Choosing the Right Startup Board: Venture Capitalists vs. Strategic Investors, with Misha Kuys

When looking for funding most scaleups take all the money they can get in their quest for growth. Get the money on the bank first and ask questions later is something I often hear back from the scale-up scene. Before accepting new term sheets however it might be wise to dig a bit deeper in the “why” of your potential new investor. In this article I’ll briefly explain the different types of investors and how they view each other to help you better understand what to look for in new investors.

The Venture Capitalist

While for start-ups the initial funding comes from friends & family and angel investors, for scale-ups the funding is more often sought from Venture Capital funds (VCs) and strategic investors as the amounts needed are much higher. VCs and strategic investors are professional companies that invest for a reason. For VCs the reason is money, they want to earn the highest return they can get to maximize their carry. This means they are focused on growing the value of the company and seek an exit opportunity. This is why VCs use a rigorous screening process to ensure they only invest in the companies with very high growth potential. Also VCs are willing to invest large amounts of capital with the aim of accelerating the growth of the company. Next to that they often bring business knowledge and a network to the table and they have an active role in building the company.

The Strategic Investor

The other type of investor is the strategic investor. A strategic investor is in many cases a large company that has an interest in the scale-up. Next to getting a return similar to the VCs, strategic investors always have an additional purpose for their investment. This could be a variety of things. Ranging from of a big corporate that struggles to keep pace with innovation to a government fund focused on stimulating regional innovation. This strategic angle should be clear to you. There are several other questions to ask when welcoming a strategic investor:

1. Are they a customer?If the investor is also a (future) customer be mindful of how the customer has organised themselves. Is the investor also the one you negotiate the sales contract with? Separating these things are not always easy and you might end up with an investor that wants to have a say on your product roadmap that might not necessarily be beneficial to all your customers. What if they invested in you and are not doing business with you. How will you explain this to other investors?
2. Are they willing to further invest?That they are willing to put money on the table now does not mean that they will also do this in the future. Unlike VCs, strategic investors don’t necessarily reserve money for follow- on investments. If the market gets tough and you need more working capital your strategic investor might be in the same difficult circumstances and would not able to invest.
3. How quickly can they make decisions?Especially with corporate investors the decision to invest in a new round might take weeks if not months. If you need a quick decision from your shareholder on a particular direction or a new funding round this sometimes can be difficult for corporate investors if they need a board decision or work with the calendar of an investment committee. Let alone if they first need the opinion of their Legal Department.
4. What if the ‘strategic angle’ changes?      While your interests might be aligned at the start, a strategic investor will also    develop itself. New changes in products and/or markets might have an impact on your relationship. Also a change in management might lead to different perspective on the investment in your company. Especially when successes take longer than anticipated other choices may be made.

Asking all these questions is important when deciding to welcome a strategic investor. While you might not always get an answer you could agree on how to best manage the relationship with a formal contact or an executive sponsor from the investor. You won’t be the last scale-up that is trying to find someone within a big corporate that is looking after their interests.

The VCs perspective on strategic investors

When asking VCs on their view of strategic investors there are very mixed responses. Some say that this is a sensitive issue as it brings a misalignment to the investors in the company. One example is a case on the sale of the company in which a competitor of the strategic investor offered the highest price. Another one is where a strategic investor did not have the budget to invest in a new funding round and as such blocked the round because it did not wanted to dilute.

I also know of cases in which the participation of a strategic investor prevented their competitors from doing business with the scale-up. While VCs recognize that a strategic investor could bring something extra to the scale- up it could also have a negative impact on the future business and valuation of the company as shareholder interests might not always be aligned as they are now. Of course, all these highly depend on how the cap table looks and what rights the shareholders have (e.g. right of first refusal, right to appoint directors) but all VCs agree that the success of having a strategic investor highly depends on its long-term commitment towards the scale-up and that it’s sometimes better to do without.