Rethinking Strategic Investments: Considerations for Financing Choices
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Rethinking Strategic Investments: Considerations for Financing Choices
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By Faith Nyabuto, Analytics Lead, Botho Emerging Markets Group
May 4, 2021
Should Kizingo accept money from a strategic investor?
Kizingo* is a start-up that provides last-mile food delivery services across Uganda. The company has achieved unprecedented growth in the last two years and attracted the attention of large industry players and venture capitalists alike. The two largest food and beverage manufacturing companies in the region have approached Kizingo about potentially investing in the company. While the proposition seems interesting, Kizingo will need to think critically about what this means for its current and future growth prospects and decide whether a strategic investor makes sense for them.
Like any other external financing mechanism, investments from strategic investors carry with them critical terms of engagement that require careful evaluation by potential investees to establish fit. At face value, strategic investors can seemingly provide companies with more value than purely financial investors, especially since the former are often directly aligned in terms of business interests. However, by their very nature, strategic investors can restrict future opportunities for entrepreneurs due to competitive considerations. This is in contrast to financial investors, who tend to invest primarily for maximum return on their capital. While a strategic investment can carry several potential advantages for a business, founders of start-ups, like Kizingo, often find themselves at the crossroads in deciding between strategic and financial investor offers.
Strategic investors, also known as corporate investors, are corporations that make investments into smaller companies - often startups - to realize strategic and financial gains. They differ from financial investors, typically private equity and venture capital firms or angel investors, who tend to invest primarily for monetary return. Notable global corporate investors include Google Ventures, which spun out of Google in 2009, Pfizer Venture Investments, the venture capital arm of Pfizer Inc, which was founded in 2004, and Coca Cola’s Venturing & Emerging Brands, founded in 2007.
Strategic investors continue to inject more and more money into the startup ecosystem in Africa, playing a crucial role in bridging the funding gap. Growing interest in early-stage ventures on the continent over the past few years by both international and Africa-based investors has also led to increased participation from corporate investors. According to the African Private Equity and Venture Capital Association, corporate investors represented 11% of the total number of investors that participated in venture capital deals on the continent in 2014-2019, coming third after PE/VC fund managers and PE/VC investment firms. Major current corporate investors in the African startup space include Japanese automaker Toyota, which established Mobility 54, a venture capital firm specifically targeting African startups in 2019, as well as global payments giant Visa, which bought a significant minority stake in Nigerian payments platform Interswitch in 2019, and French giant Orange, which spun out Orange Ventures as a separate legal entity in 2021 to invest $430 million across different regions including Africa.
A strategic investment may provide a company with legitimacy and market validation, making it easier for the company to pursue commercial opportunities and attract additional venture capital investment down the line. In 2013, Tesla’s solar subsidiary SolarCity invested in the Series A of Zola Electric (formerly Off Grid Electric), a Tanzania-based renewable energy company. Since the investment, Zola has received more than $200 million in funding from other prominent institutional investors, such as the International Financing Corporation, Helios Investments and General Electric, and expanded its operations into Côte d’Ivoire, Ghana, Nigeria, and Rwanda. While direct correlation may be presumptuous without the full context of the company’s operations, having a prominent investor does help with opening doors to bigger opportunities.
Working with a strategic investor provides a company with access to otherwise unavailable technology, resources, and know-how, all of which have an eventual impact on performance. Corporate investors will lend industry expertise and a fresh perspective in board decisions. Agreements with corporate investors often include broader commercial arrangements, such as product marketing, distribution, and research and development (R&D), which can bring in additional revenues. For example, Sendy’s $20 million round in 2020 was backed by Mobility 54 and included an R&D arrangement through which Sendy will develop new technologies to enhance operational efficiency.
For all these benefits, there are several drawbacks associated with a strategic investment that founders should carefully consider. Firstly, strategic investors often use venture investments as a low-cost way of gathering market intelligence to protect themselves from emerging competitive threats. In pursuit of this objective, they may leave little room for sustained knowledge spillover to the company. In 2019, Yamaha invested in Nigerian motorcycle transit startup MAX.ng and cited market research as part of its motivation. It remains to be seen whether MAX.ng will extract commensurate knowledge transfer benefits from the partnership. Secondly, accepting a strategic investment may foreclose other opportunities, such as commercial deals with competitors due to the perception that the company lacks autonomy in decision-making. A strategic investor’s focus on a narrow range of projects may also deter a company from pursuing disruptive innovations and opportunities that may be beneficial to the company, but that might not be aligned with current interests of the investor.
One of the key selling points of external investors is their ability to provide further funding to the company in later rounds. A strategic partner may either not be motivated to provide additional funding once they achieve their strategic goals, or may not have access to enough investment capital for follow-on investment. For example, Cameroon-based Afrostream, a subscription video-on-demand startup stated that it shut down its operations in 2017, because it was unable to raise further investment. This development arose despite having French multinational Orange as part of their early investors. Lastly, strategic investors almost always ask for the right of first refusal (ROFR) to buy the company in future. This clause allows the strategic investor to match offers that any other acquirers present. In addition to locking out more attractive offers and limiting the price the company is able to negotiate, such provisions may also discourage competitors of the strategic investor from acquiring the company if they believe that the strategic investor stands to benefit from the deal.
Accepting investment from a strategic investor carries several long-term implications for a company's future. While strategic investments may seem better than purely financial investments, start-ups such as Kizingo should do their due diligence, consider all available options and carefully evaluate offers against their companies’ current and long term objectives. Entrepreneurs should seek investors that are well-positioned to help their businesses grow without limiting their scope of operation or foreclosing future opportunities. With the right strategic investor, entrepreneurs can build independent companies that eventually scale to become household names.
By Faith Nyabuto, Analytics Lead, Botho Emerging Markets Group
*Author's note: Kizingo is a fictionalized enterprise, presented for the purpose of discussion. Any resemblance to an actual company is purely coincidental.