This is part of my ongoing Raising Venture Capital (VC) series
Yesterday I had lunch with a really interesting and capable serial entrepreneur who is raising his A round. The topic of ”strategic” investors came up. It felt like Groundhog Day because I have this conversation again and again – literally dozens of times each year. And I had 2 “strategic” investors in my first company.
So I thought I’d try to lay out a framework for how you should think about it as many you will inevitably be faced with this experience.
What is a “strategic” investor and why do you keep putting the word “strategic” in quotes?
When people refer to a strategic investor they are usually talking about an investor that comes from the industry you serve as opposed to an independent venture capital investor. I put strategic in quotes because they are often anything but “strategic” and thus the term can be an oxymoron. Many serial entrepreneurs who have been burned would use something less kind than quotes.
But they’re promising to massively increase my uptake, they’ll give me huge legitimacy and maybe they’ll buy me some day?
Yeah, I know. And Microsoft always convinces me that their next version of Windows won’t be slow and I get fooled every time. When they promise to help you with marketing, sales, distribution, integrated product development, etc. it sure is tempting. And they probably have every intent of helping you. But the venture guys don’t make the calls on what the product / business guys do. The reality is that their core business is not venture capital. So push comes to shove they will be driven by their core business (as they should be) – not the $5 million they put into your company. You are the tail, not the dog.
OK, so maybe they won’t be helpful. Most VCs aren’t either? What’s the difference?
Great question. It’s true that many VCs over promise how helpful they’ll be with introductions / strategic advice / recruiting, etc. But this is benign. Strategics can have some negative impacts:
1. You’re not their core business – their interest will swing more wildly with the markets
When times are good “strategics” want in. They’ll pay up for it and promise much. When times are bad many cease investment activity all together. OK, I know this is true with VC also, but to a lesser extent. Investing is our core business. We have nothing else to revert to.
2. They value their core business more than your success – and they should!
I saw this directly. I had two strategics in my first company. One was the hardest working guy on our board and the biggest mensch. He was also chairman of a $6 billion company! I loved working with him and learned much from him. He tried his best to balance his needs and ours. He was a needle in a haystack in that I think he really cared about my success. He also wasn’t the venture guy – he was the big cheese. But even he would feel conflicted when I had to cut the engineering team because he valued our product more than his investment. When we wanted to sell the company he was very hesitant because he didn’t want somebody to buy us who might not be a good steward of the product going forward.
The other strategic was a train wreck. One month after investing the guy who invested left his firm. The guy who took over said, “I never believed we should invest in dot com’s. I will be on your board but don’t ask me for anything.” He literally said it that bluntly. His words were an understatement. He fought me for 3 years and actively worked against our interests – I think to spite the guy who put in the money. I struggled to get every signature or consent. The market knew he was an investor yet he wouldn’t promote us within his own company. You can imagine how that made us look in the German market where his company is a big deal.
In retrospect he was right for his business but it sucked for me. Keep that in mind when you’re thinking about ’strategic’ money.
3. Many strategics have less experience in helping entrepreneurs
Another big question you’ll want to answer is whether your strategic investor has a long history in investing in startups. How have they behaved in good times and bad? Make sure to reference check with other portfolio companies. I often talk about why you want “smart” money (yes, I use quotes because I know it’s not always as smart as it promises to be). But working with VCs means you’re working with people who deal with entrepreneurs as their career. When you deal with doctors or dentists for angel money, for example, you’re dealing with people who don’t. The same can be true with strategics. So make sure you know what the team and what the individual is made of.
4. Many strategics have bureaucratic decision-making processes
One of the problems in working with corporate entities is that the venture arm doesn’t always have an autonomous decision-making ability. As a VC I need to get buy-in from my partners when tough stuff comes up. But I only have 3 of them and they spend every day dealing with these kinds of situations. Imagine your investor has to call the CEO of a $20 billion company for approval for your merger or sale. Fun.
5. You may struggle to land their competitors as your clients
So you took money from the largest player in your industry. That’s awesome because you now have credibility. But guess what – number 2-10 in the sector now you view as an agent for the evil empire. It will be much harder to get deals done there and may drive people to your competitors. I know that you’ll tell them that BigCo owns less than 20% of your company. Remember, they’re not venture investors. They don’t see it that way. They see you as an extension of their competitor and that all information will flow to the corporate parent.
6. You may find that when you want to sell your company it is harder to get a fair price
See point 5 above. If you thought it was hard to sell your product to the competition try selling your company. Yeah, I know it happens all the time. But for an M&A department that is already super busy they don’t want to be seen as a stalking horse for the company that owns 20% of you so sometimes they don’t even want to bother. Plus, many acquisitions happen when you are already partnered with the company so you may have to get beyond the hurdle in point 5 before getting to this step. So if you ask many bankers they’ll tell you that there’s a “discount premium” that you’ll get at the time of the sale as a result of having a strategic.
So should I ever consider taking money from strategic investors?
There are times where strategic money makes sense. I personally recommend it in the following situation: When you have your A round and/or B round done, the business is progressing well and you’re not early stage. That way the strategic isn’t as involved in the early-stage messy stuff when you need to quickly change direction when your strategy isn’t working and need to get more funding rounds done.
There is a second reason I recommend this. You can often get 3 or 4 strategics to invest alongside each other and then nobody sees you as an extension of another company. You may not get fierce competitors to co-invest but perhaps you can get enough closely related companies that you don’t have the branding problem I’ve spoken about. Also, you have more leverage to not take them all on as full board members.
You may also do your due diligence on the firm you’re talking to and find that they’re an outlier. You may find that they’ve been investing for 15 years, their entrepreneurs love them and they’re entrepreneur friendly. So if you get good feedback just make sure that you understand the framework above to think about how to best mitigate your risks.
Are any strategic investors better than others?
Yes. There are many funds that are associated with corporation that are structured as proper VCs. Three examples where I know the teams personally, respect them and have heard great feedback are: Steamboat (Disney), Comcast Interactive Capital (CIC) and Intel Capital. I’m sure there are many more. What I’d point out in all of these firms is that they have had a long view of the VC market, they are pretty independent from company decision making, they aspire to make money on the fund rather than fuel their core business, they are structured like VCs and therefore attract A-quality people and none of them over promise that their company will ‘make you.’ As a result the market knows this about them and doesn’t view them in the same way. They are strategic with no quotes
Where can I go for help?
Try VentureHacks, The Funded or OnStartups- three great communities to tap into other entrepreneurs and ask them for their experiences. Oh, and maybe a few of you will meet me in the comments section to discuss your experiences. I’d love to get the debate going. And if you know any great strategics please list them. I’d love to give them some recognition.
(Cross-posted @ Both Sides of the Table)