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During the late 1990’s and into the year 2000, entrepreneurs experienced unprecedented success in raising equity capital through venture capital financings and public offerings. In addition, many entrepreneurs were able to raise capital at very high valuations and on very favorable terms. The recent economic slowdown has resulted in a significant decrease in the availability of equity capital. Those entrepreneurs that are fortunate to raise capital in the current environment often must accept lower valuations and more investor-favorable terms. As a result, strategic alliances are becoming an increasingly attractive alternative for information technology and life science companies to raise capital and survive the current economic situation.
Generally, strategic alliances are arrangements between two or more entities that are created to achieve mutual goals through collaboration. Strategic alliances take many forms, including contractual arrangements (such as license agreements, marketing agreements, and development agreements), minority equity investments, and joint ventures that are operated as separate legal entities (such as corporations, limited liability companies, or partnerships). Regardless of the form, strategic alliances share common features such as: (i) defined scope and strategic objectives; (ii) interdependent contractual arrangements within the defined scope and to achieve the strategic goals; (iii) specifically defined responsibilities and commitments for each party; (iv) independence of the parties outside of the defined scope of the alliance; and (v) a fixed time period in which to achieve the strategic goals.
The simplest form of strategic alliance is a contractual arrangement. Contractual-based strategic alliances generally are short-term arrangements that are appropriate when a formal management structure is not required. While the specific provisions of the contract will depend upon the business arrangement, the contract should address: (i) the duties and responsibilities of each party; (ii) confidentiality and non-competition; (iii) payment terms; (iv) scientific or technical milestones; (v) ownership of intellectual property; (vi) remedies for breach; and (vii) termination. Examples of contractual strategic alliances are license agreements, marketing, promotion, and distribution agreements, development agreements, and service agreements.
The most complex form of strategic alliance is a joint venture. A joint venture involves creating a separate legal entity (generally a corporation, limited liability company, or partnership) through which the business of the alliance is conducted. A joint venture may be appropriate if: (i) the parties intend a long-term alliance; (ii) the alliance will require a significant commitment of resources by each party; (iii) the alliance will require significant interaction between the parties; (iv) the alliance will require a separate management structure; or (v) if the business of the alliance may be subject to unique regulatory issues. In addition, a joint venture will be appropriate if the parties expect that the alliance ultimately may be able to function as a separate business that could be sold or taken public.
Historically, information technology and life sciences companies have sought minority equity investments from strategic commercial partners. This form of strategic alliance has gained increased popularity in the current economic climate. In many cases, the equity investment will also be accompanied by a contractual arrangement between the parties such as a license agreement or a distribution agreement. From the company’s perspective, an equity investment from a strategic commercial partner may be structured on more favorable terms than those obtained from venture capitalists, and it may increase the company’s valuation and enhance the company’s ability to secure future rounds of funding. Venture capitalists and underwriters generally view these types of strategic alliances as validating an early stage company’s technology and business model. In some cases, they have even become a condition to an underwriter taking a life science company public. The strategic commercial partner may desire this form of alliance to gain a competitive advantage through access to new technologies and to share in the upside of the other party’s business through equity ownership.
Early stage companies may gain significant operational advantages as a result of forming strategic alliances. Moreover, the growth of early stage companies may be significantly accelerated through strategic alliances, and the companies may be more successful in obtaining future equity investments. In addition, early stage companies may find that strategic alliances are the first step to the acquisition of the company by the strategic partner, and they give the parties the opportunity to evaluate whether or not an acquisition is desirable.
Strategic alliances also have their risks, particularly if the parties are not financial equals. These risks include the loss of operational control and confidentiality of proprietary information and technology. Some alliances can involve a clash of corporate cultures or the perceived diminution of independence. In addition, the parties may deprive themselves of future business opportunities with competitors of their strategic partner.
The parties must carefully consider a number of factors in the decision of whether to enter into a strategic alliance, and how best to govern the relationship once the alliance is formed. In addition to the parties’ business objectives, the parties should consider a variety of accounting, tax, antitrust, and intellectual property issues when structuring a strategic alliance. A properly structured strategic alliance can bring many new opportunities and enhance the parties’ growth potential. In addition, it can provide an alternative source of capital during difficult economic times.
This article was published in the July 2001 issue of the Triangle TechJournal.