Silent Investors On The Cap Table: What Founders Need To Know

A significant percentage of startups and early-stage companies have silent investors on the cap table. Bringing in silent partners is a great strategy when you need cash investment but don’t really need guidance and mentoring.

Companies raise funding throughout their life cycles. Their goals can range from achieving certain milestones to expanding and accelerating growth. Not all investors are suited to providing more than capital. Some are content to delegate the responsibility of running the company entirely to the founder or other key investors.

These silent investors are only concerned with the returns they can earn from their investment. You can leverage their support if your funding strategy centers only around a vital cash injection. So, let’s dive in and understand silent investors on the cap table and their benefits for your company.

Understanding Silent Investors

Silent investors or silent partners, as they are also called, are an integral part of the contemporary startup ecosystem. Most investors like to play an active role in the management and operations of the company in which they invest. This is a crucial advantage since they bring many pros to the table.

You can rely on venture-backed board members to drive the company’s success by providing advice, mentoring, and industry-specific know-how. Access to networking opportunities and follow-on capital, as well as credibility, are only some of the other advantages.

Although having experts on the board is a valuable contribution, you can have only a limited number of members. From the founder’s perspective, you wouldn’t want to dilute your control over the venture and its decision-making.

Then again, investors may have conflicting investment objectives, leading to disputes during boardroom meetings. Disputes can stall the company’s growth, which is a huge risk. You can avoid this potential issue by restricting the number of board seats you give up when raising capital.

When you need additional capital, invite silent investors who won’t attend meetings or interfere with decision-making. You won’t be accountable to them for discussing strategies or divulging information about the company’s financials. These investors have complete faith in your business acumen.

In return, silent partners expect a percentage of the profits you’ll earn. This percentage is outlined in the investor agreement, which both parties sign as a pre-determined figure. The investor may or may not also require an ownership stake in the company.

The percentage of returns is mutually agreed upon between both parties, but you can expect to offer around 10% of the profits. These profits and other payments are payable monthly, quarterly, or yearly as specified in the investor agreement.

Pros of Having Silent Investors on the Cap Table

Inviting silent partners to back your company is a tactical approach that has many advantages. Here’s what you can expect.

Access to Funding

When your startup is still in its infancy, you’ll need mentoring and advice to get it up and running. Lead investors can also provide this money. But you will need smaller amounts of capital from time to time as the company grows. But without raising a major series round.

At this time, you can lean on silent partners to provide you with the money you need. This financial boost need not come at the cost of dilution or unaffordable interest as in bank loans. You can bridge the cash shortfall with assistance from a silent investor.

Raising funding from a silent partner is far less stressful and more streamlined. The transaction is just about the financial benefits for both parties, and is easy to negotiate and finalize.

Conventional investors like venture capitalists and angels prefer to back companies operating in sectors with which they are familiar. However, silent investors are unconcerned about the sector. This factor broadens the portfolio of potential capital sources. You can explore beyond your industry.

Yet another advantage of having silent investors on the cap table is risk diversification. A typical silent investor agreement is structured like a limited partnership, where the investor does not carry any liability. This liability can relate to legal matters or debts the company incurs.

Given that close to 82% of startups fail because they run out of money, you’ll avoid this risk by relying on silent partners.

Retaining Control Over Decision-Making

Founders are always wary about losing control over their company and not realizing their mission and vision. This risk is so worrying that many choose a merger or acquisition (M&A) rather than approach venture capitalists.

Seasoned founders with successful exits under their belt are typically ready with a robust business model and a minimum viable product. They likely have a framework for their go-to-market strategy, market positioning, and business development.

At this time, they only need capital and an investor who trusts in their judgment to drive the company toward success. But, without the interference. And, silent partners are just what they need.

A great example of silent partners is Jim Goetz from Sequoia Capital, an early investor in WhatsApp. He had full confidence in the founder’s capabilities, allowing Jan Koum and Brian Acton to develop the app and run operations.

Google is yet another example of Andy Bechtolsheim investing in an early-stage company, providing $100K. He allowed Larry Page and Sergey Brin, the founders, to follow their vision and build the company.

Vital Fuel for Business Growth

Using silent partner capital, you’ll accelerate growth for the company whether it is investing in top talent or equipment. You’ll can also divert resources toward growing your customer base and marketing and advertising initiatives.

The money will help you take advantage of opportunities without the need to provide explanations to the investor. As long as your payments are made on time, they allow you complete autonomy to run the company.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Downsides of Having Silent Partners Aboard

Although having silent investors on the cap table is a huge advantage, you should be prepared for the possible downsides.

Bigger Chunk of Profits

Complete control over the company’s decision-making comes at a price. Expect to pay a higher slice of your profits as compared to returns conventional investors and VCs expect. For instance, some partners may require anywhere between 10% to 30% of the profits.

This rate can depend on several factors such as the risk factor associated with the industry in which you operate. Industries like real estate, utilities, energy, water, food, and healthcare have consistent demand and are thus considered low risk. Accordingly, the profit ratio is lower and around 10%.

However, sectors like construction, cryptocurrency, financial services, and travel are typically high-risk. Profit ratios can thus go higher, like around 25%.

Lack of Expertise

If advice and mentoring isn’t high on your list of priorities, you should go with silent partners. But, their pacl of expertise and knowledge of the business landscape can be a downside. Particularly when the company is facing a crisis situation or during an economic downturn.

The lack of expertise could result in conflicts since the investor cannot understand the challenges you face. Further, since they have no say in the company’s operations, they’ll hold you accountable and question your management skills. Not only do you stand to lose their trust, but also the capital.

Further, you cannot expect to lean on the investors for advice and guidance or even a presence at board meetings. Even if they do have the resources to assist you, they may not have the time or bandwidth to help. That’s part of the reason why they opt to sign up as silent partners.

Active business partners have a more hands-on approach since they are committed to the company’s success. Their invested capital is at stake, so they are more likely to help you navigate challenges and resolve issues. At best, silent partners may have a financial background. But, at times, you need more.

Risk of Dilution

Depending on the terms and conditions in the investor agreement, you may have to offer equity or an ownership stake in the company. As long as the company is in the early stages, the equity you give up may not seem like much. But it can pose a significant problem when you raise further funding rounds.

Keep in mind that during the due diligence, you’ll divulge information about the silent investors on the cap table. Their profit sharing and equity stake may not sit well with potential investors considering backing the company. You might end up scaring them away.

Finding Silent Partners

Searching around your network and contacting family and friends is a great starting point for locating silent partners. You could also reach out to angels, family office, investment firms and informal sources of capital. Check online directories like Crunchbase, AngelList, and any other for information.

Depending on the objectives you’re hoping to achieve from the capital raise, you’ll consider entering into horizontal or vertical partnerships. For instance, if you want to expand your product portfolio, collaborating with another company working in the same space could be a solution.

You could take advantage of shared inventory sources, marketing and advertising programs, and distribution channels. However, be sure to do your due diligence to ensure their credibility and track record as silent partners. You’ll also make it clear at the onset that you’re looking for a silent investor.

Regardless of your company’s funding stage or the investor class you’re approaching, you should know how to put together an investor outreach strategy. Check out this video in which I have explained how it’s done.

Working with Silent Partners

Now that you’ve weighed the pros and cons of silent partners, let’s talk about how to streamline the collaboration. Considering the many positives, you can work around the downsides and ensure smooth working. Here’s what you need to know:

Vet the partners carefully before accepting capital. You’ll choose entities that understand your vision and mission statement for the company. Build trust and open communication lines early on.

Even though silent investors aren’t involved in the day-to-day operations, you should keep them in the loop. Maintain transparency and provide regular updates of the company’s financial performance. Emailing minutes of board meetings is also advisable.

Drawing Up the Silent Investor Agreement

As your expert fundraising consultant will advise, when accepting investment from formal or informal channels, draw up the necessary paperwork. Work with your legal counsel to create a clear and solid partnership agreement. Ensure that it is legally binding and includes all the critical clauses.

At least 67% of silent partnership agreements are structured as Limited Liability Partnerships (LLPs) or Limited Partnerships (LPs). Drafting the document carefully eliminates the risk of confusion, disagreements, and conflicts. Here are some of the details the agreement should include:

Roles and responsibilities that each partner will have in the company. Silent partners will participate only up to the extent defined in the agreement.
Partners can expect profit-sharing and returns proportionate to the initial investment. However, this share is typically smaller than the profits earned by active partners.

• Liability is limited to the capital invested in the company.
• Rights to review the company’s financial statements
• Equity share the silent investor will receive and the capital they will contribute
• Silent partners must keep all sensitive business information and company data confidential.
• Information about how the partnership will dissolve, if necessary. The agreement will outline the exit framework and how the partner can sell their stake or withdraw the investment.
• Conflict resolution pathways such as arbitration or mediation to avoid extended court procedures and expensive litigation.
• Profits from the investment appear in the silent partner’s returns also.

The Takeaway!

Having silent investors on the cap table can be an advantage and a downside, depending on your objectives. At the same time, understand that a company always benefits from different classes of investors providing growth-oriented resources.

Investors are not necessarily just about capital, they contribute a lot more. But, if you’re only looking for a cash injection, you’ll approach silent partners. Ultimately, you’ll make the right decision for your company depending on its growth stage and needs.

It’s how you’ll secure the company’s financial stability and ensure it has adequate runway to meet its goals.

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