Syndicate Investing: Collaborative Funding Strategies For Early-Stage Startups

Syndicate investing is quickly emerging as a viable source of funding for early-stage startups. New ventures carry a high element of risk and typically don’t have many assets to offer as collateral. For this reason, traditional funding channels like bank loans are not a practical option.

The next options include venture capitalists and angel investors that offer capital in return for equity in the new company. Depending on the terms and conditions, they may also require board seats, preferred shares, and decision-making rights.

Accepting these terms may not be practical for an entrepreneur unwilling to accept potential dilution and give up stock.

Syndicate investing or approaching an investor syndicate is another source worth exploring that may involve favorable terms for the founder. Is this something you should consider?

Understanding Syndicate Investing

A syndicate is an investment system where a group of smaller investors pool their money together to invest in startups. You might also call it an ad-hoc venture capital firm comprising investors who want to invest small amounts of funding.

Syndicate investing works well for founders and investors. Founders can connect with small investors who are looking to get their feet wet in the world of venture capital. On their part, investors can enter a syndicate to participate on a deal-by-deal basis.

The syndicate head is an organizer who makes decisions about the startups to back and works out the finer details.

Participants are typically accredited venture capitalists, high-net-worth individuals, or angel investors who pool capital as limited partners (LP). Accredited investors are entities with an annual income of $200K or a minimum net worth of $1M.

Each syndicate may have a consistent base of participant investors included in all deals across the board. However, the participants may differ from deal to deal since they always have the option to opt out of a specific deal. Deals are called Special Purpose Vehicles, which is the legal construction term.

VCs and angels interested in investment opportunities can create an account on a syndicate funding platform like AngelList or Syndicate. Alternatively, syndicate leaders may reach out to investors with an invitation to join the collaboration.

Once they sign up, the leader presents members with a list of viable startups. They can assess the startups by conducting due diligence, such as examining financials, the business plan, and the business model.

Members can also get information about the founder and the founding team before making the final decision.

Syndicates are Headed by a Leader or Lead Investor

The leader or lead investor directs the functioning of the syndicate investing fund. This entity is typically a seasoned founder or angel investor with extensive expertise in the startup ecosystem. Their job is to identify new and viable investment opportunities for their members.

In return, leaders receive a percentage of the profits the syndicate earns, which is called the “carry.” The syndicate leader has in-depth knowledge of the startup landscape and has likely previously worked with similar companies. They allocate funds to promising new ventures for maximum returns.

Syndicate leaders don’t levy any processing fees, and the percentage of the profits is pre-determined. Typically, they charge around 20%, which is the industry average per AngelList. The syndicate does not have any funds of its own but relies on participants to pool capital and keep transactions running.

Let’s try an example. An investor contributed funding worth $20K into a syndicate investing fund. After a successful exit, the investor earns a distribution of $175K of which they must pay 20% to the lead investor.

This amount works out to $35K, deducted from the profit. Accordingly, the investor walks away with a profit of $140K, having invested $20K to begin with.

Syndicate Investing Firms Operate

Syndicate investment coalitions are also considered a form of venture capital fund created for the sole purpose of supporting businesses. Although the potential for returns is high, the risk factor is also high. At the same time, investors can participate with amounts as low as $1K to enter the fund.

Several online platforms allow small investors to sign up to be members of the coalition. Next, they receive proposals, including details of promising startups and the capital amount the targets need.

The packet also contains term sheets and other documentation on how to create an SPV. Members can choose to participate or decline the opportunity.

The syndicate investing leader manages the investment and makes the necessary decisions to keep the transaction operational. When the investment is ready for liquidation, the lead investor takes care of the exit and distributes profits proportionally. They also deduct the applicable carry.

From the startup founder’s perspective, reaching out to a syndicate is a streamlined and efficient strategy for getting funding.

They can get capital from several investors without having to enter into separate transactions with each. Maintaining entries in the cap table and investor exits costs in terms of legal fees and time allocation that is easily avoided.

Syndicate members like angel investors and VCs are typically full-time investors, though the number of full-time participants is typically low. Members can also be individual small investors who want to add value to the startup community.

Syndicates have an element of inclusion and diversification, enabling small investors to participate. Even entities with zero to limited experience in how the startup world operates can take advantage of investment opportunities. These passive investors or backers prefer to rely on more experienced lead investors to manage their money and earn profits.

How Syndicate Investing Works for Startups

Startup founders can approach syndicate coalitions via outreach programs or cold emailing. Here’s what happens next.

1. You can also contact them on social media platforms to secure an allocation or participation in the funding round.
2. If the lead investor expresses interest, you’ll submit the financials and other information.
3. The syndicate lead conducts meticulous due diligence to vet your startup as a good candidate for investing. They will examine your pitch and ask for additional information if needed.
4. Next, leaders approach accredited members of the syndicate with the offer to invest in the startup.
5. Members can respond with more questions and associated check sizes called “commitment.” They are not legally bound to accept the offer and can choose to decline.
6. Once the commitments come in, the lead investor creates a special purpose vehicle (SPV) https://www.fool.com/terms/s/spv/ as a legal entity.
7. They also draw up the documentation and start a bank account.
8. Investment allocations range from $200K to $300K on average, but can also go up to $50K to $400K.
9. All through the holding period, syndicate heads manage the taxation and legal obligations.
10. Once the investment is ready for an exit, the lead takes care of the distributions and profit management. They also deduct the carry before remitting returns to members.

Keep in mind that in fundraising, storytelling is everything. 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), which I recently covered. Thiel was the first angel investor on Facebook, with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

Advantages of Syndicate Investing Capital for Startups

Getting syndicate investment for your startup can have multiple advantages not just for this round but also for future rounds. Here are the benefits of this funding option.

• Partnering with an accredited syndicate opens up a world of opportunities for founders. You’ll connect with the extensive network of founders and investors linked to the lead investor. Syndicates actively assist startups in building, scaling, and investing in them.
• Founders get access to a broad pool of investors but without the need to negotiate with them individually.
• The investment process is streamlined and hassle-free since only a single entity is at the table.
• Accessing funding from a syndicate adds credibility to the company, making it easier to raise future funding rounds.
• Angels participating in the syndicate may be open to offering larger amounts of capital to promising startups they have worked with.
• Connecting with syndicates operating within your business vertical raises your chances of quickly getting funding and closing allocations.
• Listing a large number of investors in the cap table could make it harder for startups to raise further funding rounds. That’s because investors are always wary of dilution. Partnering with a syndicate means only a single SVP will appear in the cap table.

Downsides of Syndicate Funding for Startups

Although syndicate investing has its share of upsides for startups, you should also be aware of potential downsides.

• Securing company secrets, data, and other classified information becomes super challenging because it is shared with multiple stakeholders.
• You’ll risk the product design and other details getting leaked to competitors, which may result in losing that edge. This factor can also be a significant risk when the company is IP-driven and has not yet acquired patents and trademark protection.
• Founders and startups lose privacy in their dealings with investors since the terms of the deal are openly discussed on the syndicate forums.
• When approaching a syndicate for an allotment, founders should be prepared for the risk of investors saying no. Convincing the lead investor does not necessarily guarantee funding.
• You may have to interact with and answer questions from multiple small investors. Many of these entities may not be familiar with the startup ecosystem, and putting your point across can be challenging.
• You may have to follow up multiple times before the actual funding comes through.

 

Syndicate investors are just one of the funding sources you can tap. Check out this video where I have explained how to find investors for your startup. You’re sure to find it helpful.

Why Investors Opt to Work with Syndicates

As a startup founder considering approaching syndicates, take the time to understand the investor mindset. You should get behind the scenes for information about how syndicates work and why investors pool capital into them.

Perks of Joining Syndicates

• For starters, participating in syndicates allows investors to diversify their risks. They can invest in multiple small companies instead of diverting large capital to a single startup. For instance, investing $1M in a single startup carries much higher risks than investing the same amount in 10 companies.
• Small investors are typically busy people who don’t have the time, expertise, and bandwidth to focus on investing. They are happy to delegate the fund management to a dedicated expert who knows their way around the startup ecosystem. Paying the carry is preferable to navigating investments.
• Setting up and running an SVP costs a lot of money in terms of legal fees, management, processing, and more. Pooling the costs results in each investor carrying only a small portion of the costs, which is a huge advantage.
• Investors not open to investing large capital may find it harder to access innovative and disruptive startups with high potential. Especially when these companies are capital-intensive and need high-ticket funding. Working through syndicates opens up these channels for them.

Risks of Joining Syndicates

• Syndicates operate under the guidance of the lead investor. Participants in the pool typically don’t have many decision-making rights besides accepting or rejecting the offer. Ultimately, it’s all about the leader’s expertise; if this person falls short, the risk rises exponentially.
• Certain syndicates may have minimum investment amounts that participants must contribute. This is why members must select coalitions that align with the investment needs. They must also enter into deals after carefully assessing the potential risk for losses.
• Not all startups are built alike, and some must undertake extensive R&D before yielding an MVP and profits. Investors looking to exit in a short time must select their investments carefully. For instance, life sciences and drug development have no fixed timelines for getting results.
• Investors need to demonstrate that they are accredited before they can participate in the syndicate. However, lead investors need not be accredited.

The Takeaway!!

Startup founders can add syndicate investing firms to their list of potential funding sources. Reaching out to them is easily done via social media platforms, professional networks, and meet and greets. Scout around for syndicates on sites like AngelList, where you can find investors writing small checks.

Syndicate investing works well for founders and investors, particularly small investors looking to profit from backing startups. Even if they have limited funds, they can participate in innovative and disruptive companies with the potential to earn rich profits.

A good starting point is to research the syndicate’s track record for information about the type of startups they have backed previously. You’ll also want to target firms that operate within the business vertical where you work. That will raise your chances of getting approval and funding.

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