An industrial is a jealous husband

Either because fundraising is damn hard or because they sincerely believe in a great synergy potential, startup founders (or, unfortunately, fundraisers) often consider entwining VCs and Industrials in a funding round. It’s a tricky thing.

I’m not saying that it’s always and under all circumstances a bad thing, but every entrepreneur has to be aware of the risks associated to it, be it on the operational side or on the exit side, and make sure the deal terms are well understood and acceptable for both founders and VCs.

What can an industrial bring you in a financing round?

There are three main things the presence of an industrial in your funding round can bring your startup:

1. Credibility. Common heuristics: “BigCorp has been an expert in industry XYZ for over 50y+, so if they back StartupX it must be very good!”. It’s true that industrial players oftentimes know their market extensively and can be very wise on the product.
2. Potential synergies / business. When negotiating a round, the industrial will often sell you all the potential synergies you both can achieve by working together. And truth is, sometimes it really makes sense (at least on paper), as the GM-Lyft partnership. It can bring you an established distribution network, access to a wide set of customers, or negotiate better deals with suppliers.
3. (Sometimes) Higher valuation. Another name for an industrial is the concept of “strategic player”, as opposed to a financial investor. The #1 goal for such a player is rarely to do the best possible return on investment multiple at the exit, so in some cases an industrial can be willing to preempt the deal from VCs and offer you a higher valuation.

What should you fear?

Two sides of the medallion, each of these positive points has its negative counterpart.

1. Incumbents. So yeah, they know their market. But keep in mind that the single worst fear of a well-established, “old economy” industrial is to be disrupted by a quickly-executing, tech-driven startup. So make sure to understand on which precise aspects of their business they can bring you real credibility.
2. Exclusivity. Or no effort at all. Industrial players may be willing to use their negotiation power to impose an exclusivity on your business relationships. Be careful, because as much as doing business with your investor is a floor for your revenues, doing business only with him can be a serious can to your growth, whatever his size. On the contrary, there is a serious risk that, once the initial frenzy faded out, the industrial gets excited about something else and, given that his €1–5m investment in your startup is a drop in the ocean of its cashflows, you overestimated the business opportunities with him.
3. Capped exit valuation. Imagine you raised a nice round with a bunch of VCs and BAs, and one industrial. Your startup grows well, is starting to become a leader in its market, and subsequently triggers interest from another industrial potential acquirer.
   The first question he’ll ask: “Dear founder, I’m pretty interested in what you’re doing, but I saw BigCorp is on board, what is their agenda and what rights do they have?”.

That’s where this article was heading. Getting an industrial on board will often come along with exotic clauses the strategic player wants to grant himself. The worst one is the right of first refusal (“droit de préemption” in French) in case of the acquisition of a controlling stake of the company (not a minority stake between shareholders). It basically means that if a potential acquirer makes all the efforts, due diligence, expenses and risk-taking of making you an offer at €Xm, then the industrial shareholder in your cap table can buy it effortlessly at €(X+epsilon)m. This is a way for the industrial to make sure not the pay the market price for your company, because it essentially precludes other players from making an offer. That’s why we VCs are so afraid by this clause.

What should you care about when negotiating?

I’m absolutely not saying Corporate Venture is in itself a bad thing for entrepreneurs. It can very well make sense, and be a very constructive and not preemptive relationship. We at XAnge invested in the SaaS-based marketing suite for restaurants Zenchef alongside with Edenred and are pretty happy. In other cases it can happen that your fundraising is not going that well and the only possibility left is to raise with a corporate, in which case it seems natural to give the project chances of success rather than killing it right now, especially when you can envision a path of success.

I am only highlighting the things you have to be aware of, and make sure are checked.

1. Give no discount because of possible business opportunities/ synergies. Equity is the reward for cash investment, stock-options are the reward for contribution in kind.

Give no discount because of possible business opportunities/ synergies. Equity is the reward for cash investment, stock-options are the reward for contribution in kind.

2. Try to negotiate to drop the right of first refusal. Or at least to turn it into a right of first offer, pursuant to which the corporate in your cap table will be able to make an offer to acquire your startup without knowing the price tag associated to the other term sheet on the table. Hence, chances are that the valuation will be higher.

Such right respects the spirit of the deal, which is the fear of seeing the startup being acquired without having the opportunity to make an offer for it.

3. The more you can take, the better. For instance I saw corporates accepting to drop their board seat and their indepth investor information in case of expressions of interest from a potential buyer. That’s the kind of move that shows you that your agenda and the corporate one are aligned.

With all that being said, I hope negotiations with corporates will become more symmetric! Good luck all for your fundraisings.