The conventional investment thinking is that strategics are great for exits, but not ideal for early stage investment. However, it may well be the best investment solution, depending on the technopreneur’s goals, the type of strategic investor, the reason why the investor would like to invest, and the structure of the deal.

In our article of Sept 2018 Go for the strategic exit we made the case for the strategic buyer being more likely to provide a higher valuation on exit than a financial buyer, due to its lower cost of capital and the additional value it will accrue from the synergies with the target.

But conventional investment thinking is to avoid early stage investment from strategics, such as espoused in the Forbes article Why Strategic Investment is not Always a Good Strategy for Startups.

The VC model is a very specific trajectory that suits startups that need lots of capital in high growth markets, where there are successive funding rounds and reaching the next funding milestone is a make or break event for the company. However, this is not for all startups.

If you as a technopreneur go for the early stage strategic investor option, it is unlikely that a VC investor will follow-on with a later stage investment. So an early stage strategic investment is not just “another round” in the VC sense. It is a different kind of trajectory.

The starting point in evaluating strategic investors is determining the real reason for their investment interest in your startup. You would, in reality, be providing the potential investor with the strategic rationale when approaching it, but the key is understanding what the corporate really intends to do with your startup.

Strategic investors come in many shapes and sizes, but can be generally categorised as i) corporate balance sheet investors, ii) a Corporate Venture Capital (CVC) funds where the corporate is a Limited Partner (LP) to the fund, or iii) hybrids such as an investment holding company.

Whatever form the strategic investor takes, it will want to determine the synergies with their business units. One word of caution here (based on hard experience): If it looks like this is starting to become a long or convoluted step, then cut your losses and move on.

The balance sheet investor will tie its investment decision closely to the  synergies with its business units. It is also a reason for caution, as the motivation is often acquisition with investment as a way of buying an option, whilst evaluating your company close-up. So it is imperative that you consider the acquisition scenario at this point. Would your startup run standalone, or be absorbed into an existing business unit? If you believe that in an acquisition scenario you can achieve your financial and career goals, then all good.

The CVC investor will always want some level of alignment with their corporate LP’s objectives and priorities, although this can vary from having a commercial agreement in place with the corporate’s business unit (on one hand), to just being in a field of interest of the corporate (on the other), or anything in-between. CVCs operate more like VC funds in that it is unlikely that they will have any acquisition clauses, but are likely to favour some of the less palatable VC clauses. A CVC is often a co-investor behind a VC that will be driving the term sheet.

The hybrid strategic investor, such as an investment holding company, can be a great option. In this case the investor is investing from their balance sheet, but as a holding company this is often not tied to a particular operating company, and so your company is less likely to become captive to a particular business. Also, in the case of a group of companies, the holding company can provide access and synergies with multiple companies that could be in adjacent areas of business. This can be a very good option potentially providing “the best of both worlds”, but again, it is important through the process to understand the motivation behind the investment.

Strategic investors are less fixated on traction metrics than VCs (see this Andreessen Horowitz article) and more interested in the strategic fit. VCs look for very specific profiles with regard to market and growth that many superb tech companies will never fit. Also, all too often VCs are not able to take the time to properly understand or evaluate prospects (even sector specialist VCs).

There are other advantages to the technopreneur of having an early stage strategic investor, which are more likely to accept a higher valuation, and avoid the nasty VC clauses, such as liquidation preferences and anti-dilution, which can very substantially erode the technopreneur’s  take-home value after having successfully built and sold their company.

In many cases, a well targeted strategic investor campaign is more likely to be successful then an extensive round of VC discussions.