VCs vs Strategic Investors

In the life of a startup comes a time when you are on the cusp of take-off.  You’ve got your business plan down, the deck looks crisp, the financials seem to show a nice long hockey stick curve heading all the way into the horizon and the 20 second elevator pitch has been prepared and practiced.  If you’re really on top of things, you’ve also managed to get a few initial pilot customers who’ll buy when you have something to sell.

It’s time to bite the bullet and start having conversations with investors, since as famous bank robber Willie Sutton once said, that’s where the money is.

This blog differentiates between two major investor groups, viz; VC and Strategic Investors.

Timeline to funds:  As a young pre-revenue startup, your clock is already ticking.  In such case, VCs are likely to provide you with funding first, since they are also under a timeline to provide returns to their investors.  It doesn’t hurt to sign on some strategics as pilot customers, as this helps your negotiations with VCs.

Timeline to exit:  This is one of the major differences between VCs and Strategic Investors.  VCs invest for a fixed timeline, at the end of which they need to exit and make their money.  They are in it for the money.  Strategic Investors, on the other hand, don’t ever plan to exit, unless the investment turns out to be a dud.  They consider investments as outsourcing their R&D.

Valuation:  VCs try to minimise your valuation when they invest, but once they do, their motivation is to maximise your valuation for future investors.  Strategic Investors, on the other hand, are not that concerned with the valuation at initial investment.  However, since they expect to buy the rest of your company as commercialisation progresses, they try to minimise your future valuation.

Exclusivity:  VCs operate on the premise that since they have no idea what technology will succeed in a given sector, it makes sense to invest in multiple startups with different technologies or routes-to-market.  They will thus not only not provide exclusivity to the startup, but consciously and aggressively invest in multiple startups with different technologies to address the same customer vertical.  They also encourage cannibalism across their investments (since their focus is money maximisation, rather than soft factors like emotions, as mentioned above).  Strategic Investors, on the other hand, are loyal creatures.  Thus, once they invest in a startup, it is likely that they would sign a non-compete where they refrain from investing in similar technologies or even across multiple technologies addressing the same market.

Future funding:  With VCs, future funding is not a given.  It depends on their funding cycle and if the buzz is still there.  With Strategic Investors, the opportunity for future funding is extremely large, since they consider you as an extension of their own business.

Market buzz:  VCs often invest based on market buzz.  If you happen to have the market buzz in your name, your chances of funding (or at least getting the opportunity to pitch, which is almost half the battle) with the VC increase dramatically.  Since Strategic Investors are more focussed on their business, and they happen to know exactly what it is, the advantage of a buzz tends to be limited (unless the Strategic Investor happens to be a new tech company (e.g. Social media).

Executive sponsor:  VCs normally have a partner driving the business with clear oversight, driven towards milestones and eventual exit at a healthy multiple.  Strategic Investors, on the other hand, don’t always have executive sponsors, particularly for large conglomerates, which often have turnovers exceeding $100 billion.  It’s important to keep in mind that their R&D expense runs in to billions of dollars.

For decisions of a few million dollars, a manager in the venture team may have the sign-off authority.  Combined with that, the average time a manager spends in his role in a corporate is 3 years.  This risks the startup becoming an orphan, since as it grows and requires future funding, for which board clearance may be required, no one from executive management wants to sign off on new technology.  At the same time, it’s also not easy for management to write off the investment and hive it off, in case it becomes successful in future.  The result is homeostasis on the corporate level, due to which the startup eventually withers off.  This, in spite of a viable business value proposition.  For a startup, it’s key to identify an executive sponsor within a Strategic Investor.

Fund cycle:  VCs have fund cycles, which imply that at the end of this, they have to return the funds to their investors.  The fund cycle often tends to be between 7 to 11 years.  The startup needs to know if the investors are towards the beginning or end of their cycle since this will also determine when the investors need to exit.  Strategic Investors don’t have this limitation and invest based on requirements, so long as they have an executive sponsor or the board has already signed off the amount.

Customers:  VCs normally want the startup to address all customers possible to capture maximum value.  The good ones will also strive to open doors to their strategic relationships to enable this.  Strategic Investors, on the other hand, deter others to become customers, since the latter also assume that the Strategic Investors have the priority in getting the latest release or the best solution, that ultimately provides competitive advantage.  This is the most significant and underestimated risk of getting Strategic Investors in the mix.

Level of certainty:  The greater the level of certainty of revenue, the more the logic of getting VCs.  This is because VCs will help in maximising the value of the company once revenue begins, for future fund-raising or exit.  If the level of certainty of getting to revenue or achieving milestones is less, it is better to go with Strategic Investors, since they are more patient and more willing to pay more good money after doubtful, since their focus is not financial return but the option to have a business solution that provides future competitive advantage.

All the best for your investor discussions.