If you’re the founder of a startup, chances are you’ve likely heard the term “strategic investor” on more than one occasion. What exactly does it mean though?

Generally defined, a strategic investor is an organization that invests in something for a reason that’s something other than financial. Here are some of the ways in which a strategic firm will become involved with a startup:

  • Providing access to their contacts
  • Providing access to their collective knowledge and experience
  • Supplying data sources and raw materials
  • Being a buyer of the end product
  • Being a channel/distribution partner
  • Being an acquirer of a startup

Early on in the life cycle of a startup, the business itself is too small to matter, as well as too numerous for any incumbent to pay attention. Doing this may cause an incumbent to get distracted, which will cause them to fail to use their size advantage in order to stay ahead of all of the competition. A smart incumbent will instead put investment dollars into startups that are more promising to provide themselves with the following advantages:

  • Visibility regarding the possible scope, timing, and likelihood of the disruption so that they can stay ahead.
  • A spot at the table in the event that any of the firm’s competitors attempt to acquire one of the startups.

A well-constructed strategic investment should always be prepared to face all sorts of interest misalignments. The investment should also be managed by both parties, as this will help them create as much alignment between the interests as possible.

One big risk that you will take when you accept a strategic investment is that you could end up alienating a lot of incumbents by taking this step. This is something that can actually turn into a good thing for your strategic investor, however, because by investing in your startup, they are essentially preventing competition from being able to access disruptive technology that you have.

While you may be saying that your strategic investor wants you to be successful in all of your endeavors, this isn’t actually always the case, especially if your investor is actually strategic. For instance, if the investment ends up going to zero, this could end up being the result of a rounding error on their balance sheet. However, if your business becomes a billion dollar venture, then your investor could end up having the opportunity to buy you out early, which will enable them to remain in business themselves.

Being a part of this kind of partnership can afford your startup with all sorts of great advantages, such as the following:

  • Credibility
  • Opportunities in networking and business development
  • Being able to access corporate resources
  • Negotiating power
  • Lower costs for expansion and capital

There are also a few key points that you can make note of in order to help bring the conversation more towards aligning interests:

  • Invite more than one strategic investor to take part in discussions, especially if they don’t actually intend to help you.
  • No matter what, avoid exclusivities. This is something that a lot of strategic investors will always ask for, which is something that they technically shouldn’t be faulted for since it’s actually in their interest to ask. If they insist on something like this, however, limit this to a specific set of competitors in a well-defined area, as well as for a limited amount of time – as in months. In return, they should be willing to compensate your business for possible revenue loss.
  • If you choose to announce that you’ve decided to partner with a strategic investor, you still should make it clear that you also have other customers as well. This is because if your investor is the only customer, this will end up causing other incumbents to shy away from you. Do not make any announcements until you know for sure that your strategic investor is one of many clients that you have.
  • Between signing the signed term sheet and the closing documents, take the time to get to know the members of the internal team that you will be working alongside. Furthermore, begin working on a post-investment engagement plan, and determine how willing the team is in order to help make this happen. Their overall willingness level will serve as an excellent indicator of whether or not you should proceed with the investment itself.

The Business Consulting Services team at Hollister Legal Services, PLLC (“HLS” or “Firm”) offers its client base attentive, comprehensive high quality legal services in business tax, immigration and other practice areas. The Firm is distinguished by its expertise in finance, corporate, tax, technology and immigration skill sets. HLS’ business consulting services principal mission is to deliver winning solutions for its client base.