How to maximise the value of strategic investors
What do two of the largest fintech M&A exits in Europe have in common? After the recent announcement that Tink is being acquired by Visa for $2.2 billion, and three years on from iZettle’s $2.2 billion sale to PayPal, we can identify one common thread — neither transaction happened out of the blue, but rather were part of long relationships between the acquisition targets and the acquirers.
It’s no secret that strategic investors are more prevalent than ever before in the startup ecosystem. Globally, an estimated $73 billion of corporate venture capital was committed last year, up over 120% from 2016. Large companies increasingly recognise the value of being an early investor into the most innovative startups in their sector, and the access this facilitates to talent and technology they might otherwise struggle to bring into their business.
It’s a trend we have seen at Dawn across many of our portfolio companies, from the likes of iZettle and Tink, to others that are building a roster of corporate backers. The recent Series B of Divido, a white label consumer lending platform between financial institutions and global retailers, was co-led by HSBC and ING, while OpenGamma, which helps financial traders to manage their margin, counts leading exchanges including CME Group and Japan Exchange Group among its investors. And AccessFintech, a network that tracks the trade lifecycle and offers risk management service for banks and buy side firms, counts Goldman Sachs, JP Morgan, Citi, Credit Suisse and Deutsche Bank among its roster of investors as well as key clients.
The growing importance of strategic investors means that corporates, startups and VCs alike must understand how to maximise the value of this kind of partnership. There is huge potential in these relationships, but there are also pitfalls to be aware of and mistakes that must be avoided.
The potential is most obviously manifested through access that flows in both directions. Much as strategic investors gain a foothold in the most innovative corner of their industry, startups can benefit through customer introductions and channel partnerships facilitated by corporate investors. One of the reasons HSBC has invested in Divido is to provide its retail finance platform to customers in that industry — a mutual benefit for a corporate that will sharpen its technology offer, and a startup that gains new customers in the process.
Alongside the immediate transactional benefits comes the opportunity for both sides to take a long-term view. By bringing on board strategic investors, a founder can lay the groundwork for a potential future acquisition of their business. In parallel, the corporate investor can assess over time how well the company might perform as a wholly-owned subsidiary.
For startups, a broad-based cap table is generally something to aspire to. Most will benefit from having investors and advisers who combine the financial focus and experience of proven VCs with the domain knowledge and industry reach of strategic investors.
But founders need to build their cap table deliberately, bringing on the right partners at the appropriate stages of growth. While corporate venture capital does exist at the seed stage in the form of accelerator programmes, typically strategic investors should be sought only once a startup has achieved product-market fit and is ready to scale. Large corporates are typically better equipped to bring an established product to market, than to assist in its development.
Founders should also think about balance and the importance of retaining control. One risk with strategic investors is that they can exercise too much influence, steering a startup’s development towards their own interests in a way that may inhibit overall growth. The best way of avoiding this is to keep the cap table diverse — taking smaller investments from many partners rather than large amounts from a few. As an example, iZettle had over ten strategic partners prior to its sale, none of whom owned more than 2% of the company. That way, founders can benefit from the input of strategic investors without becoming beholden to any single partner.
The trend towards strategic investment has become well-established and shows no sign of abating. Industry leaders have recognised the advantage of investing early into each generation of innovators, and as strategic partners they can offer distinctive benefits to startups on the path to scale and exit.
These are relationships, if developed and managed thoughtfully, in which all parties stand to benefit: a startup is best positioned with a mix of investors who bring different perspectives and a breadth of operational support; a strategic investor increases their exposure to innovation; and a VC is well-served by having co-investors with deep industry expertise.
When strategic investors do the work to earn their seat at the table (which in our experience they do) then they are extremely valuable partners. With the startup world stronger for their involvement.