The Essential Do’s and Don’ts of Adding Strategic Investors to Your Cap Table

To work with a strategic or not to work with a strategic? That is the question. Which path do you choose?Credits: Vladislav Babienko on Unsplash

As a founder, you and your co-founders ideally hold 100% of the company. If you give anyone else equity, you’d better have a good reason for it. Most of the time, you might consider adding shareholders to your cap table because you’re trying to accelerate growth, rather than growing slowly over time.

That’s why you turn to venture capital. VCs can give you the money you need to burn to fuel your growth, which is why many founders end up engaging with them. The same goes for the engagement of corporates, a.k.a. strategics. You engage them because you want them to deliver a strategic value for the company that can help you grow faster rather than go the usual linear slower path. This is especially true for climate tech companies who are working on scaling new technologies.

The goal of this article is to be a resource for founders who are thinking about collaborating with strategics. The first two parts are about the benefits of having a big corporate on your cap table and the right time to bring them on board. The third and fourth parts are the do’s and don’ts once you’ve made up your mind to engage a corporate.

A word of warning — this article is not attempting to be exhaustive nor a legal guidebook. It is purely based on our own experience. Some people will agree, some will not. Apply judgement. And please ping us, we always want to learn and get better, so together we can build life-changing companies.

If you don’t have time to read the entire article, here’s a TL;DR cheat sheet with the key points:

Credits: Extantia

Why engage strategics?

Each startup and industry can have its own reasons. When putting together this list, we had climate tech companies in mind, but it can apply to any startup, especially those working on hardware-based solutions.

1. Off-take agreements — This is the holy grail. If the strategic is also going to be an end customer of your product, putting them on your cap table can make it easier for them to make binding off-take agreements. While off-takers ordinarily only see the risk of downsides (e.g., in case your first-of-a-kind plant never reaches commercial operations), off-takers with an equity share will still be compensated for the risks they took, over and above the nominal deposits that suppliers normally have to put down for long-term contracts. This is the exact playbook companies like H2 Geen Steel took to raise billions in equity and debt.
2. Scaling — In climate tech scaling is everything (just think about the size of the energy sector), and no one knows more about that than big corporations. They finance, build, and operate large-scale billion-dollar projects. Scaling has many facets, like engineering, procurement, and construction, or EPC for short. Figuring this out all on your own could easily lead to disaster, so handling any one of those facets would make partnering with a strategic worthwhile. For example, you could rely on your corporate partner’s experience, using their massive procurement chain to reduce your product’s bill of materials (BOM). One of our companies did just that and managed to shave off over 30% of their BOM. Or, on the engineering side, you could take advantage of your corporate partner’s cheaper and faster access to labs and testing sites to do early-stage pilots.
3. Go-to-market — Deployment is everything, and without bringing your product to market, you won’t get very far. Big corporations have access to big customers. If you have your corporate partner on your side when you want to sell your product, you’re coming to the table not as the new kid on the block, but as someone backed by a big brand name. So, next time you’re asked to show your balance sheet to a potential client, you can reply: “How about I show you my cap table…?”.
4. Non-dilutive funds — Big corporations also have their ways of getting big bucks. By partnering with them, you could gain access to larger grants, and warm introductions to their house banks. This could make an enormous difference for you as a founder, and might even help you survive the cash vs. product race that every founder will eventually need to run.
5. Regulations — Let’s assume you’re developing a new type of low-carbon cement. To bring it to the market, you’ll need the construction laws to change so that you’re allowed to market it as “cement”, making it more attractive to buyers. If you happen to have a big cement company on your side, their lobbyists could help you get the necessary bills passed, solving a problem you would never be able to solve on your own. And it isn’t just cement. Outdated regulations can put a stop to many a promising climate tech company, and partnering with the right strategic could help you put the right words in the right ears.
6. Exit strategy — Finally, most of the M&A activity in the world is done by corporations. And those M&A transactions don’t happen out of the blue. They’re usually preceded by a partnership where the larger company gets to know the smaller one’s capabilities, and comes to a decision that they would be better off acquiring it. Having a strategic as an investor means you’ll be working very closely from the start, which also means you’ll have plenty of chances to get to know each other and bring about a fruitful partnership.

Timing — when to make a move

What is the best time to get a strategic into the cap table? There is no simple answer to that. Deciding the right time for a startup to let a strategic corporate investor get involved relies on many factors. As a rule of thumb, startups are ready to handle corporates from Series A onward. You want to make sure you can swallow them with all their requests and timelines, and not that they swallow you and completely defocus and derail you from your course. Here are a few questions you should ask yourself to make sure now is a good time to engage with a corporate:

1. Can I deal with all the extra requirements? Reporting, policies, deadlines?
2. Am I blocking any future possibilities by engaging with this corporation? Am I losing a competitive advantage or revealing unique selling points? Will they milk me instead of buying the cow?
3. Will the corporate really bring me value now, or can they be brought on later? What do I really need at this stage?

Again, there is no single truth here. We recommend speaking with your other investors or peer founders to get general advice on working with a strategic, specifically with the one you want to engage with.

Now that you’ve made up your mind, let’s talk about how best to engage with strategic investors

The Do’s: What you should do when bringing a strategic to the table

So you’ve decided that you want to bring a strategic to the table, and now you want to know where to start? Then, first of all, you need to remember that not all corporates (or their investment arms CVCs) are equal. To make sure that you’re making the best move for your start-up, you should ask a few questions to understand what kind of strategic you’re dealing with.

The following are questions you definitely need to ask before making any big decisions:

1. What is the structure of the CVC? — Does your intended strategic partner invest from the balance sheet, or from a fund? Basically, when they make investments, where does the money come from? If they invest from the balance sheet, it means that they’re using the cash reserves that already exist on their balance sheet, and if they invest from a fund, it usually means they’ve set up a separate fund structure for VC investments. Strategics that invest from funds are way better for you, because these partners aren’t going to have to change their strategy as frequently as balance sheet investors. Balance sheet money is the first to be diverted to other areas in critical times, meaning that if things get tough for your partner, that money won’t go to you.
2. Is the team incentivised? — No corporate partner is going to put a ton of effort into a project that they can’t see themselves benefiting from. If you want to get the best out of your partnership, you have to make sure your strategic knows what’s in it for them. If your partner shares in your success, they’re going to be a lot more motivated to get you where you need to be.
3. How long have they been around? — You’re probably already aware that the corporate world is messy. How long has your strategic partner actually been in the game? How long has the person you’re talking to been doing this job? CVCs are subject to reorganisations and strategy changes, so to save you the headache and the hassle later on, you better make sure that your intended partner has the capacity to be stable over time.
4. To whom do they report? — Who’s in charge of this whole operation. No, not the CEO — to whom does your corporate partner actually report most closely to? If it’s the CFO (chief financial officer), that’s not great. You’ll want your corporate partner to report directly to the CTO (chief technology officer), because you’ll want someone familiar with the research and development process to better understand your needs. CFOs will cut loose non-material financial investments in hard times. CTOs will fight for innovation that secures the future.
5. Can they actually add value to your start-up? — Before you make any promises, take a look around. Is the corporate experienced in funding start-ups like yours? Look at their other portfolio companies. How are they doing? Reach out to those companies and ask them how or if they feel supported by the corporate. Talk to everyone you can. Has the partnership worked for them? Remember, you’re bringing a strategic on specifically to add value to your company, so you need to do your due diligence and see if they will actually keep the promise.
6. Are your interests aligned? — This is probably the most important question you need to ask before you decide to work with a strategic. If your interests are not aligned, your partnership can quickly end in disaster. Don’t assume that CVCs have the same motivations as ordinary VCs. VCs often go into an investment thinking of their exit, maximising the profit they get out of their investment. As much bigger entities, CVCs are often dreaming a bit broader. They might be looking to engage with new technology and innovation (and maybe even to copy the best ideas), or they might be keeping an eye on potential acquisition targets, possibly to acquire them later with advantageous terms.

Whatever the case, don’t be naive. Don’t assume that your corporate partner has your best interests at heart — remember that they’re looking out for themselves. To make the most out of your partnership, you’ll need to find a way where you can both get what you want, without you getting the short end of the stick.

Okay, so you’ve done your homework, you’ve asked your questions, and you’ve verified that this strategic partner would be great for you. Now you’re thinking of actually getting this deal down on paper.

What shouldn’t you do?

The Don’ts: Things you should absolutely never do when engaging a strategic

It goes without saying that while there are a lot of advantages that can come from working with a strategic, there are also a ton of risks. To protect yourself, make sure you do your homework, and avoid getting into any of the situations on the list below.

1.M&A rights — When it comes to mergers and acquisitions, never, ever, under any circumstances agree to give your strategic partner the right of first refusal (or ROFR). Without going into complex legal language, the ROFR gives the corporate the right to be the first buyer of the company. Which in turn means that no other corporate would bid for your company as they know that if they do the corporate-investor will have the right to outbid them and if they don’t then there is something suspicious going on. This is death by Catch-22. Basically giving the ROFR to a corporate means that only that you’re blocking any other exit opportunities and your sole hope of an exit is that corporate.

For the same reason, never give your strategic partner the right of first offer (or ROFO). This gives the investor the right to give an acquisition offer before shares are offered to any other buyer. Same mess different language.

If you have to agree to anything, you can agree to giving your corporate partner the right of notification , allowing them to be notified when there is an acquisition offer on the table without revealing the identity nor the sum offered. If they are serious, they can put a competing offer, which is actually in your benefit.

2. Investment from a corporate competitor — Make extra sure that your strategic partner can’t block collaboration or investment from one of their competitors. The last thing you want to do is cut off any avenues of investment or partnerships. The only thing you can safely agree to is that if a competitor is taking a very large stake in a secondary or acquisition (meaning, something over 25% or over 50%), then your corporate partner has the right to be bought out. This is still not great, but this could work for you if you’re already on your way to a partial exit.

3. Board membership — You never want to have a corporate for a board member. One, corporates are everything but quick, and you need to make quick decisions in the board. Two, you might have clients from competing corporations and you definitely don’t want your corporate board member exposed to that. It will quickly turn into a dance, where your corporate board member has to excuse themselves in every meeting.

You can have your corporate partner be an observer, but while a director is bound by fiduciary duties to the company, an observer is not, and would not be required to consider the company’s best interest in dealing with confidential information. Likewise, there’s no requirement for an observer to excuse themselves from a meeting if they have a conflict of interest (or if a conflict of interest arises during the meeting). While these are issues that come up in the context of any observer (whether appointed by a VC or a corporate), the potential for a conflict of interest is arguably greater when dealing with a corporate investor. For these reasons, make sure to sign corporate investors on a side letter before becoming observers, assuring the way they will deal with confidential information and excuse themselves in cases of conflict of interest.

4. Following the leader — CVCs should always follow, and should never take the lead. Letting a corporate be the lead investor in a start-up, meaning that they’re the biggest shareholder in a share class or even overall, is a surefire recipe for disaster. You’ll be dependent on the big corporation for every single one of your moves, and we have yet to see a case where that has turned out well.

There are certainly more (this page is a good start), but these are the main points we’d like you to pay attention to.