Are Strategic Investors Interests Aligned With Entrepreneur Interests?

Did you read the story about Quixey?  Dan Primack wrote about it yesterday.  I don’t know the details behind Quixey.  Dan lays them out pretty well.  The point I want to focus on is “strategic investors”.  Over the past couple of years, corporations have gotten more active investing in earlier stage companies.  Many have set up VC funds, or are contemplating setting up VC funds.

In order to avoid fees, many of them invest directly into companies.  In some cases, this works out.  I have been involved in deals where the corporate investor has been a good partner.  In the case of Quixey, it went wrong.

If an entrepreneur is considering accepting an investment from a corporate VC, they need to find out what the mission and charter of that VC is.  Are they independent?  In the case of Google, they are.  How much money has the company allocated and what are the strings associated with it? Is the company committed and does it’s C-level management team really understand the ins and outs of venture capital investing?  Failure is not handled well inside most corporate cultures.

Another thing to get straight right away is that the entrepreneur can’t build to suit to the company.  That runs a very big risk of not building a scalable product and turning the opportunity into a consulting play.

Consider how the market the startup is attacking will view having a strategic investor.  Will the startup be able to sell to the customer base it’s targeting or will having the strategic scare customers away?  With the advent of Artificial Intelligence, Machine Learning, and Big Data startups, many customers might be skeptical about becoming a customer and having a strategic investor see things it wouldn’t normally see.

Strategic investors sometimes have very little experience when it comes to venture investments.  I have seen them totally screw up the valuations of companies.  This also can happen with an angel that doesn’t have a lot of angel investing experience.  Valuation can really get too far ahead of itself, and once the startup is over their skis raising capital can be arduous.  Investors that don’t have a lot of experience don’t tolerate down rounds as well.  As I look out over the tableau of companies, there are a lot of down rounds happening.

Sometimes traditional VC’s push really hard to get high valuations to make their portfolios look good as well.  Better to let the market set valuation.

From the corporate perspective, I can empathize with their angst about paying fees to a VC.   I empathize with their angst about giving up control of decision making over dollars invested.  But, it might be a very good strategy to have the company interview funds you are interested in building a strategic relationship with and entering the market from that perspective.  The fund can act as an intermediary between the market and the company allowing independence on each side.  Sometimes that independence is worth a lot more than the fees paid.

It also depends on where a venture fund is focused.  Does a corporate VC really want to delegate the resources to get in that particular scrum?  If ROI is the goal, there is a lot of hard work that comes with getting truly good deal flow.  Early stage entrepreneurs often don’t like to talk to corporates for fear their idea will get integrated into the corporate system and they won’t have a chance.

Again, from the corporate perspective, it’s important to understand from the beginning what the dialogue and information flow from the fund will be.  Sometimes super large funds might not be the best fit.   It also will be almost impossible for corporates who are entering the venture market today to have access to the established top tier funds.  That means they will have to assume the risk of unestablished newer funds.  The good news for them is the data has shown that emerging managers running smaller funds do better than the rest of the marketplace.

How much money should a corporation dedicate to venture?  All depends on the size, the risk they want to take, and the industry they are focusing on.  Medical startups can chew up a lot more capital than retail software startups.  The key is to dedicate the resources and to empower the people in charge of the resources to make decisions.

I have written about 0% interest rate policy plenty of times before.  It changes risk/reward metrics big time.  With the expected drop in corporate tax rates, those metrics are in for a hard reset again.  It will be very interesting to follow how corporate executives invest those windfalls.

  • awaldstein

    This will continue to happen at an accelerated pace.

    If I was an enterprise, i would dedicate myself to this as the most financially prudent way of being part of the future ecosystem as it arose.

    • Interesting. I like that idea. Not exactly sure how to execute it. I had that thought when I presented corporate VC to CME years ago. They didn’t bite. A company like Cerner or Epic or FIS or FISERV would be classic. They aren’t going anywhere, but they need innovation.

      Pick a major company and tell me how you’d do that so there was an ecosystem around yourself.

      • awaldstein

        Off the cuff–every manufacturing company like Toyota has an expressed interest in three areas: Making sense of the huge potential and mess of IoT. Making sense of how to build the smart car that speaks back to safety and troubleshooting in real time and Making sense of how to address the efficiency of a completely mobile, just in time, dispursed, flex workforce.

        I could build an investment strategy I bet that would put my hands in the key places to both understand and mold it.

        From the complete other side, I believe the best VC firms will start hiring their own Experts/Enthusiasts that go out into the market like the enterprise and build the market ahead of and with the direction that their investments will get to.

        Fascinating stuff. I’ve been thinking about how personally I can play in this.

        • Or, the best VC firms will find people and build their own deal flow. We are starting to do a little of that.

          • awaldstein

            I think that in order to be successful things need to shatter.

            On the VC side some buddies and I tried to get Glass House off the ground. a development house of sorts built on the model of funding and creating films. Just not right. At least yet.

            On the other side, been talking to some VC informally about coming in house and developing markets for their portfolio company. Not sure how this can/will work but I think it can and I’m super drawn to do this.

          • “developing markets for their portfolio company.”

            Do you mean developing markets as in international expansion markets? Or markets they could move into laterally? Or something else..?

          • awaldstein

            i mean that it is becoming harder, much harder especially on the enterprise front for any company to build a market for new tech and processes.

            Almost impossible.

            It I were investing in a number of enterprise level IoT startups I would hire someone like me to work full time to build the networks and contact to prime that market years ahead of being ready to sell.

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