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Strategic Partnering – When, Why and How

January 1993

A strategic partnership with a larger company may make excellent sense at some point in the life cycle of most growing technology companies. The reasons may vary from a need for research and development cash to a realization that utilizing a third party’s marketing capability may generate a greater net profit than going it alone. But how can a company decide when it is right to seek such a relationship, and how should it go about it?

When?

Strategic partnerships should always be considered as an alternative when R&D and marketing methods are being evaluated. Once a company’s consciousness has been raised to that level, it then becomes a matter of evaluating the relative benefits, availability and strategic consequences of that method of reaching an objective, compared with other possible methods (e.g., private, public or bank financing). Of course, strategic partnerships will not always be feasible: if a company is interested in obtaining expansion capital instead of funding for developing a new product which another company would like to market, the chance of attracting a partner is fairly low.

Although funding partnerships are often thought of as being primarily creatures of the biotechnology industry, they have become commonplace in other areas as well. For example, the 1992 Software Industry Business Practices Survey jointly produced by the Massachusetts Computer Software Council and Price Waterhouse indicates that over 40% of all software companies responding had at least one alliance in place which provided some measure of funding, and 61% of all respondents were engaged in at least one marketing alliance.

Why?

The best argument for successful strategic partnerships is that the smaller company invariably receives benefits beyond mere funding, and often the funding itself is on a valuation and/or terms more favorable than could be obtained elsewhere. For example, the larger partner will often agree to a lower valuation for stock received, accept common rather than preferred stock, and not expect a seat on the smaller partner’s board of directors. The smaller company may also be able to access, at least on a royalty basis, a broader market much more quickly than it might otherwise be capable of addressing.

In other cases, the smaller partner may receive useful technology, valuable advice or other benefits not available from more traditional financing sources. For example, the collateral benefits listed by the respondents in the survey referred to above included the sharing of customer lists, use of the larger company’s booth space at trade shows, joint marketing efforts and the coordinated development and marketing of complementary products.

How?

The first step in securing a strategic partner is evaluating what partners may be both available and interested; the second step is deciding how to approach them. In most cases, the company seeking the partner will know who at least some of the most logical partners are, and may already have business contact with them for other reasons. However, the choices may not be obvious, or the smaller company may lack the time, influence or expertise required to get a large company’s attention. Where this is true, the smaller company may find it advisable to retain a consultant or investment banker to assess the market and make the contact.

Such an advisor can also be helpful in avoiding a critical but common mistake which many small companies make: contacting a larger company at too junior a level. Where this occurs, an interminable negotiation usually results as the decision whether or not to enter the relationship crawls up the management ladder at the larger company. Most often, the project will get shot down along the way. As a result, it is often better to forgo an otherwise promising partner entirely if it is impossible to open initial discussions with senior management.

Once the interest of a potential partner has been obtained it is essential to assess the expectations, resources and objectives of each side, and thereby determine how mutual and complimentary they may be. If the match is poor, or the managers responsible for implementing the partnership are not committed to its success, it is again better to terminate discussions quickly. In such a situation, the potential partners will only waste valuable time and effort creating a forced arrangement where one partner will be likely to lose interest or try to renegotiate the deal at a later date.

Both parties should also be mindful of the long term strategic consequences of a relationship which may otherwise appear beneficial. For example, if the smaller company gives away extensive exclusive marketing rights in its core products or technology, it may severely depreciate its value to future investors interested in funding unrestricted ventures. Conversely, a larger company which stakes an important market play on the technology of a small startup company may be placing unwise dependence on a financially unstable partner. In the first case, the remedy may be to restrict the rights conveyed. In the second, the risk may be bounded by placing the technology itself in escrow, so that the larger company can attempt to complete the research and development or maintain and support the product itself if the smaller company fails.

In order to make negotiations with a potential partner efficient, it is important for each company to determine the broad overview of the type of relationship which the other company is interested in pursuing as early as possible. Proposing and agreeing upon a non-binding letter of intent between the parties is a good way of flushing out points which may be unacceptable to one party or the other. In that letter, both companies should commit to negotiate in good faith to complete a mutually satisfactory agreement by a set date. In the course of the more detailed negotiations which follow, both parties should remember that they will need to work together over an extended period of time for their mutual benefit. If either side pushes too hard during the negotiations, it may sour the relationship, or leave so little benefit to one partner that it will abandon its commitments to the joint enterprise.

A Final Note

Although there are a number of common overall structures to a strategic partnership, the exact terms of such an arrangement are extremely variable. For this reason, it is imperative that a company consult with its attorneys, accountants and financial advisors before a letter of intent is signed. Once that document has been executed, it will be next to impossible, from a practical perspective, to change these “non-binding” terms.