Sourcing Strategic Investment, Part II

Thoughts on funding your business with corporate venture capital

Make a wish that corporate venture continues to grow.  It is an increasingly vital source of capital for many companies.  How many financial venture capitalists are investing in material science these days?  Or cleantech?  Or hardware? In Part I of this series we discussed why this is so important, as well as considerations for entrepreneurs who are pondering corporate investment (see Part I).  In Part II, we discuss finding corporate investors that understand entrepreneurs’ needs for flexibility and ubiquity.

Flexibility

In a strategic investment, the corporation typically seeks to gain a strategic or operational advantage by investing in emerging technology.  The company seeks access to new markets, a large customer, a dedicated supplier and other benefits in addition to capital.  Sounds like a match made in heaven, right?

Well, it’s complicated. Those additional desires often make their way into forms of agreement; not always, but often.  Separate from “agreements” there is “the relationship”.  And any good relationship requires ongoing trust and mutual benefit.

In Part I we made reference to common types of agreements such as: distribution and supply agreements, license agreements, exclusivities, non-exclusive rights to product/technology, right of first refusals (ROFRs) for sale of company, preferred pricing arrangements and favored-nation clauses.

If there are no agreements beyond the investment, then what is expected from the

relationship may be vague, but there are expectations nonetheless.

So, as both parties seek advantages beyond capital, it is important that the manner by which they are achieved is compatible with the way the entrepreneur plans to run the company.  Is there a common vision for where you want to go and how to get there?  The latter is notoriously mutable.

If the entrepreneur changes business models, is there reason for both parties to continue working together?  What about a change in product mix?  Is the strategic a supplier and the entrepreneur needs to also use other suppliers?  Is the strategic a customer and the entrepreneur wants  to sell to their competitors?  Is the strategic a distributor and the entrepreneur needs channels they don’t cover?  Is the strategic a potential acquirer and the entrepreneur wants to make sure he can still obtain the highest possible bid when you sell the company?  Likewise, is the strategic pursuing certain lines of business that the entrepreneur may see as competitive?  Can you do all these things within the framework of the relationship and keep it intact?  The two parties want to assume the best going into a relationship, but a frank conversation around each of these issues may go a long way in management expectations and ensuring alignment.

A critical need for entrepreneurs is flexibility, whether that is to change strategies, business models or product mix.  Many strategics need flexibility as well,.  Corporate objectives and personnel shift more quickly today than ever before.  How will changes in management or corporate objectives impact the relationship?

Strategic investors that have been in venture investing for some time understand an entrepreneur’s need for flexibility.  Others may understand it conceptually, but still need to put the interests of their organization first.  Finding a comfort zone among potentially conflicting goals is an important part of the discussion. What are your expectations for this relationship?  And what if you need to make some of the aforementioned changes?

Early in my career, while negotiating a strategic investment, I remember someone using the phrase “the imagined horribles.” It had to do with attempts to document away bad things that could happen.  The utterance of that phrase released some pressure. We all realized we were investing way too much energy in negotiating things that probably wouldn’t occur. 

That’s not a suggestion to be a Pollyanna.  We did include language in that agreement to protect against some imagined horribles, but we curtailed it.  The suggestion is that building a venture requires flexibility.  It might not be in the interest of either party to document every aspect of the relationship.  The relationship, like the business, will change and adapt. Allow it do so. Focus on the most critical needs of each party.  If there is reason to continue working together, the parties will do so. If there isn’t, an agreement may bind, but will it benefit?  Or does it prevent the deal from getting done in the first place?

Ubiquity

Seeking ubiquity of one’s product requires vision, guts and more than a bit of confidence. A desire to achieve it is a trait common among great entrepreneurs. 

So, in taking on corporate investment, a key assessment for any entrepreneur is whether the investor will help augment or restrict the achievement of ubiquity.  Will the strategic help the entrepreneur reach new markets or customers?  On the flip side, will the strategic ask for exclusivities or restrictions on what the entrepreneur can do? 

For example, strategic investors may want exclusive right to a product or technology, providing an advantage in the market versus the competition. This doesn’t seem like an unreasonable demand in exchange for capital and distribution.  And it's a tradeoff that has been made.  However, many entrepreneurs recoil at the suggestion of any kind of exclusivity because it inherently conflicts with the ubiquity they seek. 

Fortunately, in this era, many corporate investors don’t require entrepreneurs to make this choice even when it would seem in their best interest to do so.  Why?  Because gaining access to the very best entrepreneurs and technologies requires terms acceptable to not only the entrepreneurs but also to the other investors.  And for many important technologies, a syndicate of investors is required to get the company to the promised land, however that may be defined. 

Besides, there are several ways to “win”.  If the strategic wants to own a technology or product outright, they are in the best position to understand its value and acquire or license the technology.  Even without exclusivity, a strategic typically gains a first mover advantage if they are working with an entrepreneur to commercialize a new technology.  There are the intangibles of a culture of innovation that comes with a program of working with entrepreneurs.  And, like all the other investors, the strategic has the benefit of their equity value if the product succeeds.  In sum, a strategic can win in many ways if the technology becomes widely available, even to direct competitors.

For entrepreneurs who are still concerned about a strategic limiting his/her options to sell product to anyone (or just the perception of being linked to one customer), they may consider strategics on the supply side rather than the buy side.  A strategic that supplies raw materials to an entrepreneurial venture also wants that venture’s product to become ubiquitous.  They may instead seek exclusive rights to supply or to match other suppliers, which is another point for negotiation.  For now, let’s just say redundancy in the supply chain is critical for most businesses that intend to scale.

Ironing It Out

So, here is the challenge: finding common ground amidst mixed motivations.  The entrepreneur seeks to protect his needs for flexibility and ubiquity.  The strategic seeks to serve the strategic objectives of his corporation.  They both seek to generate a return on investment (ROI).  Focusing on that common objective is something that tends to align all the key stakeholders.  It can help parties move beyond provisions that would otherwise impede flexibility or ubiquity.   If you’d like to discuss any of these matters, send an email to lkh@theventurelab.com to schedule a time.  Until then, best wishes for a prosperous venture.