Getting to “Series A” via Strategic Investors


by Reza Chowdhury |

recent report indicates that the share of angel investments in New York has increased from 12% to 20%.  Despite this early stage optimism, since the financial meltdown caused by the sloths on Wall Street, the city’s share of venture funding has remained steady, indicating there may be a “Series A Crunch” for some companies who are looking for their next round of capital.  Companies that have sound business models will continue to get funding.  “Hollow giants” will continue to get funding because investors are drawn to the sexiness of these companies, just in case they end being the next big thing – and no investor wants to miss the next big thing.  However, the majority of companies may have difficulty securing additional funding.

So, what caused it and what are the alternatives?

There may have been too many companies that have been funded over the last five years. This may be explained by some the “irrational exuberance” on the part of some unsophisticated investors (read ‘dumb money’) who got sucked in after watching The Social Network.  The collapse of the financial markets and the dismal yields in a city once driven by Wall Street returns have propelled early stage investing into a viable investment class or the next shiny new thing.  However, what is causing the Series A crunch really isn’t important, but the fact that it may or may not exist will affect entrepreneurs and their ability to raise capital.

In the near term, many startups may have to consider other sources of funding, as the availability of capital may be scarce for those ideas that probably should not have been funded in the first place.  The strategic or corporate investors may be good sources of financing because, as earnings improve, they will be seeking to put capital to work. Cash is king and if you need cash, corporates may be a good last resort.

Not all is bad with corporate investors.  There are a number of benefits.  Corporate investment in your startup offers instant validation to your idea/product/service.  They can offer significant value and the impact may differ, based on industry.  Corporates also offer an immediate pipeline to sell your products into and the sheer size of their marketing budgets don’t hurt, either. Most corporate investors are looking for enabling technology, and a preliminary investment may just be an “interview” for an eventual acquisition or “acquihire”.  There are also a number of strategic components to partnering with a corporate investor which can be validated by sexy powerpoint slides that are developed by bloated diligent corporate marketing departments.

With so many positives, why wouldn’t corporates be your ideal investor?  Corporate investors tend to offer less capital than their VC counterparts, and at lower valuations. Unlike venture capitalists, they are not really in the business of taking risks and, instead, tend to take a very conservative approach. However, this differs from firm to firm.  Corporates may strangle your ability to garner future capital, as retaining preferential rights is commonplace for a corporate investor.   Other investors may be unwilling to invest alongside a corporate as well.  Some things to know or watch out for before you consider a strategic:

  • There may be high rate of turnover in the people you’re working with on the corporate side, whereas people at VC firms tend to make a longer commitment. You may find yourself “orphaned”
  • Some corporates give nice up-rounds, but limit exits.
  • Culture
  • Speed – Strategic investors are very slow, but that is changing
  • Understanding of business
  • Exit path may be limited

A strategic investor may not be the most desired route to take, but they do represent an additional source of capital and knowledge. Remember, whom you get capital from is important as well. There are more than 900 corporate venture funds and these funds participated in 15% of the deals last year, according to David Stevenson, Executive Director of the Merck Global Health Innovation Fund.  No one city serves as the epicenter of so many gigantic industries as does New York.  Whether you are building an adtech, fintech, fashion tech or foodtech, there are large players in New York who should have an inherent interest in your business, if you are doing something right.  It just may require knocking down some doors and having to deal with a little red tape (ok, a lot).   I am encouraged by recent initiatives, such as corporate-sponsored hackathons, the corporate incubators, and events like SwitchPitch, but as one of my friends pointed out, the issue remains: what is the follow up process when these initiatives are out of the spotlight? Are the strategics really interested in building partnerships or are they doing this for some token publicity purpose? Or are they doing it to steal generate new ideas that they can then use internally?

As New York cements itself as the next choice destination for entrepreneurship, fostering cooperation and interaction among the corporate and startup communities needs to be explored on a higher level, and with an open and realistic attitude.   For those working in the larger corporations out there, startups can be an excellent resource for your department and company, but there needs to be a methodical approach that doesn’t just involve your venture arm or ad agency (yes, I recently heard a story from an ad executive who told me that their clients ask them which startups they should be looking at).  I understand that moving the needle at a large entity is often difficult, and you are content with drawing your salary every two weeks without rocking the boat.  And at the end of the day, if a project fails, it’s your ass that’s on the line, if the new strategic initiative was your idea.  However, you should be considering taking some of the risk off of the table by looking at startups that are already demonstrating measurable traction in your space, with a product that is already built. Looking at the startup as a partner rather than a service provider should be paramount. Unfortunately, the vendor mindset is the impression I received after attending some events that were specifically targeted to bridge the gap between startups and corporates. Leveraging the domain expertise of a large corporation in conjunction with the agility of a startup is true “intrapreneurship”, instead of the buzzword connotation that is going around.

Lastly, for the entrepreneurs, there is no shame in building a $100 million company that is funded through strategics, and then exiting.  Perhaps you will not get Fred Wilson to invest alongside these strategics or maybe you will. We all like to cheerlead the billion dollar Tumblresque exits, but in New York, offers are here today and gone tomorrow. Using a strategic to get where you need to get to quickly may be more sensible than waiting for the “F you money” that may never come.

via AlleyWatch