Article adapted from Seraf: Portfolio Management for Early-Stage Investors
A very common practice in the investment world is syndication. Syndication allows multiple investors — whether they be individuals, angel groups, VC funds, etc. — to join together and provide the funding resources needed by one company. Syndication has been a common practice amongst VC firms for decades. It’s also been common practice amongst individual angel investors who have increasingly chosen to come together into angel investment groups. As of very recently, the term is also being used by some of the on-line platforms to connote a mechanism whereby a group of investors can commit money to be invested alongside a lead investor. But for the purposes of this discussion we are focused on syndication between angel groups. Inter-group syndication of this type has only been common for about ten years in the angel group world. It makes a lot of sense because it broadens both the financial and the human capital resource base of the company, but it is a challenge because it requires a fair amount of coordination amongst a lot of people.
Some of the very first syndicates were formed in New England in the mid-2000s. Given the close geographic proximity between angel groups in the Northeast, it was natural for these groups to band together and pull together large financings for startup companies.
Ham, in his position as Managing Director at Launchpad Venture Group, played a big role in some of the first angel group syndicates in New England. So let’s hear what he has to say about how angels can work together to form enough capital to properly launch a startup company.
Ham, tell us about one of the early angel group syndicates you were involved with.
In April 2005, Launchpad was introduced to a very promising Medical Diagnostics company called Cognoptix. The company was developing a new approach for the early detection of Alzheimer’s. Their technology was a real breakthrough in an area of growing concern and significant costs to the US Healthcare system. We were impressed with the founding team and knew this was a company we wanted to back. As is typical with early stage life science companies, Cognoptix expected to raise significant money before they would be ready for an acquisition. When they approached us in 2005, they were looking for a relatively small amount of capital, in the neighborhood of $1M, to help them take their proof of concept to the next stage. After completing our due diligence over the spring months, we were ready to move forward with an investment. However, Launchpad was a relatively small angel group at the time, and we didn’t have enough capital from our members to fully fund Cognoptix.
During this same time period, the Managing Directors of angel groups throughout the New England region were meeting on a monthly basis to discuss best practices at our respective groups. One area of focus during our meetings was figuring out ways of raising larger amounts of capital for early stage companies in our portfolios. George McQuilken, the Managing Director at eCoast Angels, offered to hold a regional angel group meeting in Portsmouth, NH. One of the main agenda items at the meeting was a series of investor presentations by companies looking to fill out an open round of financing. Launchpad invited Cognoptix to present to the audience of approximately 100 angel investors. With a term sheet in hand and an endorsement by Launchpad, Cognoptix was able to raise the rest of their open round within 2 weeks of their presentation. Angels from groups all over New England participated in the initial round and continued to fund the company in several subsequent rounds of financing. This was the first large multi-angel group syndicate formed in the US.
What are some of the biggest challenges in putting together a syndicate?
Pulling together a syndicate of investors is never easy, whether you are talking about individual angels, angel groups, or VCs. Helping a company raise funds with a syndicate of investors adds time and complexity to the fundraising process, and you will need to take this into account when you are helping an entrepreneur raise capital. First off, you have to find a lead investor to negotiate the deal terms with the entrepreneur and then manage the syndicate of investors. It’s common to hear an entrepreneur lament the fact that they have lots of interested investors lined up if only they could find someone to lead the deal. Assuming that the lead investor is on board and willing to help with the fund raising, there remain additional challenges.
Let’s take a look at some of the bigger issues we faced at Launchpad in the dozens of deals we syndicated over the past 10 years. As mentioned above, it takes a lot of time to syndicate a deal. As the lead investor, after negotiating a term sheet and preparing a syndication-worthy diligence report, you are expected to:
- Work with the company to determine the minimum amount of financing needed to help the company achieve key future funding milestones
- Build a fundraising plan to hit the target amount of needed financing
- Introduce the entrepreneur to potential investors and investor organizations
- Support and champion the deal with potential investors
- Share your diligence materials with potential investors and be available to answer questions about your diligence process and findings
- And finally, work to make sure the deal closes in a timely fashion
Do all syndicate leaders take on all of these activities? No… but the good ones do, and they make a big difference in a company’s ability to raise capital.
What are some important issues that investors need to be wary of?
When you are asked to join a syndicate of investors, you should be careful about how much you rely on the lead investor’s ability to properly perform due diligence on the company. Especially with angel investors, there is a broad range of approaches to diligence and in such a range, there will always be some approaches that do not live up to your personal standards. And, in some cases, even when there has been some good diligence work done, you might still be asked to invest without any written diligence report from that effort. Here’s a tip: if you have a certain set of diligence standards that you apply before you make an investment decision, don’t give up on those standards just because you are impressed by your co-investors.
Another challenge with syndicated deals relates to investor alignment. What do I mean by “investor alignment”? When you have multiple investors in a company, you want to make sure they are in agreement as to (i) the best path to exit for the company and (ii) what an acceptable exit would be. For example, if you have angel investors who would be happy with a 3x return in a year or two and a VC who is looking for a 10x return in three to five years, you might have an alignment issue. If the VC has voting control on the board, she can block an exit that might be acceptable to the angel investors. I’ve been in this situation before, and in the end, the company was sold for pennies on the dollar instead of the 3x return that the VC rejected. That’s the hard way to learn the alignment lesson! So, it’s important to know your co-investors and what their expectations are for the company.
What are some important issues that entrepreneurs need to be wary of?
From the entrepreneur’s perspective, there are a variety of factors that need to be taken into consideration when building an investor syndicate. Investor alignment, as we discussed in the previous question, is a key consideration. For example, you want to make sure, before you finalize an investment, that the founders and the investors are on the same page with respect to fundraising strategy. Other issues to consider include:
- Make sure the lead investor knows how to champion a deal and has great connections to other investors
- Build a syndicate with angels and other investors who will add value by making connections, helping find future key hires, and in general opening their personal network to help the company.
- Coach the CEO and board appointees on how to run an organized and efficient syndicate, including not trying to get too many irons in the fire at once.
- Be very wary of the investor who is constantly pestering you for information, and never adds any value to the company