"How do you get venture money from strategic partners?"
"Is it wise to raise start-up money from large corporations?"
Those are questions I frequently get. They are increasingly important because the business models of more and more start-ups are linked closely to large public corporations.
This week I spotted a good example of a start-up whose financing includes strategic partners.
Violin Memory completed a financing round of $35 million, announced on February 6, 2011. That is part of $110 million raised since its founding in 2005. Let's look at the lessons from the deal.
- This round is a mid-stage financing, not seed or early financing. Announced as the second round, this suggests the first was large at $65 million. That is a very large sum of money for an early stage start-up to raise.
- The earlier round is actually a series of financings. You can follow the trail in historical blogs. Large amounts of capital are raised that way for start-ups. It is not easy to do. The company probably did a classical seed round followed by a much larger A round. That is common.
- Two related public technology corporations participated. It is rare for more than two to join a deal. One is more likely. Participating corporations benefit in multiple ways from the success of the start-up and thus participate. They do not do it to make a lot of money on their cash investment, they are not like VCs.
- Venture investors participated. Violin Memory did not disclose the names of other participants in the recent round, at this time. The most common deal structure is to have the lead investor be a large venture capital firm with a large amount of capital avaliable. That VC will set the terms of the price per share for the round. Corporations do not see themselves as the best to set the valuation of any start-up deal.
- This round was done after products were launched and selling to customers. That is when the start-up is less risky to investors. The start-up also gains psychological momentum by receiving the support of strategic partners willing to announce support for the new enterprise. It is rare for large corporations to participate in seed and pre product launch rounds of venture capital financing.
- Financing with strategic partners blocks me-too competitors. A start-up following Violin Memory is now unlikely to get either financial or closer technical support and cooperation. This is a powerful blocking tactic.
There are a couple of other observations for you to think about.
- This may be a sign of start-up weakness. Sometimes large rounds of cash are difficult to raise (high valuation sought by VCs or founders; strong competition; recent disappointment with fresh sales). Then VCs are known to bring in large public corporations to finish the round of financing. And you may find a lot more VCs added to the round, often each taking small amounts of the deal. Those are signs -- to some observers -- that the start-up is struggling.
- Large corporations slow down the time to closing the round. Public corporations hold board meetings every three months. They rarely call for a special meeting of the board to approve a (tiny) financing. CEOs have to be prepared for a long closing calendar if corporations are part of the deal.
So give this some thought as you make your plans to raise capital. When you plot the sequence from seed to IPO, put in a place for strategic partners to join one of the mid-stage rounds.
BOTTOM LINE: Strategic partner financing can help you build an unfair competitive advantage. They bring credibility to a struggling new enterprise. They add techology cooperation. Their public announcements encourage customers of the start-up. The cost of capital is the same as that of VCs. But they do slow down closing on a financing. And many see their participation as a sign of weakness. Put strategic partner financing into your alternative plans. It can add power to your start-up as it grows its unfair advantage.
I wish you The Best on your Adventure!