MENLO PARK, CA - March 25, 2019 - There is no perfect formula for determining the right capital partner. While purchase price may be at the top of your list of priorities, there are many other important questions that must be answered if you have multiple parties at the table for your next round of financing. How does a potential investor interact with portfolio companies (high touch vs. low touch)? What is the expected hold period? Where is the investor in its fund life? Will there be additional dry powder to support inorganic growth or other uses beyond the initial investment, and is there a demonstrable history of such support? Is the investment offer for primary, secondary, or a mix? What will liquidation preference look like post-transaction?
One of the most important considerations to evaluate is whether to partner with a control investor. When looking for full liquidity (or close to it), this decision is less controversial. However, if you are raising capital to pursue growth opportunities for long-term value creation, it is natural to have a negative bias to the question, “should I give up control?” Despite this being a challenging decision with long-term ramifications, there are benefits that come from partnering with a control investment partner:
Remove misalignment within the investor base. The motivations of your early stage investors who have likely been involved with the company for many years may not be the same as those of your more recent investors. Early stage investors might be more conservative in their decision making to minimize dilution and capitalize, near-term, on the value created thus far. Later stage investors without this bias may be more willing to remain with and take greater risks to grow the business in pursuit of long-term value creation. Ultimately, having a single voice that is aligned to the long-term financial plan enables management to focus on execution and do what is right for the company.
Accelerate decision making. With a majority investor, you no longer need to receive buy-in from multiple parties to make material changes. Whether reallocating engineering and sales spend, augmenting the executive team, or altering the product roadmap, you want a board that can move quickly and decisively. Disparate investors can slow down a business by hindering speed to market, under-funding development initiatives, or failing to support/execute a necessary pivot. Pursuing inorganic growth through M&A is a perfect example of where having a control investor enables a company to act quickly, particularly through fewer board approvals. Control investors can also help reduce recruiting cycles. Depending on market conditions, hiring the right people ranges from competitive to extremely competitive. Spending an extra few days getting approval from multiple parties can be the difference between landing or losing a key hire.
To maximize these benefits, ask the following questions when considering a majority investment:
Are you aligned with this investor? This advice applies to any capital raise, but especially to a process bringing on a majority investor: ask for and call on references. Speak with management teams from the investor’s current and former portfolio companies. Determine whether they prioritize growth at all costs or expect growth without ceding profitability. Investigate how they react when a company is cash-constrained, and if there is an opportunity for add-on acquisitions, can/will they contribute the necessary follow-on capital. Perhaps most importantly, you should figure out whether you are aligned on exit timing. If the needs of your business have changed since prior rounds, there can be a real opportunity for improvement with a control investor. While having a diversified board of blue-chip investors with great ideas sounds nice on paper (and often is, in reality), if the collective voice is not well aligned both strategically and economically and can’t quickly reach consensus around critical decisions, other structures may be more beneficial to your company.
Does the investor have the expertise and capacity to contribute? Investors with operating experience bring real value. Based on my experience as a business founder and operator, I rarely ask a management team to do something that I have not had to do myself. Whether it be to assist with recruiting, exiting team members, business development, or debt financing, you want an investor that is not only qualified, but is also responsive. You want board members and investors who will pick up the phone and help you solve problems. An investor that simultaneously sits on 10+ boards and doesn’t have either an operating or consulting team at their disposal may not have the capacity to do more than show up to board meetings.
Are you giving up control, or consolidating control? In 20+ years of evaluating investments, I’ve observed that executive teams concerned with “giving up control” often fail to appreciate the actual control they have in a multiple- or many-minority cap table. A management team is not truly in control when their shareholder base includes investors that collectively own greater than 50%. In tough times for the business and moments of urgent opportunity, the lack of a controlling voice can mean control by hold-up or hold-out. Lack of consensus among multiple minority investors will lead to delayed support for business execution. Partnering with a control investor who has demonstrated, referenceable alignment with – and the capacity to contribute to – your strategy of business value enhancement can be a win for all stakeholders.
While it certainly requires more diligence and thoughtfulness pre-transaction for a management team, a majority investor may be the right partner for the next phase of your company’s life.
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Roy Thiele-Sardina is a Co-Founder and Managing Partner of HighBar Partners, a private investment firm focused on enterprise and infrastructure software companies undergoing change or transition. HighBar provides patient, long-term capital and resources to fund growth and assist management teams with financial, strategic and operational execution.