For tech startups, corporate venture capital (CVC) is an attractive option. Not only can corporates provide capital, but they can also offer commercial synergies and valuable services. These could include assistance with product design, introductions to potential customers and/or vendors, brand association as well as regulatory and technical support in specialist areas – all benefits which a startup might not otherwise have.
In our experience, corporate investors typically invest for strategic and synergistic as well as financial reasons, which often impacts their investment terms. So if you’re looking into this option on behalf of a tech startup, it’s important to know what to expect.
So here are a few things to consider when looking for investment from large corporates:
The degree of consent rights
While both financial and corporate investors require consent rights, corporates often require different rights, such as consent rights over the investee company entering into contracts with competitors.
Corporates may also require more extensive control over compliance issues, for example requesting the company to adhere to the corporate’s anti-bribery, corporate social responsibility, and ethics policies.
In our experience, they also tend to invest with a longer-term investment horizon than venture capital investors (which generally seek an exit within around 3-5 years) and as a result, often require additional rights over an exit.
However, some corporate investors require lighter consent rights compared to a typical VC. The corporate investor may be constrained by competition and/or accounting policies which mean they will want to avoid controlling the investee company, whether by virtue of positive consent rights (i.e. the investor approving certain actions) or negative control rights (i.e. the investor being able to block certain actions).
Restrictions: Information and competitors
Due to its strategic nature, corporates often include a number of restrictions on investee companies dealing with competitors. Typical restrictions include limits on the disclosure of information to, the provision of goods or services to, or transfers of equity to, competitors.
Options for M&A rights
- ROFR: Corporates regularly request a right of first refusal (ROFR), which provides the investor with a right to be offered any shares being sold by other shareholders in the investee company after the selling shareholder has solicited an offer for their shares from a third party. Startups often resist ROFRs because they can be seen to make a company potentially less valuable as a potential acquirer may be reluctant to make an offer if their offer can be matched by the corporate investor.
- ROFO: A more company friendly but similar mechanism is a right of first offer (or ROFO). A ROFO provides an investor with the right to be offered the shares before any external solicitation takes place. If the investor refuses the offer, then the selling shareholder may solicit third party offers on the same terms that were presented to the investor.
- ROFN: An even softer provision still is a right of first negotiation (or ROFN), which only provides the investor with the right to negotiate with a potential seller of shares for a defined period of time before those shares are offered more widely.
Agreeing a ROFR or ROFO (or both) is often one of the trickier negotiation points when dealing with corporate investors, but a workable solution is usually obtainable in most circumstances.
Corporate investors sometimes want a call option to acquire the company. This is often at an agreed price or a price based on a formula in the event that the company is successful generally or achieves certain specified milestones. In rare cases, the parties may even pre-negotiate the terms on which the acquisition will ultimately take place.
Corporates may also want a put option giving them the flexibility to sell their shares in the investee company back to the company or other existing shareholders (typically for fair market value) in the event of certain triggers.
These might include the investee company failing to achieve performance milestones by a certain date or for regulatory or reputational reasons.
For example, fintech companies regularly find that financial institutions such as banks request a put option in order to sell their shareholding promptly should they need to do so to ensure compliance with financial regulatory requirements.
The appointment of an Investor Director or observer rights
VC investors generally require a board seat. While CVCs often request a board seat as well, they do in some cases rely on appointing an observer instead.
From a startup‘s perspective, it’s worth considering what information an observer will be able to access. 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 its confidential information.
Likewise, there’s no requirement for an observer to excuse themselves from a meeting in the event they have a conflict (or if a conflict of interest arises during that meeting). While these issues arise 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, it’s fairly common for observers appointed by a corporate to be excluded from access to certain information or board meetings.
Compliance and policy requirements
Many corporate investors require their investee companies to agree to specific undertakings over-and-above those commonly required by financial investors.
For example, corporate investors increasingly subject their investee companies to rigorous environmental, social, and governance (ESG) standards, including compliance with anti-money laundering regulations, anti-bribery and corruption, anti-modern slavery, and other relevant policies.
While the primary concern for any tech startup is raising capital, particularly in the current COVID-19 environment, CVC investors can bring a number of significant benefits which can help founders accelerate their startup‘s development.
That said, it’s crucial for startups and their founders to ensure that there is strategic alignment with their CVC investors. It’s important to carefully negotiate the legal terms which CVC investors may require in addition to the standard terms that are typically required from financial investors.
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