A number of startups in our portfolio have considered taking an investment from a strategic customer. The idea is that the large company will care more about the relationship if they own a percentage of the startup company. The large company also feels better perhaps because they get upside if the startup becomes extremely valuable.
Simply put I’ve seen this play out in three different ways after such an investment:
-strategic partner is helpful
With financial investors the incentives are typically aligned with the founders.
But strategic customers that own equity in your startup have different interests. They care about their own company first as you would expect.
Few suggestions to keep in mind:
-put together an outline/termsheet of a business relationship you want with the strategic partner and make sure you both see the world the same way. Getting a business deal done along with an equity investment can be a good way to surface key sticking issues.
-consider what happens if the strategic partner terminates the business agreement over time but still owns equity in your company. This is a likely scenario to it’s important to think about that.
-Often times the strategic investor will want some type of blocking right, that is the ability to block a sale of your company. Their rationale: they don’t want to see your company being sold to a competitor. Blocking rights are either spelled out as such specifically or they ask for a softer version of this in a ROFR (right of first refusal). In reality a ROFR is just the same thing and I would not accept that. One way I’ve seen a startup navigate this clause is by narrowing the timing of such a blocking right to 6 months or 12 months. I’m not a fan of that either
-avoid having a strategic customer on your board of directors
-one way to give your strategic customer incentives in your business without selling them equity is by giving them performance based warrants. That way if they don’t deliver the goods they don’t own any equity.
-consider how this strategic investment will impact your ability to work with other strategic partners/customers.
If the tone of this post suggests I’m not a big fan of strategic investments than I’ve done my job today. I’m really not.
So just be careful and keep your eyes wide open.