There are pros and cons to taking investment from a strategic (who is also a logical acquirer), and it has less to do with the nature of the strategic itself than it does timing, size of investment and control provisions.
As a general rule, it is a bad idea to take strategic investment early in a company’s development. While these opportunities often look smart and value-added, they can often be very painful and ultimately value destroying. Investments made by large corporations are generally spearheaded by a particular individual. These individuals can leave the firm, get reassigned or re-prioritise their focus such that the investment becomes “orphaned.” Depending upon how much the start-up was relying on strategic assistance from the investor (business development help, working as a true channel partner, leveraging the product/service internally, etc.), this can be either simply disappointing or truly threatening.
The signaling of a failed strategic relationship isn’t very good, and depending upon the size of the investment and whether there are board rights, M&A blocking provisions or even a buy-out option, these factors can make raising additional capital or getting bought by another firm difficult if not impossible. Nobody goes into these situations thinking they are going to fail; parties on both sides have the best of intentions. But the reality is that things change, especially within large companies, in ways that are very difficult to anticipate. For a young company for whom such a relationship is a critical element of their business development and sales strategy, capitalisation or both, it is an optionality-reducing decision that can give rise to truly disastrous outcomes.
Even in the best of cases where the business relationship is working, taking strategic capital can place a cap on the exit value of the start-up because other buyers may perceive that the strategic partner already has the M&A sewn up. They also worry about sharing confidential information with a start-up that has a competitor as an investor. There may also be terms related to governance in the investment document that give the strategic influence over M&A decisions that makes a true auction impossible. Bottom line, conveying power and influence to a strategic early in a company’s life introduces business risk and potentially limits exit options. My advice: don’t do it.
The best idea is to push for a close business relationship that can be jettisoned if it’s not working, and to hold the carrot of future investment out there as a motivator. I have seen this work extremely well and focuses both parties on what really matters – delivering the value of the start-ups product/service to the customers of the large company. In this scenario everyone wins, and the start-up has mitigated the downside of an early strategic partnership.
The right way to accept strategic investment is from a position of power and independence, and this is best exemplified by the recent investment by WPP in Buddy Media. Buddy had just raised $15 million Series C at a high valuation in the wake of building a massively successful, fast-growing business. WPP and Buddy had been working together for some time, and sought an even tighter business partnership to accelerate the roll-out of Buddy’s platform across all of WPP’s properties. The did this via a $5 million investment by WPP into Buddy as part of the Series C, augmented with a performance-based agreement that clearly established business goals and deliverables between the parties. The downside of Buddy of this deal: zero. WPP has no control over the company in any way, shape or form. If the relationship works as it should it is a home run for both sides. If it doesn’t then WPP will have made a profitable investment while Buddy will have executed its plan with or without them. This is when taking investment from a strategic can make sense – when the balance of power is heavily tilted in favour of the start-up.
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