|
 One of the thorniest problems in taking investment dollars from corporate strategic investors is the risk of "selling the company without selling the company." You want the money, you want the benefit of the power that corporate partner can bring, but you don't want to be arbitrarily capping your upside. However, the corporate partner has a set of worries, too. They don't want to give you money so you can make yourself so valuable they can't afford to buy you later, when you have grown into a significant enterprise. So, how to you deal with these conflicting issues and goals?
Recently, we saw a negotiation settle around a tried-and-true model from the world of sports - baseball binding arbitration. The model worked like this: The strategic investor would put their money in for X% of the company. In addition, they received an option to buy the entire startup at any time over the following three years, unless the company filed for an IPO.
Now for the tricky part: How do you set the price today for a possible event up to three years from now without either capping your upside (if you are the entrepreneur) or paying for value you helped create (if you are the strategic investor)?
Here's where the arbitration comes in. At any time in the three year window, the strategic investor can propose an acquisition. They then must put their price in a sealed envelope. The company puts its price in a sealed envelope as well.
The arbitrator opens the envelopes together and the following rules apply:
- If the numbers are within 20% of each other, the arbitrator splits the difference, and the deal is done.
- If the numbers are farther apart than that, the arbitrator picks one. If it is the strategic investor's bid, the company must accept. If it is the company's bid, the strategic must either accept, or lose its option forever.
So, how does this serve both parties?
- It keeps both sides honest in their bidding. If one goes way out of range, they risk the other number being chosen, with the consequences attached.
- It allows for a rational process not based on performance metrics that can't be fully understood when a startup is still in its early days.
- It maintains relationships going forward, that will be crucial if the company is acquired, since the rules are defined and the decision is with the arbitrator, not between the parties.
In business, we all can fall into the trap of using sports analogies to describe our situations. Here's one where a sports model really is helpful!
 |
