Deciding what type of investor to seek for your growing company is a critical decision. Once you are past the initial start-up phase, equity capital can be sought from venture capitalists, angel investors or strategic investors. This is the first of two articles which provide a brief overview of the differences among a venture capitalist, an angel investor and a strategic investor, and suggests what you should consider in seeking funding from a strategic investor.
Differences Among a Venture Capitalist, an Angel Investor and a Strategic Investor
Venture capitalists are professional investors which bring cash, business experience and advice, and a network of potentially helpful contacts.. As part of providing fairly-large investment dollars, a venture capitalist usually takes an active role in your growing company through board participation and secures relatively tight control over major decisions, even if the venture capitalist is in a minority share ownership position.
An angel investor tends to provide a smaller amount of money for investment than a venture capitalist. Usually, an angel investor is a high net worth individual who has been successful in business and probably has day-to-day operational experience. While some angel investors will take an active role in your company through board involvement, many angel investors remain more passive and do not seek as much control over decision-making. While both a venture capitalist and an angel investor will seek a high rate of return on their investment, the angel investor will generally be less aggressive on valuation and is usually willing to wait longer than a venture capitalist for payback.
In the case of both a venture capitalist and an angel investor, their only interest is a cash-on-cash return on their investment. A strategic investor is also interested in a return on its investment, but will make an investment in your company because of a strategic interest in your business. For example, if you have developed a novel product or some interesting, new technology, the strategic investor may wish to complement its own growth by strategically integrating your company's novel product or new technology into its business. A strategic investor is usually a larger company, often in the same industry as your company. Compared to a venture capitalist, a strategic investor is usually less aggressive on valuation, i.e., is willing to take a smaller equity position in your company for the same amount of money. The strategic investor will also generally be less aggressive on controls on decision making.
A strategic investor will seek an equity position in your company plus something else. The "something else" is what makes the strategic investor different. The most common means by which a strategic investor seeks its strategic advantage is to require a license arrangement, a marketing or distribution arrangement, some sort of collaborative development agreement with your company, or an option to buy your company. For example, a strategic investor may require your company to license the new technology to the strategic investor, or a strategic investor may require your company to enter into a collaborative development agreement whereby you agree to further develop the novel product or new technology jointly with the strategic investor.
What to Consider If You Seek a Strategic Investor
If your company is only in need of cash, consider a venture capitalist or an angel investor as the source of funds. Don't pursue a strategic investor just because you believe you may get a better valuation than you would receive from a venture capitalist. However, if you seek a relationship with a larger player in your industry, consider a strategic investor. When considering a strategic investor as a source of funds, you should know the following:
Partner Selection. Identify the pool of strategic investor candidates. Determine the kind of strategic investor with which you want to be affiliated. Would your company benefit from working with a competitor which has a sophisticated distribution network that can provide enhanced distribution channels to your company? Would your company benefit from working with an industry leader which has a complete sales and marketing infrastructure that your company lacks, the so-called "feet-on-the-street?" Would your company's acceptance in the marketplace be enhanced if it were affiliated with a seasoned industry player that has the respect and confidence of the marketplace? Evaluate where your company needs help and identify those strategic investors who can give your company that help.
Approach and Process. Plan how your company will approach the strategic investor candidates. Do you or someone in your network know someone within the organization of the strategic investor? Alternately, your professional advisors, such as attorneys and accountants, may facilitate your approaching a strategic investor. Consider whether an investment banker could best represent your company's interests to the strategic investor. Your objective should be to establish a meaningful relationship with someone who has authority and influence in the organization of the strategic investor.
Assess the Motivations of the Strategic Investor to Invest in Your Company. Anticipate what the strategic investor will want from your company and whether you are willing to agree to those terms for the help you need. Understand the "something else" that the strategic investor wants from your company and assess the impact that the "something else" will have on your company and its future growth and exit strategies (sale, IPO, etc.).
If the strategic investor seeks a license to your new technology, consider whether your company will grant an exclusive or non-exclusive license. What will be the acceptable scope of the license? For what period of time will the license be granted? In what geographic location can the strategic investor apply the technology? If the strategic investor seeks a collaborative development agreement, consider whether your company will share ownership of any resulting improvements. For what aspects of the joint collaboration is your company responsible? If your exit strategy is a sale of your company, can you convince a strategic investor to accept a "right of first negotiation" rather than a "right of first refusal" (which has a chilling effect on obtaining alternative bids for your company).
Allot More Time for the Funding Process. A strategic investor's investment usually requires the internal approval of its management and sometimes its Board of Directors, and has to move its way through the in-house legal department. As a result, you should be prepared for protracted negotiations. Use a non-legally binding term sheet or letter of intent at the beginning of the negotiation process. The term sheet or letter of intent can serve two purposes. First, the document will be a means to try to hold the strategic investor to its promises made at the outset. Second, the document helps "flush out" and make clear the strategic investor's deal terms.
Work with Your "Sponsor." You should establish a good working relationship with an individual within the organization of the strategic investor who is excited about your company. Your sponsor can help to maneuver your deal through the corporate bureaucracy and politics. Your sponsor can also help to implement the deal after it is signed.
Negotiate the Terms Carefully. Don't be pushed into a corner by the terms of a strategic investor with much greater leverage than you. Ultimately, you do not want to enter into an arrangement that hinders your company's ability to reach its goals. For example, if your company would like the flexibility to work with more than one strategic partner, then an "exclusive dealing" term could eliminate your company's ability to work with other good strategic partners. Appropriately define the scope of "exclusive dealing" arrangements. Keep in mind that a strategic relationship may not work. As a young company, you cannot afford a lawsuit against the strategic investor if something goes wrong. Therefore, you should carefully negotiate the terms of the financing such that you can break the terms of the agreement if that is in your best interest. Take care to avoid ambiguous wording that would only facilitate legal claims by the strategic investor.
Plan to Implement. While negotiating the financing, you should meet with the strategic investor to plan how the relationship will be implemented. Such implementation meetings will help you see how much priority and resources will be devoted to the relationship by the strategic investor, i.e. how the deal will actually work after it is signed. Sometimes what you learn will help shape the agreement, or cause you to change your mind altogether.
Be Flexible. Keep your funding options open. If a particular strategic investor does not work out, walk away and seek your funds elsewhere.