Tag Archives: Value add

When to raise money from a strategic investor

As a startup, there are two benefits of raising money from a strategic investor.

First, the strategic support provided by the investor can provide value beyond what a financial investor can provide. For example, this may come in the form of new customers, new suppliers, a distribution channel, technology, or a reduced cost base.

Second, a strategic investor can turn into a strategic buyer at the time of exit.

There are also two downsides to raising money from a strategic investor.

The first is that the strategic investor can, either through their investment rights or through persuasion, pull your startup in a direction that makes sense for the interests of the strategic but not necessarily for your startup. This goes beyond the different perspectives that founders and all investors, including financial investors, can have about the best direction for the company to achieve its goal of maximizing long-term shareholder value.

The second is that the presence of the strategic investor and the fact that it is often a likely buyer of the company has the potential to limit other exit options for the company. As a result of the restricted exit options, financial investors are often less willing to invest in the company.

When you’re an early stage company, you have yet to exhaust the many ways in which you can create value. You’re also far removed from an exit. As a result, the costs of raising money from a strategic investor outweigh the benefits. If you have other options, you should avoid raising money from a strategic investor.

When you’re a late stage company, a strategic investor can provide new value in an environment where you’ve exhausted many of the easy ways to create value. You also start to think about an eventual exit. The benefits of raising money from a strategic investor might begin to outweigh the costs, so you will want to think about doing so.

Capital without interference

I was recently speaking with the founder of a very successful tech company. We were talking about the company’s largest investor, which also has a strong brand, when the founder shared that he’s very happy with the investor.

Hoping to learn some of the contributions which a reputable investor makes to their companies, I asked what the investor does that makes the founder so happy. The founder’s answer was that the investor doesn’t do anything. And as a result of not doing anything, they don’t interfere with the business.

Some great founders just want, and only need, an investor’s capital without their interference.

And some great investors don’t add much value. They just make the right investment decisions and don’t subtract value.

Term sheet making and taking

In venture capital, sometimes you have the luxury of being a term sheet maker. In other words, you get to have a strong say on the terms at which you’re investing in a company.

The conditions under which this is more likely to occur are when there is limited competition for the deal, you have a unique ability to add value to the company which is recognized by the founder, you’re investing a relatively large check size, and, better yet, a combination of multiple of these conditions.

But often, these conditions aren’t present. There are multiple bidders at the table, each of these bidders is in a position to add value to the company or at least this is what’s perceived by the founder, and your investment amount is relatively small.

When this is the case, you often have to take the term sheet that is put forth by the company. In other words, the company dictates most of the terms.

While this is suboptimal from an investor perspective, not doing these deals would mean missing out on some great companies. In fact, some of the conditions which produce an environment where you need to accept being a term sheet taker are the direct result of the quality of the company. For example, higher quality companies attract more bidders to the table and this gives the companies a stronger say on the investment terms.

When this is the case, if you really want to be part of the company, you have to take the term sheet on the table.

AngelList VC funds

In April 2015, after AngelList launched pre-funded syndicates, I published a post about AngelList’s future direction. In the post, I wrote that “I wouldn’t be surprised if syndicate leads first remove an investor’s ability to opt out of investing in specific startups, and then start raising an aggregate amount of capital to invest in a number of startups during a fixed period of time (a fund) rather than on a deal-by-deal basis. In other words, AngelList may become the very system it was looking to displace.”

Fast forward 2 years and AngelList announced that it is indeed beginning to launch new VC funds on its marketplace. The fund sizes are small for now (sometimes as small as $0.5M-$1M), but will likely grow larger as the model begins to show results. This will attract more institutional capital like Bain Capital Ventures which is already backing some of the new funds. The funds are also beginning with a fixed 1 year life, but once again this is also likely to grow longer as the model is proven to work.

What I did not predict was that the general partners of these VC funds would primarily be current operators. This is the natural result of AngelList decoupling a general partner’s ability to add value from their ability to raise money. This favors current operators whose experiences give them an edge in the former area while their limited time makes it challenging for them to do the latter.

However, AngelList’s new program is unlikely to be limited to current operators in the future. Anyone who has the ability and work ethic to add value to startups but could use some help with fundraising is a great candidate for the program.

The program will help shift the skills necessary to be a successful venture capitalist away from the ability to fundraise from limited partners towards the ability to add value to companies. And that will increase the number of successful startups, which is a good thing.