The Importance of Lead Investor in a Syndicate
1.1. What is a Lead Investor? Key Responsibilities
A lead investor is an individual responsible for managing an investment syndicate. They serve as a link between the startup that raises capital and syndicate members. Besides having a strong belief in the startup’s business idea and supporting its success, this person also protects interests of other co-investors, i.e. members of the investment syndicate.
It should be noted that lead investors are often the ones with the highest share of capital invested in a newly-established company that has developed an innovative product or service.
Before the actual investment stage, the lead investors are focused on finding startup founders who not only have a fantastic and potentially profitable business idea, but also possess adequate skills and a quality team capable of effectively bringing it to life.
Here’s an overview of lead investor’s main responsibilities:
- Performs due diligence. The leading investor is in charge of producing a due diligence report, which entails a thorough analysis of the startup to be invested in. The report’s goal is to minimize the risk of the investment, as well as to help making informed decisions. It deals with benefits and drawbacks of investing, competitive landscape, regulatory compliance, intellectual property rights, and other aspects that are important for business success.
- Negotiates with startup founders. Another responsibility of the investment lead is to manage the negotiation process with the startup business, which includes investment terms like the portion of equity that is given to investors, company valuation, funding rounds, and so on. The document produced out of this is called a term sheet.
- Recruits syndicate members. The lead investor is proactive when it comes to inviting more co-investors to join the deal.
- Represents the syndicate and members’ interests. In the context of an investment syndicate, the lead investor is actually an administrator. He or she has an active role in making sure that all syndicate members (co-investors) are satisfied with the terms of a deal, funding rounds, and the way the investment funds are to be spent. In many cases, decisions are being made based on each syndicate member voting power, that may be proportional to the committed investment amount.
- Provides expert support. Chances are that lead investors are experienced when it comes to the niche or vertical of the invested startup, often being former founders themselves. Due to their experience, expertise and skills, leads may help invested companies in developing a business plan, introducing them to new potential investors, and customers.
- Manages or performs administrative tasks. The lead investor not only hires law firms to manage legal paperwork on behalf of the syndicate, but also manages administrative tasks such as closing deals, collecting funds, and transferring them to the escrow account.
Sometimes, the lead investor gets actively involved in the startup’s operations and takes the seat in the board of directors. He or she might as well engage with third-party consultants to help with the investment process.
1.2. Lead Investor’s Role During the Fundraise
Once the lead investor has verified that the startup’s vision is worth investing in, they will begin establishing a relationship with them and inform syndicate members who may be interested in co-investing in the deal.
In the first phase, the lead investor devotes a significant portion of their time into examining and validating the startup’s business plan and business model.
Valuation of the Company
The next step is negotiation with the startup regarding company valuation. Factors that affect the valuation are the team’s expertise, company assets, market conditions such as competitors and growth potential of the product or a service.
It should be noted that there are two perspectives related to this: pre-money and post-money valuation. In simple terms, pre-money valuation is startup value before deploying the investment funds, while the latter refers to pre-money valuation plus the investment amount.
Establishing the Term Sheet
The second step in the process is to establish the term sheet, which outlines key details that will protect the interests of both investors and founders. This non-binding agreement ensures that all parties agree on the main aspects of the investment transaction, although it does not cover every single detail that will be included in the final binding contract.
The term sheet typically includes information on startup valuation, the amount of the investment, stake percentages, anti-dilution measures, as well as details such as voting rights and decision-making power, liquidation details (including how investment returns will be distributed among parties), and the length of time that investors are required to remain in the deal.
Representing the Syndicate and Reporting
The lead investor should be readily available to other syndicate members, as well as startup founders, regarding all questions or issues that may arise during the process. Besides executing and closing the deal, the lead also sets up reporting mechanisms for other investors in relation to the startup progress.
1.3. Lead Investor’s Role After the Fundraise
Since lead investors play the most important role when it comes to startup funding and making sure the investment is successful, they remain actively engaged after the fundraise is completed. Lead’s post-investment responsibilities include the following:
Key Point of Contact
As previously mentioned, lead investors in a syndicate often take a seat on the board of directors, but their primary responsibility is to protect the interests of other syndicate members. Depending on their level of involvement, they may be actively involved in the company’s operations or provide support in areas such as mentorship, strategy development, human resources, and growth management.
After the investment funds are committed, the lead investor serves as an intermediary between the invested company and co-investors, ensuring that all parties are kept informed of relevant developments and that the investment is on track to meet its goals.
If additional sources of investment capital are needed, the lead investor will make efforts to secure additional funding.
2. Characteristics of a Lead Investor
2.1. What Qualifies an Individual to Lead a Syndicate
As you can see, there’s a wide range of syndicate lead’s responsibilities. Thus, such persons should have a number of skills and traits. Here are key attributes of a successful lead investor:
- Strong startup investing experience. These individuals have preferably invested in early-stage companies before, and witnessed the whole journey from initial idea, through challenges when reaching growth milestones, to ultimate success and return of the investment.
- Good network of connections. Ideally, the lead investors should be in position to find other investors that will join the syndicate, introduce the company to potential target groups, assist in finding the adequate talent for the company staff, or connect the company with experts in a given field that are able to help in overcoming the industry-specific challenges.
- Adding value. Startups often seek more than financial support. They turn to lead investors who provide much needed guidance based on their rich experience in supporting innovative companies.
- Person of Good Reputation. A syndicate lead is expected to be someone who is trusted by other investors. This trust is critical to the success of the syndicate, as it allows the lead investor to attract more people who are willing to invest. When investors have confidence in the lead investor’s decisions, they are more likely to commit funds to the syndicate, which can increase the size and scope of the investments. Therefore, it’s important for a syndicate lead to build and maintain a reputation as a trustworthy, reliable, and knowledgeable professional in the industry.
- Set of additional skills. As a syndicate lead, you’ll be responsible for a wide range of tasks, from making final decisions on behalf of the syndicate to organizing meetings, taking care of legal formalities, providing investment plans, and reporting on progress. To succeed in this role, it’s essential to have excellent communication and negotiation skills, as well as extensive knowledge of marketing and accounting tools.
3. Tips on Leading a Syndicate
3.1. Considerations When Starting a Syndicate
If you’re thinking about establishing an investment syndicate, you should take into account the following steps:
Organize the Membership
Make sure to choose members that are willing to contribute and participate in a proactive manner. Besides being financially competent to join the syndicate, the co-investors should be people of trust and willing to engage in research and due diligence. 7
You might consider implementing an entry fee or a recurring membership fee – this can eliminate individuals that are actually not serious about devoting their time and effort.
Define the Main Objectives
Once the membership has been established, it’s time to reach a consensus about mutual goals and objectives. Upon agreement on this, create an operational plan together for achieving these goals.
Determine the Organizational Structure
Define your responsibilities in leading the syndicate. Will there be additional managers? How will they be chosen and possibly succeeded? Determine how often the meetings will take place, as well as the way the syndicate records will be kept and maintained.
Decide on Legal Structure and Take Taxation Into Account
The two common legal structures for syndicates as Special Purpose Vehicles (SPVs) are LLCs and partnerships. The syndicate will need to obtain an Employer Identification Number (EIN) from the IRS. Have in mind that different legal structures may imply different tax requirements. Investing in startups is considered a taxable event. Learn more about legal and tax considerations in section 5 of our Syndicate Investing guide.
3.2. Long-Term Perspective for Syndicate Leads
Although prospective syndicate administrators may perceive closing the deal and making the investment as a challenging task, this is actually the easiest part. In this section, we’ll discuss the major points that syndicate leads need to have in mind in the long-term:
Remember that taxation laws change from time to time. Always consult with your accountants and lawyers in order to manage your partnership or an LLC properly for Federal Tax purposes. Determine whether audit rules apply at the partnership level or they are imposed on individual syndicate members.
Chances are that the taxation or other laws relevant to your syndicate will change over its lifetime. This may require amending of operating agreements between syndicate lead and members.
Moreover, if there is accrued interest obtained from the security instrument you’ve used for investing (e.g. convertible debt), it is considered a taxable event. Make sure to have everything set up in your books to meet your tax reporting obligations.
Investment Opportunities May Require Additional Cash
To reach the next milestone, startups may need additional financial resources. If that is the case, there’s a high possibility that not all co-investors will be willing or able to contribute more, even if this is anticipated as a contingency in your operating agreement.
In the worst case scenario, the syndicate might have to give up on the valuable opportunity if co-investors fail to respond to the capital call. Whatever the case, keep in mind that the lead investor’s responsibility is to implement collective decisions.
Reporting and Questions by Co-investors
Running an investment syndicate is a long-term relationship that may last for a decade. Logically, the members will want to get informed about the status of the investment from time to time. Some co-investors will ask a lot of questions, while others will ask few.
To keep things efficient, one good approach would be to create a list of potential questions and answers. It is perfectly normal for investors to ask for details on progress, since they have devoted their financial resources. That’s why you’ll definitely need to establish a system for keeping them informed.
Retirement Plans Can Be Tricky
Some syndicate members may prefer to invest using a Self-Directed IRA (SDIRA). This may complicate syndicate formation, since it will require filing additional forms and documentation. Also, the SDIRA account holder may periodically ask about the status and value of their investment.
Issues After the Investment Has Performed Well
When the investment generates positive return, it’s very likely that passive co-investors who have shown little interest in progress suddenly show up asking access to records and books, and even wanting to influence the way returns are distributed. This is especially true in case there’s a significant return on the investment. You’ll need a lot of social intelligence to manage this; all the efforts you’ve made up to that point will be subject to scrutinization.
4. Pros & Cons of Leading a Syndicate
Becoming a syndicate lead has less requirements and challenges than leading the venture capital firm. It’s an excellent way to start building your own network and track record as a group investment leader. Here are some of the benefits and drawbacks to consider before actually proceeding to establish an investment syndicate:
Networking and building relationships. You’ll get to build your skills in reaching out to other potential syndicate members and writing deal memos that attract interest from other angel investors and VCs. Ultimately, you’ll create your own network of investor relationships.
Establishing a track record. After a couple of successful investments, you’ll be able to prove the validity of your investment thesis, which will allow you to access pools of capital more easily.
Defining the focus for your syndicate. As a syndicate lead, you will have the opportunity to analyze and perform due diligence on numerous potential deals, which will help you establish a clear understanding of what kinds of startups or industries are the best fit for your syndicate. In the following phases, you will be able to develop processes and automation for deal flows.
Securing better terms. Since syndicates invest using pooled funds, they can raise more money than individual investors. This increased investing power can make startup founders take your syndicate more seriously and may result in more favorable terms, such as a larger percentage of ownership rights in a business, information rights, and so on.
Fewer legal requirements. Setting up an SPV for your investment syndicate is not too complicated. Basically, it involves forming a legal entity, obtaining signatures from each party, and opening a bank account. It is far less demanding than establishing a venture capital fund.
Carry. In addition to investment returns, lead investors earn a carried interest (commonly referred to as “carry”) for managing the syndicate. The typical carried interest rate for syndicates ranges between 15% and 20% of overall investment profits.
In contrast to VC funds, which invest in a number of companies from a single fund, syndicate leads have the chance to generate significant returns from a single deal. While the total return for a VC fund manager is calculated by taking the average of all investments (which can be significantly lowered by unsuccessful investments), syndicate leads can potentially make a lot of money from a single investment.
Huge effort needed. Everyone considering becoming a syndicate lead should be aware that it requires a lot of work. In addition to performing the necessary legwork for a startup founder during the fundraise, you’ll also be responsible for satisfying the interests of all co-investors and managing legal, administrative, and tax matters related to the syndicate. It’s a significant responsibility that requires a high level of organization, attention to detail, and time management skills.
The Unique.vc platform offers a comprehensive set of tools and features for investment syndicate leaders. Whether you’re establishing a new syndicate or migrating an existing one to our platform, you can take advantage of a range of features that will allow you to manage it more easily.
These include legal and tax support, automated cap tables, and streamlined transaction tracking. With these tools at your disposal, you can focus on your core responsibilities as a syndicate lead.