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Financing a Startup Company Series: Strategic Investors

Companies ,such as Google, have formed investment arms that make strategic investments in companies, such as Nest Labs, that may eventually be acquisition targets.

Companies ,such as Google, have formed investment arms that make strategic investments in companies, such as Nest Labs, that may eventually be acquisition targets.

This post continues our Financing a Startup Company Series and focuses on strategic investors.

Strategic Investors get their name because they invest for a strategic business related reason.  Sometimes this investment takes the form of an advance on an order for the startup’s product or service, sometimes it involves the purchase of equity in the startup, and it can be a combination of the two.  For example, Apple recently paid GT Advanced $578MM so that the company could provide Apple with a supply of sapphire crystal over the next five years.  Google Ventures was an early investor in Nest, the smart thermostat startup.  Recently, Google purchased Nest outright for $3.2 billion.

Looking at the equity based investment route, while ‘traditional’ investors seek to invest in a startup with the goal of making a return on their investment, Strategic Investors that buy stock in a startup might not even look to make money on the stock that they buy.  Instead, common investment objectives for Strategic Investors include gaining access to a product or service that they want to incorporate into their own business or product lineup, or keeping an eye on new technology that they may want to buy at a later date.

The advantages of Strategic Investors are:

  • Potential access to the manufacturing, distribution, and technology resources of the investor.
  • (Potentially) a large customer for the startup’s product or service to ensure ongoing revenues.
  • Access to capital at a time when many financial investors may not be interested.
  • A potential acquirer later down the road.

The disadvantages of Strategic Investors are:

  • They may want a right of first refusal on the company.  Because this can discourage other bidders, the startup may not be able to get the same value on an exit.
  • They may limit to whom the startup can sell (their competitors).
  • They may demand that the startup focus solely on the product or service that they are most interested in.

When considering taking on a Strategic Investor, be aware that not all Strategic Investors act in the same way and have the same goals for the startups in which they invest.  Many times a Strategic Investor will see the startup as a partner who provides a source of innovation, and will thus assist the startup with help that goes beyond financial investment.  This collaborative relationship is not always the case and it pays to research the manner in which the potential investor has treated prior startup partners.

Be clear about, and consider separating, any commercial deal from the investment.  If there is a business deal that makes sense for the two companies, try to keep equity out of the equation.  The main reason for this is that if, later down the road, the commercial deal no longer makes sense, it is easier for the startup to move forward without the strategic investor holding a large chunk of cash.  If the Strategic Investor wants equity in the startup as well, try to make this a separate arrangement.

Look carefully at any provisions relating to board rights, voting rights, merger and acquisitions, buy-out options, and use of funds.  These, and other provisions, can limit the startups ability to determine its own future.  Be careful about giving up too much on this front; even if the relationship seems to be one of collaboration and aligned interests, what happens if the Strategic changes its plans or if the person at the Strategic who liked the deal leaves?  On the flip side, if the startup is expecting more than just money (i.e. access to the Strategic’s manufacturing plants or distribution networks), ensure that someone with experience negotiating these types of deals reviews the paperwork to make sure the startup gets what it thinks it is getting.  The deal should include ways to incentivize the Strategic Investor to follow through on its promises to help the Startup.

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  1. Pingback: Financing a Startup Company Series: Intro | Wolverine Startup Law

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