In the world of the investing in and acquiring of companies, strategic investments sit on the fence between these two camps. When an established company sees a smaller one making progress in a field that it is interested in, it may make an investment in the company for one of several reasons. Doing so can give the company a bit of leverage in terms of helping steer the startup while not dropping a big acquisition investment. That said, it is important for startups to understand both sides of the coin before taking on strategic investors.
“One way I’ve seen a startup navigate [the right of first refusal] clause is by narrowing the timing of such a blocking right to 6 months or 12 months. I’m not a fan of that either.”
– Bijan Sabet, Spark Capital
partner
wrote on
today, pointing out the potential pitfalls for startups with strategic investors. He says that in his experience, relationships with strategic investors are usually not positive ones for startups because of the misalignment of incentives.
A venture capitalist is incentivized to see the startup succeed; the better the startup does, the greater the VC’s return on investment. Strategic partners, on the other hand, obviously care more about protecting themselves than the success of a smaller company. As Sabet adds, this can lead to bad deal terms for the startup, including giving the partner the ability to block an acquisition.
“They don’t want to see your company being sold to a competitor,” writes Sabet, referencing a “right of first refusal” agreement. “One way I’ve seen a startup navigate this clause is by narrowing the timing of such a blocking right to 6 months or 12 months. I’m not a fan of that either.”
Another way that Sabet suggests startups can avoid bad strategic partnerships is to introduce incentives for the partner to turn the tables a bit. Startups can set goals or quotas that will incentivize the partner to provide for the startup in order to receive its equity. With this safeguard, if the startup doesn’t significantly benefit from the relationship in the way that it needs, the partner goes home empty handed.
The Good & the Bad
For startups, strategic partnerships boil down to pretty clear pros and cons.
The Good: Strategic partners can provide much needed capital, especially at a time when financial investors may be balking at the company. They can also provide resources and exposure for the startup than can be invaluable to its success.
The Bad: Strategic partners aren’t as focused on the interests of your company, and in most cases aren’t even in it for the money. Companies take on smaller partners to help promote their own brand or to leverage new technologies. While a strategic partner could lead to an eventual acquisition, it could also prevent the startup from being acquired elsewhere.
The Solution: Be wise. Carefully inspect the details of the partnership and be sure it doesn’t forfeit too much power to the partner. If need be, use merit-based rewards or other incentives to ensure the partner holds up its end of the bargain.
For startups, a strategic partner is a careful endeavor to consider, but if done right it can be beneficial. If you have any other reasons why a startup should or should not take on strategic partners, please share your thoughts in the comments below!
