According to CB Insights, 30% of fundraising dollars in Q1 2014 was from strategic (or corporate) investors, with corporate VC funds participating in 15% of all rounds. The discussion invariably comes up at Board Meetings when a fundraising process is begun. Legendary VC Ted Dintersmith of CRV once said to me, about taking capital from strategics, “Be careful. You’ll have sold your company. You just won’t know it.”
These days, a new class of investors, corporate funds like Google Ventures and Intel Capital, operate more like a financial VC than typical strategic investors. Nonetheless, I’ve been on the receiving end of strategic investments for nearly all of the companies I co-founded, and I’ve learned a lot. Ted’s words still ring true today.
Below are some examples and lessons learned.
Example #1 – Handshake.com & SBC Communications (1998-2001)
In ‘98 Handshake built one of the first online booking and scheduling platforms for small businesses (from hair salons to house cleaners). Not far from Handshake’s offices in Marina Del Rey, CA was a corporate skunk works projects called Smart Pages. Smart Pages, a wholly owned subsidiary of SBC Communications, was formed with the distinct purpose of developing a “next-gen Yellow Pages.” SmartPages and corporate parent SBC Communications seemed eager to do a deal with Handshake. So, roughly one year from our A round, we closed a $20M financing at a $100M valuation (despite virtually no revenue and only a basic product).
My lessons learned at Handshake:
Valuation hypnosis – Don’t be bamboozled by sky high strategic valuations, they create issues for future financings – we would have been better off with a lower valuation from a conventional VC
No fairweather fans – Some strategic investments are used to justify corporate side projects or to tell a “story” to Wall St (in this case, that SBC was hip to the web). When winds shift, the strategics aren’t always around to help. Often their investment vehicles are the first to go.
Example #2 — Brontes & a large private co. (2003-2010)
Brontes Technologies (sold to 3M in 2006) developed a 3D scanner and digital workflow software for dentists. Our strategy early on at Brontes was to get close to potential investors, partners, and acquirers, but not too close. As we were getting ready to raise our Series B, conversations heated up with a large, privately held dental products company. We had had discussions with other players, but felt that taking capital from most industry players would have limited our exit options (fortunately Ted Dintersmith was on our board!). Playing hard to get paid off with the other potential strategics. The Series B fundraising process catalyzed the M&A process and we ultimately sold the company.
Everyone wants to join the club that won’t have them – Strategic investor interest can sometimes be parlayed into an M&A process. (turn them down as investors and they may want to buy the company even more)
Keep your enemies close (but not too close) – Be careful of whom you share information, some parties will use it to learn but have no intention of investing or acquiring despite their overtures.
Example #3 — Sample6 & Chevron Tech Ventures (2011+)
Sample6, spun out of BU and MIT, develops a technology for rapid detection and elimination of harmful bacteria in a wide variety of applications. Early on at Sample6, we were eager to explore applications in oil & gas and thus took Series A capital from Chevron Tech Ventures. However, over time, we determined that the right applications for the technology were in the food and water industries, not oil & gas. This took some of the bloom off the rose for Chevron.
Our mistakes were:
Figure out what you want to be when you grow up – We took strategic money too early- before we had really firmed up the company’s ultimate use case. We let strategic interest drive the initial explorations of the company instead of focusing on where the highest value could be created with the technology.
Crossing signals – There can be real signaling risk in taking strategic money early as well. Since we no longer were executing oil & gas applications, future investors always wondered why Chevron was invested in the first place.
I’m not suggesting that companies should never take strategic or corporate money under any circumstances. Just tread carefully – understand how the strategic’s fund (if there is one) is set up, how the managers are compensated, and speak to other portfolio companies. Strategic capital is typically best used in later rounds from investing companies that have a neutral spot in your market, and, where there is a true champion from the operating team.