalez said.
M12 is also more open to co-leading or participating in deals versus leading, Gonzalez told Fortune, although M12 will continue to lead deals (M12 led multiple rounds last year, including an investment in Web3 startup Space and Time in September). She said that VCs she’s spoken with are “excited" that they are "open to being more flexible in terms of co-leading and participating," versus "competing on leading.” Leading a round means the investor will set the terms for the other investors joining in, chip in a large chunk of cash, and often take a board seat.
But adding back in terms like the “right of first” aren’t on the table, Gonzalez said.
M12 in 2023
For much of the time that Gonzalez has been in charge over roughly the last year and a half, the market has been going through a painful recalculation after years of high-flying valuations and frenzied investing.
It’s a shift that’s prompting many VCs—and their limited partners—to adjust to the tougher environment in 2023 and potentially rethink allocations. It’s possible that’d be the case for those with only one LP: their corporate sponsors. M12, like other corporate VC arms, is funded with budget allocations from its parent Microsoft, and has an annual vintage. M12 said they do not disclose fund size or comment on how much the fund has invested.
But when times are tough for companies and they conduct large layoffs or otherwise tighten budgets, as Microsoft and other tech companies have done recently, there’s always a question of what happens with their venture funds.
"A recession naturally means that the focus will be more on the core business away from riskier projects like venture," Matthew Gilmour, a former corporate finance manager at accounting firm BDO's growth advisory team, told PitchBook last summer. "You're more likely to make stable returns off large capital projects than [investing in startups] and I think the bar could be set higher for investments than before."
Gonzalez told Fortune that she had nothing to share on M12’s budget, but says that “we’re no different” from other VCs pulling back. She added the fund is still actively investing, while Young said that the amount of capital M12 puts to work “varies a little bit every year.”
Overall, the M12 today appears to be notably different from the one two years ago. In a deep dive into M12 in the fall of 2021, Crunchbase News reporter Chris Metinko wrote that “it’s important to understand that M12 is not your typical corporate venture fund. It is first and foremost driven by financial returns—it does not invest just for Microsoft corporate to gobble up that startup later or for ‘a seat at the table.’”
It seems now Microsoft is hungrier.
