Are Strategic Investors More Important in a Downturn Economy?
First, let’s define a strategic investment. A strategic investment is one that’s made most often by a company in your industry, and in some cases a competitor. I don’t think most startups look at strategic investment opportunities - they pursue angel and VC investors first - but in a downturn economy, do strategic investors become more relevant?
A lot of venture capital money is being held onto by VCs, or being invested into their existing portfolios. Angel investors will be a bit more wary as well; they’re seeing their stock market portfolios taking a beating and will have less investment money to deploy. But strategic investors, assuming their businesses aren’t totally collapsing, may have small war chests and see opportunities to jump in and support startups.
Jason Mendelson and Mark MacLeod both provide excellent insight into the pros and cons of strategic investors. Generally Jason and Mark aren’t overly positive, and it’s easy to see why:
- What’s the motivation? A strategic investor may not be looking for the same outcome as a VC (i.e. a 10x return in 3-5+ years). And that could lead to significant conflict down the road.
- Beware of funky terms. A strategic investor may want to block its competition from playing ball with you, and that’s very risky. For example, if they have first right of refusal to acquire your company, who is going to make you an offer knowing that the strategic investor can just jump in and see everyone’s cards?
- Are they experienced? I suppose this could be a pro and a con. You might get less due diligence issues, maybe you can get a higher valuation, but you might also run into other issues because they’re not sophisticated investors.
There are definitely issues with strategic investment. But if other sources of capital have dried up, you may want to revisit strategic investment opportunities.
As is the case with any funding - whether from angels, venture capitalists or anyone else - you need to go in with your eyes open. The more you know, the more you understand about the process, and the more you’re prepared, the easier things will be. The less shocked you’ll be when certain issues come up. The quicker you’ll be able to respond to questions, and anticipate problems and issues that investors will want answers for. Keep your eyes open.
I don’t know if we’ll see more strategic investment deals over the next 12-18 months, but I think it’s an interesting point of discussion. I do think it’s the responsibility of every startup CEO (and startup founders) to look at every opportunity and assess it carefully. Whereas 6 months ago you might have ignored strategic investment because of the issues it brings, now is probably a good time to re-open those opportunities and at least pursue them a bit further. You can’t be exclusively focused on raising the perfect Series A, for example, from a top-tier venture capital firm — now is the time to review angel investment opportunities, other venture firms, strategic investment and even going back to your existing investors to discuss bridge rounds and other options.
Keep your eyes open. And keep your options open.
What’s your take? Do you foresee more strategic investments taking place? Will they become more important in a downturn economy?
Hi Ben, it’s been awhile
I saw a great example of a strategic investment in the photography business. Co. A was a very high end (and most expensive), well known establishment. Co. B was funded as a startup at the low-mid level price point with student photographers that earned equity based on performance.
They were located on the same street, different names, and identities.
When people were unable to afford Co. A, they were referred to Co. B. It worked great because Co. A could continue focusing on it’s affluent clientele while Co. B got qualified leads that fit their business model.
They were in the same industry but served different markets at different price points. That said, they also had well defined shareholder agreements that identified conflicts of interest and remedies.
Their situaion was unique because they kept their companies separate and the public never knew their was any connection.
As separate companies if there was any M&A activity, it was dealt with at an arms length and left the other business intact.
It was one of the most unique and functional strategic investments I had ever seen.
Hey Ben,
Thanks for the link in this post. You ask a good, timely question. While I recognize that excepions exist, I am as against strategic investment as ever. Strategic big public companies are reeling from the drop in their stock price these days. They don’t have the confidence or patience these days to carry uncertain investments on their books.
In contrast, VCs are private and can take a multi year view.
Mark
Thanks for this interesting perspective. The recent and infamous Sequoia “RIP Good Times” presentation to their portfolio companies encouraged entertaining strategic investments going forward. Good to see some warnings about the downsides.
I wonder if anyone has put together a survey of strategic investments to show how they’ve performed over time and what the outcomes were?
Hey Ben,
Thoughtful post. While I believe that strategic investments are an option, a key concern I have would be “Do they know if they can really do this or not?” Does a larger company have a solid grasp on their financials and how much bureaucracy and time will be involved before you see the money. With the current economy, you’re seeing large companies cut people and costs but adding more “approval/risk” groups to all financial decisions. Even if I thought I had a solid strategic investment lined up, I’d still be out there until I had the money in hand with an agreement I could live with. I probably wouldn’t hold my breathe.
Good luck to all,
Scott
A timely topic, Ben. I work with small business clients; one of these clients was in the midst of significant expansion program, with lender support, when the September financial ’storm’ hit. Now, the bank has changed its requirements (debt to equity) to the degree that the expansion cannot move forward. The client is looking for a strategic investor rather than pulling in/out completely. But, yes, the risk is higher. When they find someone with the money and the interest, what will they have to give up in return? It’s a tough spot for all businesses looking to grow (and without a ‘war chest’ to do so).
Definitely you should be careful. There’s a big chance you’ll have to step aside sometimes in the future.
I don’t think there will be too many “strategic investors” in my industry (health care). It may take2-6 years, but Obama is going to have the Federal boys taking care of things.
I won’t jump to any conclusions yet…but I am skeptical of the results.