Taking funds from a strategic investor
Your startup has gotten some traction and you’ve attracted the attention of some of the big players in your space. So much so that they’ve approached you about potentially investing in the company. While you’re flattered, you will need to carefully consider the pros and cons of taking money from a strategic investor as their investment may come with more strings attached than you and your company may like.
Taking money from a strategic investor may help open the door to a larger commercial relationship with the investor, which may be a great benefit for the company. An investment from a strategic investor may help legitimize the company in a way that makes it easier for the company to attract additional venture capital investment or achieve greater commercial success for its products. Teaming up with a strategic investor may mean access to labs, equipment or know-how that your company doesn’t currently possess. The relationship forged as part of the investment process may even help pave the way for a future acquisition by the strategic investor. The strategic investor may lend domain expertise to the company that the company may not otherwise have access to, and if the strategic investor insists on the right to appoint a director to the company’s board, that director may add a perspective to board meetings that the company’s board may be lacking.
Strategic investors also may be willing to invest at a higher valuation than a venture capital investor because they are likely investing in the company to achieve their own benefits that go beyond just the monetary return that venture capitalists and other financial investors are focused on. In short, an investment from a strategic investor may carry with it a wide range of potential benefits to the company. There are, however, several potential downsides that should also be considered carefully.
Are your short- and long-term interests aligned? The company’s motivations and the those of the strategic investor may not be same. Venture capital investors exist to put money to work, build a successful company and exit the investment with a return if they are successful. Their intentions are clear, but the motivations of a strategic investor typically go beyond simply earning a return on their investment. For example, while your company may be focused on hyper-growth and achieving profitability, a strategic investor may be narrowly focused on ensuring that it has access to your company’s technology and know-how without being concerned about the company’s long-term prospects. A strategic investor’s first and foremost concern will always be the core business of the strategic investor. If the interests of the strategic investor and the company diverge, as they inevitably will at some point during the life of the investment, your company will be better prepared to constructively address this inherent conflict of interest if it understands where the strategic investor’s loyalties lie from the outset.
Will your ability to do business with others be negatively impacted? A strategic investor may actively dissuade the company from pursuing certain business opportunities that may be great for the company but may not be in the long-term interest of the strategic investor. The involvement of the strategic investor may in and of itself inhibit certain competitors of the strategic investor from doing business with your company or considering a potential acquisition of your company thereby limiting the company’s future strategic opportunities.
What if there are internal or strategic changes within the strategic investor’s organization? The strategic investor is probably a much bigger company than yours. They probably have a lot of different strategic initiatives—yours is just one of those. You may wake up one day to find that the strategic investor is no longer motivated to make your partnership with them work, either because the person within that organization that championed your investment no longer works for the strategic investor or the corporate focus of the strategic investor has shifted to address a changing marketplace.
Will the strategic investment create IP or other operational issues? If the strategic investment is combined with a broader commercial agreement between the two parties, be sure that you would be comfortable with that commercial arrangement independent of the investment. If the strategic investor will obtain rights to your intellectual property or your products, be sure the terms of that arrangement make sense for your business in both the short- and long-term independent of whether there is a related investment.
How will the strategic investment impact your ability to get the best deal when the company is acquired? One of the strings often attached to a strategic investment is a right of first offer or right of first look with respect to any future sale of the company. Granting a strategic investor such a right will make it more difficult for you to develop competition in the process you run when selling the company, which could limit the price you are able to negotiate. Merely having a strategic investor involved in your company may dissuade some would-be buyers, such as competitors of the strategic investor, from doing business with you or seeking to acquire your company if they view doing so as somehow benefitting the strategic investor.
Be careful not to limit your own optionality too soon. By taking money from a strategic investor means you have made a choice to build your company in a certain way—in a manner that is consistent with commercial goals of the deal you struck with the strategic investor. The direction of your business will change over time as your technology evolves, you gain customer insights and you adapt to the market. Be careful not to limit your flexibility to adapt to these changes too soon by agreeing to take your business in a certain direction with a strategic partner.
Be careful not to limit your ability to raise additional of funding. If a strategic investor is investing in your company’s early rounds of financing, you should take special care to be sure that the company has retained enough flexibility to complete future financing
Accepting an investment from a strategic investor will undoubtedly have several long-term ramifications for the future of your company—some positive and, quite possibly, some negative. Carefully consider the pros and cons prior to proceeding with a strategic investor.