Strategic Investors: They’re back… and you may want them in your next round.

[Contributed by Mike Mackeen, Managing Director | Bulger Partners]When we develop a strategy for a private capital financing, it usually includes a client discussion on the benefits of including strategic investors in the round.  Large tech companies fled the minority investment game 10 years ago, but they have come back with a vengeance.  Companies like Salesforce and Google are making dozens of “passive” investments per year, alongside venture and growth funds.Strategic investors have a wide range of approaches, so it isn’t surprising that CEO’s are frequently apprehensive about engaging them.  That said, we believe there are strong reasons for considering strategic investors as an alternative in the financing process.For the purpose of this post, we will limit our perspective to the inclusion of strategic investors as “passive investors” in a growth round, being led by a VC/Growth fund, without the complexity of considering simultaneous marketing agreements (or any other side agreement).  Below are a few factors we think you should consider:Are you ready for this? Taking on a “Passive investor” does not mean you won’t need to dedicate time or resources to maintaining the relationship.  Before engaging with potential strategic investors, have an honest look at your organization and determine if you are ready to make a great first impression, and then maintain the relationship. To get the most from the partnership, you should prepare to invest in it.  Tip: Consider using the some of the capital you raised through your strategic partner to hire dedicated staff to manage the agreed-upon co-selling or co-development effort.Know what you want.  Strategic investors are not really needed for their capital.  VC and growth equity funds have ample money to put to work.  Courting a strategic investor should be considered for specific business benefit.  The expected benefits can include an on-ramp for a new business partnership, validation from a sector leader, increased attention from an existing distribution or development partner, access to market intelligence or an on ramp to future M&A.  PR value is tough to qualify, but including a leader like Google, Salesforce, or Facebook in your round amplifies the impact of closing.Don’t think selfishly. It is natural to focus on what a large partner could do to grow your business.  However, attracting capital and continued support from a partner will only happen if you reverse the calculation to focus on what you bring to the partner.  Small companies can be very valuable to larger partners.  A common circumstance we see is the best of breed vendor for a key point product that enables a large, integrated provider to win key accounts.  If you are not ready to discuss how you will help your prospective investor, your chance of success is low.Use the “Press Release Test” early.  To validate that the your targeted strategic investor will be well received by your constituency, write a draft of the deal announcement where they become a shareholder.  Getting it down on paper can help flag any potential negative reactions.Avoid the myth of “Dumb Money.”  We meet Boards that suggest a strategic investor on the theory that they will price the round more aggressively.  On occasion, it is true that a corporate investor may price the round on metrics beyond just IRR.  However, targeting corporate investors solely for this reason usually results in failure.  Even when financings do close solely under this premise, it often leads to future strife.  An investor who overpaid materially is usually not a great long-term partner. Derailing the career of your corporate sponsor is usually not a path to partnership success.Qualify your partners. – Large companies have highly varied experience in minority investing.  Some, like Intel or Comcast, have dedicated teams that do more investments than most venture firms.  However, some corporations will never have the DNA required to do anything other than buy 100% of a business.  One quick tip: if your potential investor mentions they expect a right of first refusal to buy your company, walk out of the meeting and move on.Go early and be patient – Those of us used to the pace of venture firms find the corporate commitment process slow.  Plan for that, as the right timeline for this type of financing often is slow.  Getting in place, the parameters of working together, takes time.  Getting a large company with many layers of managers, each of whom feel entitled to review to commit capital takes time.  Invest time to discuss and document how the partners will go to market together, and who has what responsibility.  Also, plan to hold a second closing of the round to avoid rushing into a hasty partnership.  One of the best strategic investments I worked on required the negotiation of a global, country-by-country, market entry plan prior to closing.  It was a lot of time and work, but it formed the basis of a successful partnership, and a very attractive round of financing.At the end of the day, this is a complex topic.  But for CEO’s & Boards who are raising growth capital, there are millions of good reasons to look to the new breed of strategic investor.

Posted on January 31, 2014 in Insights, Technology Industry