Some perspectives on how startups should think about strategic (corporate) investors. Micah Rosenbloom of VC fund Founder Collective shares his lessons learned from his time as an entrepreneur.

The following is a guest post by Micah Rosenbloom (@micahjay1), Venture Partner at Founder Collective (@fcollective).

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.”

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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.

We learned:

  • 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.

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micahrosenbloomMicah Rosenbloom is currently a Venture Partner at Founder Collective, and leads the NYC office. He is on the board of Plated, and has led numerous others investments in B2B software, consumer services and financial technology.

Prior to Founder Collective, Micah was an entrepreneur who raised four rounds of VC (over $40M) for three companies. Most recently, he founded Sample6 Technologies and prior to that, he co-founded Brontes Technologies (acquired by 3M in 2006). His very first business was Handshake.com. Micah has a BS from Cornell, MBA from Harvard Business School and because of his first work experience at the Endeavor Talent Agency, he can fix any make/model of photocopier.

  • TyDanco

    Micah: excellent article, and I generally agree, but while Ted Dintersmith’s line makes for memorable copy and not a bad rule of thumb, I can give numerous counterexamples. I know I’m taking on conventional wisdom, most forcefully put forward by Fred Wilson–http://pando.com/2014/05/16/sorry-fred-wilson-but-corporate-vcs-are-gaining-steam/–but my firsthand experience in the field is mixed.

    First, there’s probably some definitional questions. Google Ventures, while a corporate fund, could not be more supportive of its portfolio companies and never plays hardball. Having raised money from them for my last company, I can vouch that the only downside of them being owned by a corporation is a much higher group of legal requirements than is necessary for the usual early stage term sheet. Is In-Q-Tel considered a corporate? Maybe not, but I can’t think of a more strategic investor for many security or data companies than the CIA and the US Government, which are the bucks behind them. So, you can’t automatically associate evil with “strategic” or “corporate”.

    My first company, eSecLending, was majority owned by a strategic company–yet our management at the time of their initial funding was able to insert “right to shop away” provisions and other protections that effectively allowed us to have our cake and eat it too–we had the backing and support of a large financial player, but were absolutely able to have our freedoms.

    Most of the time, however, with financial companies–think Wall St–your commentary is right on the mark. You need to be wearing your big boy pants, and assume that you will get screwed as part of their “fiduciary interest to advance their shareholders interests.” But I don’t think that’s a surprise to anyone.

    Bottom line: you should always be suspicious, but not biased against. But that holds true for biz dev arrangements, M&A, the works. And if you do pursue a strategic, better lawyer up first, and don’t skip the due diligence of talking to all of their other portfolio investments.

  • Micah Rosenbloom

    I agree with your point. Google Ventures among others have a great reputation and are quite different than traditional strategic investors. I’ve seen most of the traditional guys change priorities as the economy or personnel change, and the start-ups they help fund can be caught in the middle. The ideal setup is to start by forging a business development partnership and then later consider an investment after both parties understand everyone’s intentions a bit better.

  • Mike Docherty

    Great post and insights Micah, thanks. As someone who’s worked on a lot of corporate/startup collaborations, I thought I would weigh in with a few more examples that show the benefits of corporate investment and (more importantly) attention on startups in their early stages.

    P&G’s imbedding of Sonny Jandial into Shopkick (at the behest of KPCB) was a key turning point for the startup. Cyriac Roeding, Shopkick’s co-founder gave a lot of credit to P&G for getting Shopkick to 1 million users in 6 months. Without P&G, Shopkick would have focused too heavily on retailer interests alone and missed the bigger picture.

    Enlight Bio is a biotech portfolio play that has built their entire business model on input and strategic support from a syndicate of corporates including J&J, Merck, Pfizer and others. The strategic direction, guidance and investment from these corporates is helping Enlight target breakthrough opportunities and both Enlight and the corporate partners are winning in this arrangement.

    From an exit standpoint, too many financial VC’s are swinging for the fences and delaying exits. With corporate and angel investment, it may be only a 5-10x exit, but it can happen in 3-5 years. With VC investment it’s often a goal of 10-30x as the goal and the exit is 10 years out. A Kauffman Foundation study issued a few years back showed that VC money resulted in 10% more failures, 20% fewer 1-5x
    exits and only 1% more 10-30x and 30x+ exits in comparison to angel investment.

    I just wanted to reinforce that while your guidance and cautions are right on, the rewards of working with corporates is often well worth the risks. Often it’s an opportunity to ‘reverse engineer’ your startup and get a quicker exit. It all depends on your startup, your personal vision and your market.

    Thanks for the discussion!

  • http://www.dlapiper.com/ Mark Radcliffe

    I think that this discussion is very disappointing particularly the initial quote by Ted Dintersmith which I think is simply outdated. I have been working with investors and companies (generally about 50 startups at one time) as a partner at DLA Piper, a large Silicon Valley law firm, for over 30 years. I also run the Corporate Venture Capital practice and have worked with many corporate investors. It is certainly true that corporate investors in some past periods (particularly during the dotcom bubble) acted poorly, but many traditional financial venture capitalists had similar lapses.

    However, in the past five years, I have seen a dramatic increase in the sophisitication of corporate venture capitalists: many of the current leaders in corporate venture capital worked at traditional financial venture capital firms such as Jim Lussier at Dell (Norwest) and Sue Siegel at GE (MDV). Morever, corporations can accelerate a startup’s business through their distribution channels and deep knowledge of the market. And the vast majority of startups exit through M&A, corporate investors may be a potential option for an exit (although be careful, some corporate investors such as Intel Ventures, rarely acquire their portfolio companies).

    That said, it is important to understand the corporate investors have different goals from traditional financial investors (and different risks) and you need to consider those issues as you consider them as investors.

    1. Corporations generally invest in part for “strategic” reasons so you should not approach them until you have a fairly stable strategy.

    2. Many corporate venture groups are young (475 corporations started venture capital groups since 2010) and may not have the necessary experience to understand how the venture capital industry works.You need to sensitive about the experience of the particular venture group;: for example, if they start asking for rights of first of refusal for an exit, they are demonstrating a misunderstanding of the venture capital industry. You would need to very careful and may decide to pass.

    3. Corporations may change their strategy or you may change your strategy. You should work with your lawyers to ensure that corporate investors do not have veto powers over major corporate decisions by your startup (i.e. they should not control a new round of financing), You may even want to make them act like financial investors and require them to vote for an exit if it meets certain IRR.

    Moreover, with the decreasing number of traditional financial venture capitalists, you need to seriously consider corporate investors.

  • Jack Leeney

    Interesting perspective and a great topic to review. The most important piece of the puzzle here is to have a true understanding of who is on the other side of the table, what their objectives are and very specifically how their group approaches the market. I mean the person, not the investment vehicle, not the business unit or corp dev and most definitely not the umbrella brand or corporate they are ultimately working for. This is the same diligence an entrepreneur does as you work with a GP offering a term sheet. Investigating a personal investment history, board membership history and potentially varying VC fund membership history. Everyones about to be with each other for a long time!

    Capital formation is crucial in any startups journey as you ideally navigate growth in a linear fashion (which is always how it goes, right =D). The most important consideration to truly understand a Corp investor is that there are multiple “flavors” of corporate investment programs — and lets please stop only referencing Google Ventures (a massive entrant to the market in last 5 years) and Intel Capital (the largest and longest standing Venture investor globally by a number of metrics) as the only two bellwethers here to define a growing class of VC investors. Disclosure: we’ve coinvested with both groups and admire their approach.

    Corporates generally run the gamut of three “flavors” in my opinion: Strategic (commercially inclined), Ecosystem oriented and a third which I will call Independent (vs. financial). To add another layer into the mix, sometimes corporates run multiple programs at multiple investment stages (rise of accelerators, labs, innovation initiatives internal and external) with different objectives, as well as fund of fund programs. All of these may or may not be run in conjunction or within a Corporate Development (M&A) group, the CFO/CTO/CSO office or a specific business unit. They may have totally different thematic, geographic or strategic intentions by program. They may all have different reporting lines in the organization! It’s crucial to understand the structure and nuance of each program and vehicle vs. just being “all part of one brand”.

    Strategic groups for the most part are working very closely with a BU “sponsor” or really “customer” from a startups POV. These folks are also most likely investing off balance sheet from a budget — either the venture budget or BU’s — find out. That may mean one time investment is the style and don’t expect follow on, may also mean preference is to follow vs. lead rounds but everyone’s different. What it DOES usually mean is the VC team and BU have to pitch the investment together and there would be significant commercial interest. What it also means is to expect longer execution timelines and a more concentrated, smaller overall portfolio.

    Ecosystem oriented groups are a mix of some VC behavior and corporate behavior. In brief they usually are taking a thematic approach, aligned with areas of interest for the corporate and have a bit more rope to run with as far as company selection and investment approval. They will also seek to create inroads to the relevant business units — but its no promise BU will turn into a huge customer… I think of ecosystem groups as the ability to select the best emerging companies, and seek to push them into the corporate. If roadmaps, philosophy and strategy line up everyone wins. You’ll learn post investment if it does or not.

    Independent groups are rare and may be very visible, but make up a very small piece of the overall Corp VC market. These folks in my view are really running Single LP VC funds and focused on generating outsize IRR. This is not to say they can’t help with connection to their LP/Corp Sponsor — its just not the priority #1. Google is not the only Corporate doing this! Nokia has had a long running and very successful fund, SAP also has a very strong independent program.

    If I were an entrepreneur seeking money from a mix of financial and strategic groups, I’d spend a disproportionate amount of time understanding who I am working with and what will their position in my company be for the rest of its existence. We’re all different — there is no logic in bucketing all Angels as Angels, VC’s as VC’s and Corporates as Corporates. Longevity, behavior, profile and frankly ability to help the company grow comes down to the individual investors and the capability of their platform.

  • Vinit Nijhawan

    Micah I couldn’t agree more on approaching strategic investors with caution. This is even more important for later stage investments where strategics can add a lot of value (particularly for access to markets). One option that I have seen employed by a company that I was on the board of, was to negotiate an exit option with a “floor” valuation with the strategic investor. Any other potential acquirer knew they would have to offer more than the floor valuation. This can help alleviate the acquisition “lock-in” signal with a strategic investor.