Bootcamp: Strategic Investors

I was talking with a friend of mine, Patrick Dealy, who is at MaxMD about the pro’s and con’s of taking strategic money. MaxMD has an interesting business model, based upon their being the primary registrar for the .MD domain extension. Doctors and medical institutions can register for www.drname.md there while also beginning to sell a variety of ancillary offerings (HIPPA-compliant email, etc). It becomes a nice Trojan horse for them to penetrate the medical industry.

During the bubble, companies and VC’s actively sought out strategic investors for the "C" and "D" series of financings. They relied on the "irrational exuberance" along with strategics’s limited VC experience to get them to overpay (often 2x and 3x what a comparable VC would have priced the round at). Like any system based on poor, unsustainable fundamentals, this did not end well for the strategics and most shut down their venture arms. Those that stayed involved like Motorola & Intel, remained disciplined and are more active than ever, often getting invited in the first or second round.

While strategics are starting to come back into the market, we are not seeing the silly valuations of the past, though, because of the extra strategic value, they may pay a modest premium. More importantly, they are better educated and bring more to the table, often, than money.

Should you take strategic money? Negatives are: a) if they are a customer/partner, the investment may deter other customers from working with you, b) if they are a potential acquirer, it hinders your sale at the end since others will wonder why an insider did not buy the company first and c) strategics rarely invest across multiple rounds so not a good source if you are looking for investors with rainy day dry powder.

In reality, I have not seen (a) become an issue. In fact, I am seeing strategics (even competitors) coming in together on rounds. Since they are minority investors and often passive, this has not usually spooked other potential partners. This is not to say that it never happens, so evaluate your own situation. Every once in a while, (b) does become an issue. So, it is usually best to not take money from a potential strategic acquirer unless it is clear that they are the primary/sole acquirer.

The benefits are: a) you can often get a boost in credibility if a major strategic in your space takes an interest. If you are a wireless play and Motorola puts money into you, it signals to others that their tech groups canvassed the market and you had the best technology and b) they can often bring strategic benefits to you…access to their tech teams or channels, promotion to their customers, market insight, etc. Being fellow Chicago VC mafia members, we actively look for ways to work with Motorola Ventures.

So, I am generally supportive of strategic investors coming in assuming you have minimized the potential negatives of the deal. Make certain that the money brings with it enhanced value beyond the dollars. Talk with the relevant business units before closing to layout, if you can, a game plan for post investment.