Think twice before committing to strategic investors
Transcript
In the last two weeks, I have had three entrepreneurs come to me all excited about the opportunity they have.
You see, all three of them were raising money and all three of them had an offer from a strategic investor to participate in the round.
And they thought it was awesome because not only were they going to get more capital, but they had an investor who was there,
who knew their business, who was a likely acquirer. They had paved the road to an exit.
Yet, I'm here to tell you, that's probably the worst position you can put yourself into.
Let me explain. You see, strategic investors, which I will define as investors who are investing
because of the strategic relationship with the company, as opposed to financial investors,
like angels and venture capitalists, are likely acquirers. Many times they're a business in your
industry that's much bigger and further along, sometimes even a publicly traded company.
But here is the problem. The problem is that the path to the best outcome you can have financially
on an exit is having a competitive bidding situation when that time comes. That's how
you get outsized value. That's when you create a lot of value for you and your shareholders.
But let's play this out. Let's say you have a strategic investor on the inside, maybe even on your board of directors. And let's say that you have a second company, Company B, that's thinking about acquiring you. As soon as Company B learns that you have a strategic on the inside, Company B is done. And the reason they're done is because they can either lose or they can lose. There's no way for them to win. Let me be specific.
You see, if Company B comes in and makes a good offer to buy your company, and it's a reasonable offer,
they know the strategic will know about this offer as they're on the board, they're on the inside,
and will outbid them by a dollar getting a good offer for your company.
If Company B comes in and makes an expensive offer for your company and pays more than it's worth,
that's the only way they'll keep the strategic from outbidding them.
But then they paid more than it's worth.
So company B either loses or they lose.
It's no win for them.
And so once they find out that there is a strategic inside your company,
they're going to bow out from the process
and they're not even going to bother to put in a bid,
which leaves you in the position of having one exit possibility.
Now you don't have a competitive bidding situation
and the strategic can pay whatever they want
and you either have to accept it
or keep operating and know that you'll be in that same situation again.
So, how do you protect yourself against this?
The first thing I would do is try not to have a strategic on the inside.
As tempting as that feels, having someone who could potentially acquire your company
on the inside, it really is a recipe for reducing the value of the company down the road.
But there is an alternative, and that is if you can get two or more strategic on the inside
at the same time.
You see, they'll keep each other honest.
We've all seen this.
You remember when Hulu was launched, Hulu had multiple strategics as investors.
It was part of their big press release, but they knew that they would each keep each other
honest if there was an exit opportunity.
So be careful when you're thinking about who your investors are, and particularly when
you're thinking about having a strategic, that you either have no strategics or two
or more strategics on the inside.
I hope this was helpful.
Strategic investors seem like a great way to build a relationship with a company that who could potentially acquire you in the future. THINK TWICE, because it may not be in your best interest to have them on your cap table. In this video, I explain why what seems like an amazing opportunity might be a decision you would regret…
Originally published on the MATH Venture Partners blog.