11.02.05
Strategic Investment Structure II
In my last blog, I talked about some typical side-letter terms a strategic investor might ask. In this blog, I am going to talk about some of the financial considerations.
As a rule of thumb, a strategic investor tends to take less than 20% of the equity stake in a startup mainly due to accounting consideration. In general, a startup would have financial loss in the beginning of its venture years. As such, a corporation would try to stay away from accounting for its investment’s financial loss on its book. There are a few tricky factors in what is called “significant influence” which might change accounting treatment even if the investment stays below 20%. But with Enron and other corporate accounting abuse, there are some additional rules such as variable entity structure that need to be taken into consideration in today’s environment.
Strategic investors tend to be long term investors and will likely to invest continuously unless there is a change in strategic direction. But in many cases, “pay-to-play” type of term is not welcome by corporate investors since there are many contributions besides money that have been put into developing a startup. I understand why financial investors might want to ensure everyone stays committed in the long run, but the alignment for business is more critical for a strategic investor. Even though sometimes financial situation in a corporation has changed and might not want to continue to add money into an existing investment, the business arrangement will continue and probably brings more value to a startup than the money put in.
