February 17, 2020
PUBLISHED BY Bob Bausmith
SOURCE Accelerate Innovation
B2B startups and established enterprises have always looked to each other for strategic partnership opportunities. The basic reason lies in the fundamental difference between the way the two entities operate.
Startups seek traction for new products and services designed to satisfy unmet market needs. They don’t have money or power to begin with, but teams are highly mission-oriented, sharing a collective drive to achieve their goal. Mission accomplishment is its own reward.
Established enterprises, on the other hand, are looking to exploit or retain power in significant markets. They are reluctant to change business models, pricing, go-to-market, etc. in fear of upsetting cash cows. With limited ability to innovate and incubate new business models, the established enterprise finds it difficult to retain their position in the long term.
These fundamental differences are both existential and unavoidable. As Bryan Stolle, Founding Partner of Wildcat Venture Partners, puts it, at the core, the difference comes down to a discussion of power—how much of it there is, who has it, and how it is wielded.
THE PATH TO POWER
“Power is the core concept of Strategy. It is the Holy Grail of business—notoriously difficult to reach, but well worth your attention and study.” – Hamilton Helmer, 7 Powers: The Foundations of Business Strategy [ii]
To maximize value, it’s imperative for startups to find their path to power. In strategist Hamilton Helmer’s book “7 Powers: The Foundations of Business Strategy,” he defines power as the potential to realize persistent differential returns. From his perspective, strategy has only one objective: to maximize potential business value. Power, he says, is the key to value creation, and Value = Market Size * Power.
Power is created if a business attribute is simultaneously: superior, significant, and sustainable (presents barrier to competition). Since startups don’t have much power to begin with, from a very early stage, it’s in their best interest to consider strategic partnerships as part of their go-to-market strategy. As Stolle puts it, startups should be looking for power everywhere they can. Aligning with established enterprises can offer significant advantages, from immediate brand recognition to accelerated access to markets at scale. When fundraising, startups might also consider looking to established enterprises as additional or alternative financing sources, particularly where there is a strategic imperative for the large company, typically around new market access (SalesForce & MuleSoft), sales leverage for existing product lines (&), or testing new business models (Unilever & Dollar Shave Club).
More now than ever, established enterprises are turning to start-ups for strategic advantage in exploiting or retaining power in significant markets. Stolle describes strategic partnerships with startups as formerly being a sometimes-in, sometimes-out trend for established enterprises. Venture capitalist Mike Moritz of Sequoia once joked about “the tourists finally leaving” during bursting of the Internet Bubble in the early 2000’s. Now, the large global companies have come to stay. Today, strategic partnerships between startups and established enterprises are a constant.
REGULATED INDUSTRIES: WITH GREAT POWER, COMES GREAT RESPONSIBILITY.
The sheer necessity of partnerships between startups and established enterprises is especially true in heavily regulated industries, like insurance, finance, and healthcare. Bryan Stolle is blunt when addressing this: regulators always lag behind innovation.
This presents a challenge to established enterprises. Sustained power and accelerated growth lie within innovation, but regulation often restricts or limits innovative potential. Startups, on the other hand, have fewer constraints and can ensure regulatory compliance is factored into the architecture of new products and services while pushing the boundaries of innovation. By working directly with startups, established enterprises can explore the viability of the most innovative solutions in the market, without running afoul of regulatory issues in their large established markets and product lines.
As strategic investment by established enterprises becomes more common, as well as financing arrangements where strategic investors and financial investors are both involved, alternative paths to power become more readily available
In discussion with Stolle, he defines two common variants of enterprise strategic investors he sees in his role as one of the Founding Partners of Wildcat Venture Partners, an early-stage B2B focused VC firm in Silicon Valley.
There are the established enterprises who make investments to test new business models through commercial agreements with startups. And there are the enterprises who operate a corporate VC arm. Many do both.
Of the corporate VCs, there are two kinds: those who operate as pure financial investors, and those who operate as strategic investors looking to invest in startups that are strategically relevant to their parent corporation.
When I asked Bryan about his experience working alongside strategic investors, he offered the following observations. Generally, a startup should only count on any given strategic investor for one round. Many times, they are “one and done” investors. It’s a product of the way large enterprises operate, he explains. They often undergo management or strategy changes or their priority for funding allocations shifts. Bryan said in his experience, only a third of the time does he see strategic investors maintain their investment strategy for more than three years. Startups need to be aware of this likelihood and plan accordingly.
TERMS & EXITS
When commercial agreements between startups and established enterprises are designed to acknowledge each party’s need to create value and that each party’s strategy can change and become misaligned over time, they can effectively serve the best interests of both parties. However, when the established enterprise uses a strategic investment as leverage to establish exclusivity or restrict the start-up’s go-to-market options, it can produce devastating results. This also occurs when startups decide to partner with strategic investors under terms that don’t support the startup’s business model. When a start-up sells equity to a strategic investor with an accompanying commercial agreement, understanding power dynamics from each side is critical to negotiating an effective, fair, and sustainable deal.
Stolle has some advice for startup founders and CEOs navigating these decisions. Most poignant: “don’t become a captive development shop.” It’s easy to become enamored by big brand names. “Be conscious of your own susceptibility to being starstruck,” Stolle adds. “If an established company is talking to you, they’re probably struggling with something. It’s essential to help coach CEOs on when to say ‘no.’”
It’s also essential that startup CEOs enter these relationships with a good understanding of some of the challenges they will face. If the purpose of the commercial agreement is to leverage an enterprise’s sales team, it’s critically important for the startup to ensure that the sales team knows how to sell its product and has been provided the proper support and incentives. Often times an overlay sales team with its own P&L is the best approach when getting started, as is making sure the sales reps are specifically compensated for the sales of the startup’s products. Aligning compensation goes a long way in aligning goals and making sure the relationship is a success.
It’s just a harsh reality, but without incentive, enterprise sales staff aren’t going to feel the urgency or sense of ownership that a startup sales team will. They already have a full-time job and a quota for their own products. As Stolle describes, “good enterprise salespeople are always looking to understand the dynamics of where power lies within customer organizations – they have a fascination with how it flows and look for ways to leverage it in their favor.” If commercial agreements are structured to benefit these sales teams’ paths to power, they’ll get creative and find ways to close deals for the startup’s products.
PLAN FOR FAILURE, MAXIMIZE ODDS OF SUCCESS
As much as acquisition by a strategic investor may seem like the ideal outcome, unless it’s actually happening right now, it’s not in the startup’s best interest to make acquisition by a specific enterprise seem inevitable. If the likelihood of acquisition is visible to other potential strategics, it can mute your company’s valuation. Sometimes startups and established enterprises will try to mitigate this by pre-negotiating an acquisition to provide some level of guarantee. But value can be similarly muted or underestimated in these agreements, and they carry inherent risk in the event the partnership fails.
The other side of mitigating failure is doing everything in one’s power to increase the odds of success. This means building technology that is integration-ready. It’s something that can’t be stressed enough. Designing your technology and your architecture to plug easily and directly into existing systems is the number one thing you can do if your objective is to maximize potential in a future acquisition. Stolle encourages all the companies he works with looking to take an enterprise integration approach to start with their APIs instead of ending with them. If you begin with integration as a core capability and work upwards from there, you significantly improve your chances of establishing viable partnerships and/or creating valuable acquisition opportunities.
THE RIGHT ADVICE (& ADVISORS)
If your go-to-market is through an established enterprise, it’s essential to assemble the right team around you. As Stolle says, there isn’t necessarily any one type of professional who is qualified to advise on these relationships. Some financial advisors might be able to, but definitely not all of them. Some lawyers and former execs, but not all. Some investors, but not all—VCs don’t know everything. It comes down to experience. Lots of times people have experience in one area of these relationships, but not a well-rounded understanding of the dynamics as a whole.
Take the time to develop a well-rounded board of directors. For startups, Stolle recommends having 5-6 member boards. Two investor seats, 1-2 insider seats, and 1-2 independent seats. Vet all prospective members, investors and independents alike, for their qualifications to support you in forming and sustaining key strategic relationships. Ideally at least one of your board members has experience negotiating commercial agreements on behalf of both startups and established enterprises, bringing an understanding of the perspective of each party.
Aligning the innovation and new market traction of a startup with an established enterprise’s need to exploit or retain power in important markets can produce significant business value for both parties. But the path is long and full of obstacles. Most companies will fail along the way. The few who succeed do not do it alone. Assemble the right people around you. Lean into the expertise of those who have traversed the gap between strategic investment and realized strategic value before. A strong knowledgable board and well-designed commercial agreements are keys to finding and retaining your power through strategic relationships and investments.
[i] Moore, Geoffrey. Zone to Win. Diversion Books, 2015.
[ii] Helmer, Hamilton. 7 Powers: The Foundations of Business Strategy. Self-published, 2016.
Read the original post on Accelerate Innovation’s website here.