The fact that anyone is offering you money is a good thing, at least in times like these. But wipe the smile off your face and realize that you have some tough decisions ahead of you - you need laser focus! Not all money is good money, or smart money for that matter. This issue is not limited to strategics – there are good and bad angels, good and bad VCs, good and bad private equity players, and the list goes on. The financing sector is a microcosm of life – you get all sorts and types. So never dismiss money just because it comes from a strategic. All things considered though, you need to dig into the terms and objectively analyze the deal. Some critical questions to ask are (ranked in no particular order):
- Who at the strategic is actually responsible for the investment - operations? corporate development? corporate venture unit? There is a reason that the VC model works (although many right now would argue that it is broken). VC firms are designed to do one thing – deploy money, build and grow companies and then exit the investment (hopefully with a return). Generally, you know where the VCs’ head is. That’s not to say that some VCs don’t have their own agenda (see Mark Suster’s latest post “Choose Your VC Investor Carefully” - my favorite quote is “Beware of VC seagulls, who shit on you and then fly away”), but most are there for the right reason. When it comes to most strategic investors, the reasons for investment go beyond just earning a return. On a continuum, I would put most corporate venture units on the ends closest to the VCs. I’d put the corporate development folks in the middle and the operations group on the opposing end. If the operations group is running the show on the investment, I think you run more of a risk of countervailing priorities. They may not be in the investment to grow a company, rather, they may be in it to test out a new product internally and maybe tinker with it to see if they can maximize it’s usefulness for their own good – not so much the greater good that earns top returns in the marketplace. Follow your gut. Also, the operations end of the continuum may have less sophistication in structuring an investment. This may work to your favor in that there may be less valuation sensitivity. As I’ve mentioned in earlier posts, however, if you structure that first round of outside money poorly, you run a great risk of complicating your later rounds of financing.
- Is this your first round of financing or have you already raised money? To play off of my comments at the end of the prior bullet point, and to tie this in to the next bullet point, if the strategic is coming in on your first round and they are the only investor – beware how you structure the deal. Don’t be penny-wise and pound foolish, you’ll live to regret it during your Series B round. If, however, you’ve already raised some money (i.e., this is a later series round), then it is more likely that the strategic is just co-investing and thus the VCs are structuring the deal.
- Is this a group of strategics? Is the strategic leading? Or is the strategic investor just co-investing with a group of VCs? One of my worst nightmares involved a company that I was representing in a $37 million Series C & D round, done simultaneously. The company’s entire Series A round consisted of four extremely large strategic investors and industry heavyweights. Part of the current deal involved taking out the entire Series A round. I can only remember a few other deals that were tougher than this one because the internal folks at the strategics as well as their counsel were beyond difficult and lacked an understanding of how deals like this were structured. When the other side suspects every move you make is suspicious (mainly out of ignorance), then getting the transaction done takes four times the amount of time (and paper). A lot of effort, time, personnel and money resources went into getting that deal done because of the approach the strategics took. Had they not controlled the entire round, maybe it would have been more efficient.
- Do the terms of the investment go beyond just money (i.e., are they offering to test out your product, to include it in their suite of technologies, to use it internally, are they looking to license it from you)? In my opinion, the terms better go beyond just money, otherwise the strategic is nothing more than a VC and you are losing some potential to piggyback on the strategic’s platform. Some strategics like to invest for reasons other than just the return. They may be interested in the technology for their own internal use or they may think it is a great add-0n for their own suite of technologies. Maybe they have testing or research facilities that you could not otherwise afford on your own. Maybe all of this makes you think that this strategic ultimately may just buy your company for a huge multiple right out of the starting gate. If the terms go beyond just money, try to forecast in your mind where those other terms may lead you. Speak to other companies that have structured deals like that. Speak to other portfolio companies of the strategic. What happens if the internal champion of your product leaves the strategic and now no one internally wants to test out your product. Can you say limbo? Also, beware that aligning yourself with one or two particular strategics may limit the deals you can broker with other strategics due to anti-competitive concerns.
- Is the strategic’s technology complimentary or competitive? Are they a customer or a supplier? This question is a good follow up question for the immediately preceding question.
Some other points to consider. Early strategic investors don’t always participate in follow-on rounds. They may not have the amount of dry powder that a fund has to continually participate in future financing rounds. On the plus side, strategics may be able to provide superior name cache and credibility. That can open doors and that is priceless.
In retrospect, this article comes off negative on strategics. Don’t get me wrong – I love strategic investors and I would never advise anyone to turn away money for that reason alone. But the goal here is to size up the deal and put it all in perspective. In my experience, the best approach is (i) don’t rely entirely on strategics – they are better served as co-investors, (ii) make sure that the deal with the strategic consists of more than just money – they bring a lot to the table and you want to leverage it as much as possible to make your company more valuable, and (iii) try to stick as much as possible with strategic partners that structure their investments through an internal corporate venture unit (although you should never walk solely because of this issue).