Raising funds from a large corporate group, which acquires a minority stake in a start-up, has some specifics as compared with the entry of a classic VC fund in a start-up’s capital.

Between the desire to join forces with a renowned and solid group and the fear of letting the wolf into the fold, the founders and, if applicable, the start-up’s historical investors may hesitate.

What should you know before taking the plunge?

Why invite a corporate into a start-up?

For the start-up, beyond the financial contribution, the entry of a corporate can be a guarantee of credibility, the assurance of benefiting from sector expertise or from the strike force of a large group. It is also often an opportunity to establish commercial partnerships.

Obviously, corporates are not immune to the charms of start-ups either, and the latter must know how to play this attraction. The start-up can act as a rejuvenating force for the group, which finds the opportunity, for a sometimes modest investment given its scale, to instil a spirit of innovation within its teams, to anticipate market trends and to carry out a technological watch. The potential financial return is also attractive. Lastly, looking to the future, the group can thus position itself as a potential candidate for the acquisition of 100% of the start-up’s capital on exit.

But then, if the bride is beautiful and the attraction is mutual, where is the difficulty?

The main subjects of tension

In the field of corporate ventures, two subjects are likely to complicate matters: (i) access to information and (ii) liquidity.

Access to information:

Quite legitimately, the large group wants to protect its investment and, just like other investors, may wish to benefit from a seat on the board, a right of prior approval on certain significant decisions, and a reinforced right of information. The difficulty lies in the fact that the start-up may be a potential competitor of the large group, at least in certain business segments. The existence of possible conflicts of interest (the corporate might have an interest in blocking a strategic operation for the start-up that would be in direct competition with its traditional business, or use confidential information about the start-up to improve its own services) requires a certain amount of caution.

The start-up’s governance rules and information rights must therefore be adapted to address this risk. If the corporate investor is represented on the board, it is preferable, where possible, that it does not have sole veto power over important decisions. A veto right shared between the representatives of several investors (i.e. important decisions require the prior approval of one or other of the investors’ representatives) is therefore preferable. In the event of a conflict of interest, the representative of a corporate investor may also be exceptionally excluded from a board meeting or have his or her right to information restricted. The shareholders’ agreement and/or the board’s rules of procedure generally specify the procedures for implementing these rules on conflicts of interest.

Liquidity:

The other classic source of discord between a corporate investor and other partners concerns liquidity. The liquidity objectives of the corporate investor are generally more difficult to anticipate than those of a traditional VC fund. It may be relatively indifferent to the liquidity of its stake in the company (e.g. if the commercial partnership with the start-up takes precedence over the interest represented by its minority investment in the start-up), or seek to ultimately buy out the entire capital of the company.

If the corporate investor’s objective is to buy the start-up in the long term, it may wish, from the outset of its investment, to secure as much as possible its ability to pre-empt the entire capital upon exit. This can be achieved by including specific rights in the shareholders’ agreement to the benefit of the corporate, such as (i) option to purchase all the capital in the future, (ii) right of first refusal (the corporate being able to acquire the shares in preference to a third party purchaser that has made an offer), (iii) right of first offer (any party intending to sell its shares having to propose to the corporate in advance whether it wishes to acquire them, with the price potentially offered by the corporate setting a floor price below which the transferor is prohibited from transferring its securities to a third party), or (iv) a simple right to be informed of any proposed transfer and to make an offer.

The corporate may also wish to prevent some of its competitors from entering the capital of the start-up and impose a blacklist prohibiting any transfer to certain named persons.

For obvious reasons, these rights are likely to affect the liquidity of the other parties and may therefore be difficult for financial investors to accept.

Knowing your contact and the expectations of your historical or future partners

In practice, not all corporations have the same approach to these issues, particularly as regards liquidity. Some act in a very similar way to classic VC funds (which does not prevent them from having the ultimate objective of taking control of the start-up), while others tend to want to secure their entry into the start-up’s capital as much as possible. To avoid disappointment, the founders must test the real intentions of their contacts and, if necessary, question their network on the practices of a particular corporate. If investment funds have already invested in the start-up, a prior discussion with them is essential to assess their acceptance of the entry of the corporate and the restrictions that this may pose in terms of liquidity. It is also important to anticipate the expectations of potential financial investors that may enter the capital at a later stage of fundraising.

Conclusion

To successfully raise funds from a corporate, the founders must first ask themselves what they expect from such an operation for their start-up (strengthen a commercial partnership, get closer to a group with a view to a future sale, raise funds from a new investor, etc.), and then ask themselves what the corporate’s objectives are (financial or strategic investment, securing a commercial partnership, preparing a future acquisition, etc.). On this basis, and taking into consideration the main issues mentioned above, they will have to adjust the proposed acquisition conditions (particularly in terms of access to information and liquidity) so that the marriage may fulfil all its promises.