5 Important Things to Keep in Mind While Taking Strategic Investment

21 February 2023

Strategic investments are made by parties who are not looking for an immediate financial return but instead want to influence the company so they can reap future benefits. These investors are typically called "strategic investors." They can be individuals, families, venture capitalists,  or other companies which can derive strategic value.

What they have in common is that they're not after a quick buck; they're interested in the company's long-term success and are willing to invest time and resources to help it grow.

This investment model requires a well-thought-out strategy and a solid legal understanding by both parties. That said, here are five elementary things founders and investors must be mindful of during strategic investments.

1. Founder Veto Rights

As a founder, it's crucial to retain the right to veto any significant decisions regarding the startup. This should include decisions such as major hiring and firing, altering the company's vision, and changes in the corporate structure.

As hinted earlier, these investors only chip in for a say in the startup and not total control. This is where founder veto rights come into play. These policies allow the founder(s) to maintain ultimate control of the startup while still enjoying investments from the investor.

Having such policies in place before signing any agreement protects the founders' vision for the company. 

2. Any Business Arrangements Apart From Investments by the Investor

Apart from financial assistance, the investor and the startup can agree to other business arrangements. For example, many investors may offer more than just money to startups by bringing new expertise and connections. But what does this mean for founders?

Founders must first determine if these arrangements can benefit the startup or potentially damage it. A clause that clearly defines the agreement and the investor's role (and capacity) can help startups avoid problems.

3. Tag-Along Rights in Case the Investor is Exiting

'Tag-along rights' refer to a contractual agreement between the investor and the startup, which states that if the major investor decides to exit the investment, the other shareholders can leave alongside the investor on similar terms. 

This prevents them from being obliged to stay on in a company that may not be profitable anymore. Founders and investors need to negotiate this before entering a deal, as it protects the latter against any unwanted outcomes.

4. Additional Investment Requirement Protocols

It takes time and multiple funding rounds to get a startup on its feet. Thus, in addition to the initial investment, founders and investors should discuss any additional investments that the startup may require going forward.

This prepares both parties as it sets out each party's obligation regarding further investment in the company upfront. Doing this eliminates any miscommunication or surprises later on and gives existing investors a say in ongoing growth decisions.

It also ensures that the existing investors have some say over any future dilution of their equity due to additional investments. This step is crucial to keep everyone on the same page and maintain lasting investor relationships.

5. If Buy-Out Conditions Need to Be Discussed

Strategic investors must factor in buy-out conditions when investing in a startup. This means discussing with the investor what happens if the startup is acquired by another company.

Founders also need to outline when and how to execute such a transaction. Most importantly, they must determine who will manage such a transaction and agree on specific triggers to meet before this process kicks off.

Further, these details must remain confidential and not be disclosed outside of the transaction. Preferably, seeking legal assistance to ensure that all details are legally binding while remaining fair for both parties is advisable.

These steps will ensure a smooth transition if a buy-out happens during the investment journey.

Wrapping Up

Taking strategic investment can be a boon for startups and VCs, but keeping a few things in mind is important.

Founders should focus on veto rights and consider any other business arrangement an investor offers in addition to the investment itself. They also need to lay down the terms and conditions for future additional investment needs. In the same vein, investors need their 'tag-long rights' to protect their bottom line if things go south and clear buy-out conditions if the startup lists for sale.

In a nutshell, strategic investments built on these five pillars will favor both parties and lead to long-lasting relationships.


The content of this article is for information purpose only and does not constitute advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer to relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc. before acting on the basis of the above write up. The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that the Author / Treelife is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof.

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