1. Introduction to Investment Syndicates
1.1. Investment Syndicate Definition
Investment syndicate is a group of different categories of investors gathered with a goal of co-investing in promising startups.
Together, they pool their capital into a fund (or a legal entity, an ad-hoc company) called Special Purpose Vehicle (SPV). This setup gives startup backers the opportunity to invest in projects that would be too much of a burden to invest individually, as well as to share the risk, because in the case of a failed investment, the losses are shared among the subsidiary members and not the parent companies.
In a typical scenario, investment syndicates consist of high-net-worth individuals, venture capitalists, angel investors, or family offices that have a common interest in investing in early-stage startups.
Pooling the capital together through an investment syndicate allows making larger investments than a single investor could make individually. Besides providing access to otherwise unavailable investment opportunities for syndicate investors, this is also beneficial to startups that need large amounts of capital to reach their development milestones.
Additionally, investment syndicates can provide startups with more than just capital. Often, members of the syndicate have expertise in various industries or functional areas that can be valuable to startups as they grow and scale. This can include things like strategic advice, access to networks, and mentorship.
Overall, investment syndicates are a powerful tool for both investors and startups, allowing them to achieve their goals more efficiently than they could on their own.
1.2. A Closer Look at Investment Syndicate Members
Syndicate investors can be either inexperienced parties interested in startup investing or people with expertise who invest regularly in syndication-type opportunities. Of course, the syndicate may also consist of angel investors who join forces to simplify the process and share the risk.
Generally speaking, investment syndicate members fall into the following categories:
Funds
These are established through investor partnerships, similar to venture capital funds but usually on a smaller scale and focused on early-stage companies rather than established ones.
Full-Time Investors
As the name suggests, full-time investors are individuals who make a living from investing. By actively managing an extensive, diversified portfolio of investments, they generate a consistent income.
In most cases, people in this category are very knowledgeable about different investment strategies in relation to various markets. These individuals can either invest their own capital or other people’s money as venture capital fund managers.
Part-Time Investors
Sometimes, people who engage in syndicate investing are individuals who occasionally back startups. Ideally, this category of investors comes from the startup industry and can support investment efforts by providing expertise, knowledge, or skills relevant to the startup that raises funds.
Now that we have described the typical parties involved in syndicate investing, let’s outline their roles.
Each syndicate will have a syndicate lead that sources investment opportunities, as well as backers that appoint the investment management to syndicate leads. Each member of the syndicate needs to be accredited; We will cover these aspects in more detail in the following sections.
1.3. Syndicate Lead Explained
Syndicate lead’s (or lead investor’s) responsibility is to source the investment opportunities, ie. deals. Sourcing these opportunities is commonly referred to as deal flow. In the context of startup funding, the syndicate lead is typically someone who has been a founder before, or has an extensive history of investing in successful projects.
Syndicate leads have access to investing capital, are able to provide regular flow of investment deals, and possess sufficient experience and skills when it comes to choosing the right investment opportunity. Thus, they are managing due diligence, deal flow, decision-making, and financial transactions (such as profit distribution) on behalf of the investment syndicate members.
Syndicate leads charge a percentage of profits from each backer, called “carry”.
For example, let’s say that a lead investor charges a 15% carry, and the backer has invested $30,000 in a syndicate fund. In case the investment was successful, and the backer’s distribution is $300,000, the syndicate lead will subtract the initial investment from the total distribution (300,000 – 30,000 = 270,000). After a 15% percentage has been charged, the backer will generate a profit of $229,500.
2. Becoming a Syndicate Investor
2.1. What are the requirements to join a syndicate?
It is important to note that each member of the investment syndicate needs to be accredited. This has been defined by the federal securities laws, and serves to ensure that investors who participate are financially “sophisticated” and able to handle the risk of loss.
So, what criteria do the investors need to meet in order to obtain accreditation?
The U.S. Securities and Exchange Commission provides the following guidelines—when it comes to individual investors, accredited ones are the individuals with an earned income that exceeded $200,000 in each of the two years prior to the investment, and/or has a net worth of over $1 million, not taking into account the value of the individual’s primary residence.
If the syndicate member is a legal entity, its assets or total investments need to be greater than $5 million, and the entity mustn’t be specifically formed to perform the investment. Alternatively, it can be any legal entity in which equity owners are accredited investors.
2.2. Where to Find Investment Syndicates & Things to Consider
Identify syndicates. There are several ways to look for investment syndicates to join. A good starting point is to ask your financial advisor, a lawyer, or people from your professional network for recommendations. You can also do an online search for syndicates that match your investment goals and interests. The platforms such as Crunchbase provide online databases of leading syndicates.
Some online platforms allow syndicate investing, like AngelList, Startupxplore, or OurCrowd. If you’re into web3 projects, Unique.vc is a great choice – it is a pioneering decentralized platform in which the whole investing process is completely powered by blockchain technology.
After creating the account, investors can browse different syndicates and apply for ones they are interested in. Also, lead investors can send exclusive invitations to potential backers, depending on whether the syndicates are public or private.
Research the syndicate. Prior to joining, performing the due diligence is a must. You should look into the syndicate’s track record, the types of investments they typically make, their fees, and any other relevant information. You can also ask current or past members to provide you with references and insights.
Learn about syndicate’s philosophy. Once you’ve identified one or more syndicates that interest you, try to arrange a meeting with its members. This meeting will give you a chance to pick up crucial information about the specific syndicate, its member profile, and their investment approach. Try to obtain as much insights as possible, such as the syndicate’s structure, decision-making process, and criteria for investing.
Evaluate each investment opportunity. If you decide to join the syndicate, you’ll need to evaluate each investment opportunity that comes your way. Review the business plan or white paper carefully, ask questions, and perform due diligence of the startup in question. If you’re unsure about an investment opportunity, you can seek advice from the syndicate’s lead investor and other members.
Make Your Investment: Once you’ve evaluated an investment opportunity and decided to invest, it’s time to provide the syndicate with your investment funds. The syndicate will typically have an established process for collecting funds and carrying out the investment.
Monitor Your Investment: After you’ve made your investment, chances are you’ll want to monitor the progress of the investment and stay up-to-date on achieving startup milestones, and any developments or changes. As a syndicate member, you’ll participate in meetings and discussions to stay informed about the overall performance.
2.3. How to Create an Investment Syndicate
Here are some of the key things to address before embarking on the process of forming an investment syndicate:
Define your niche(s)
Each lead investor should first determine the industries or verticals to focus on. Whether we’re talking about FinTech, SaaS aimed at small businesses, or wellness products, syndicate leads should be closely involved with the startup types they would like to invest in. Thus, the strategy is not only about niche profitability, but also about the lead investor’s knowledge and involvement in the industry.
By adopting this approach and focusing on a familiar vertical, syndicate leads will be able to provide more opportunities and added strategic value for each startup they invest in. In other words, your portfolio should consist of startups that potentially can be strategically valuable to each other.
Deal Flow Strategy – The Way You Discover Promising Startups
Anyone who thinks about becoming a lead investor needs to develop an effective approach to building a deal flow. This is perhaps the most important aspect of running the investment syndicate.
To begin with, you should 1) start making connections with startup communities around you, 2) attend startup accelerator programs, 3) research promising startups in the early stages and proactively establish relationships with its founders – Linkedin is a great means to expand your network of connections. Learn more about building a deal flow in the dedicated section below.
Approach to Capital Raising
There are several scenarios to consider when it comes to how a syndicate raises investment capital. If you are using online platforms to finance a startup through crowdsourcing, it is essential to promote your syndicate as much as possible. One way to achieve this is by sending cold emails to individuals who you think are suitable to join your syndicate.
If you are an angel investor yourself, chances are you already have a network of connections with your peers, some of whom may share the same vision as you.
A third option is to establish deals with Limited Partners (LPs). LPs are large, well-known investors who are typically able to contribute large amounts of money.
Switching from a beginner-level to an advanced syndicate lead may take years. After you have established a good reputation and a successful track record, raising capital will require much less effort.
2.4. Special Purpose Vehicle (SPV) Explained
Once you’ve gathered all the investors for your syndicate, it’s time to proceed to its formalization. For the purpose of making investments, a distinct legal entity should be created, called a Special Purpose Vehicle (SPV).
Since the SPV is a separate legal entity, it has its own balance sheet, liabilities, and assets. In contrast to venture capital funds that are formed to make multiple investments into different startups, SPVs serve to perform a single investment into one company.
A syndicate lead and startup backers are members of the SPV. Besides protecting syndicate members from liability in case the startup encounters legal consequences, the SPV allows investors to share the risk of financial losses if the investment fails.
Thus, the financial status of the SPV will not reflect on the balance sheets of individual investors or parent companies.
The SPVs can be legally structured as limited partnerships, corporations, trusts, or limited liability companies. Besides pooling funds to invest in an innovative company, SPVs can be used for a variety of other purposes not related to investing, such as securing of assets, real-estate deals, or isolating operations of the parent company.
2.5. How Much Is Typically Invested Through the Investment Syndicate?
Based on data from popular online investment platforms, syndicate leads generally invest at least $1,000. However, the typical investment amounts range from $5,000 to $10,000, which is around 2% of the investment allocation.
Syndicate allocations typically range from $200,000 to $300,000, but there are examples of round portions that amounted to as little as $50,000.
3. Identifying Investment Opportunities
3.1. How Do Syndicates Choose Startups to Invest In?
The first thing that syndicate leads (and investors in general) look for in early-stage startups is a well-grounded business plan.
The business plan needs to be realistic and comprehensive; it should contain achievable financial and growth projections, well-thought-out marketing plans, as well as a well-defined gap in a specific market.
Market Fit & Size
One of the main features of a promising startup is how the customers or consumers react to its product or a service. If there’s an increasing number of users signing up for a service on a daily basis, that is a good sign.
If a startup hasn’t attracted any customers yet, it’s important for them to review their sales and marketing processes to see if they’re effective. This involves analyzing the funnel for the four key stages: customer awareness, interest, decision-making, and purchase action. The founder and team members should focus on identifying target customers, determining the value proposition of their product or service, setting sales goals and metrics, and creating strategies to cultivate relationships with potential customers.
Provided there’s a sufficient level of traction or proof-of-concept, or in other words, if there are enough customers that demonstrated understanding and need for a new product, the startup qualifies to be considered for funding.
Besides growth potential, the investors should have in mind the size of the market. The profitability of a given product or a service is greater if the market goes beyond local or regional boundaries.
Differentiation from Competitors
Before an investor decides to invest in a startup, it is necessary to make sure that the minimum viable product is unique, or that it has competitive advantages over the competition. The business plan needs to provide enough evidence that it’s possible to beat the competitors.
An example of this can be a lower price for the same quality, or vice versa, if the product has the best features on the market, then that justifies the premium price.
The Team & Leadership
Are the staff and management qualified enough? In the initial phases of the startup development, the personnel might be limited in terms of quantity due to cost-saving reasons. However, whether a business has thirty or less employees isn’t that much of a significance – it’s the team’s capabilities, skills, and knowledge that make the difference.
If the startup develops a breakthrough solution in the web3 space, then its CEO, CTO, and other key employees need to have adequate expertise in blockchain and other relevant technologies.
The Exit Strategy
Each startup seeking for crowdsourcing needs to have well-defined financial projections. This aspect is crucial for the return on your investment. You would want to know exactly how the cash will be used during each phase, how much and when you’ll need to invest, and the most important – how much you can expect in return and when you will get it.
This requires thorough capital budgeting and ROI analyses. Therefore, it’s preferable that a startup has hired a professional financial analyst to perform these calculations.
3.2. Deal Flow Explained
A term “Deal Flow” is being used in the investing world to describe the stream of investment pitches or opportunities. It is the rate at which investment syndicates receive investment proposals. In most cases, sourcing such deals is the syndicate lead’s responsibility.
As mentioned above, the syndicate lead is ideally someone that has a large network of connections, excellent reputation, regularly meets with founders, and constantly seeks for new interesting early-stage businesses.
The members of the investment syndicate can also contribute to the deal flow, especially if the syndicate consists of people with strong presence in the particular industry. This allows for a continuous stream of proprietary investment opportunities.
Deal Flow Parameters
Deal flow should be perceived both from quantitative and qualitative perspectives. It’s not only about the rate at which new investment opportunities are presented by the lead investor, but also about whether the startups are more or less promising.
The incoming deals can be inbound and outbound. Inbound deal flow is related to startups that reach out directly to the syndicate lead with an investment proposal. This type of deal highly depends on the leader’s or syndicate’s reputation and success of prior investments. When the syndicate lead actively looks for startups to invest in, it’s referred to as an outbound deal flow.
Besides reputation and history of syndicate’s success, other factors that heavily influence the deal flow are current economic conditions, as well as market trends.
4. Syndicate Investing Process
4.1. Investment Rounds Explained
Each startup with a ground-breaking product or a service needs to complete different stages of business development. Initial stage would be a proof-of-concept, when the company proves there’s sufficient market demand for its innovation. In the following phases, the startup expands its customer base, takes its operations to the next level in terms of scalability, and so on.
Every phase of the startup growth cycle relates to a different funding round, in which investors provide financing in exchange for the portion of the company’s ownership or equity. Let’s explore these phases in more detail:
Pre-Seed Funding. This is the earliest, unofficial stage of startup funding, where the company aims to get its operations up and running. In most cases, the sources of financing come from startup founders themselves, their friends and family. The main purpose of pre-seed funding is to prove that the product or a service actually fulfills its promise.
Seed Funding. This is the first formal funding round for a startup, where the capital is actually raised from external investors. In this phase, the startup needs financial resources to perform the market research, and develop its minimum viable product. Seed funding rounds typically involve syndicates, individual angel investors, venture capital funds, or friends and family. The amounts raised in this phase are relatively small; they usually range from $50,000 to $2 million.
Series A Funding: The Series A funding usually happens once the company has gained some traction and has a working product or service. It is typically larger than the seed funding round. This phase requires development of a strong monetization strategy; the business model should have a well-defined plan for generating profit in the long run. The amounts raised in Series A funding can range from as little as $2 million, all the way up to $25 million.
Series B, C, and beyond. In these phases, the startups are already well-established and successful in terms of adoption and streams of revenue. The Series B, C, and D (the latter doesn’t always take place) help companies to attract institutional investors, expand to other markets, scale their product or develop new ones, and prepare for an Initial Public Offering (IPO). Check out a dedicated guide in our Learning Center to find more out about startup investment rounds.
4.2. Syndicate Investing Phases
Generally speaking, the cycle of syndicate funding can be divided into a couple of phases.
1. Opening Phase
The lead investor have identified an excellent investment opportunity, ie. the startup that provided enough evidence about the future success of its product. He or she presents the company’s business plan to other syndicate members, while specifying the projected time frame for investment closure.
2. Investment Phase
In case the other syndicate members are interested, they will usually ask the investment lead to provide more data and information in order to examine this investment opportunity. This is covered in section 3.1. of this guide and includes parameters such as team profile, market size, business model, or milestones achieved so far.
Also, at this stage a term sheet needs to be defined. This non-binding document outlines the relationship between each syndicate member after the Special Purpose Vehicle (SPV) has been formed. It includes aspects such as investment amount of each backer, voting rights, stake percentage, and dilution protection provisions.
Other documents, such as risk disclosure and operating agreement, should be signed too. This serves for all the syndicate members to demonstrate understanding of the risk involved in startup investing, as well as to define the roles and credentials within the syndicate.
After the deadline has been reached, the investment will take place only if the minimum amount has been collected, ie. all the members have voted to execute it. The voting rights may be based on the investment amounts provided by each syndicate member.
3. Closure and Forming of the Special Purpose Vehicle
In case the minimum investment amount has been reached, the syndicate proceeds to form a vehicle for investment execution. Depending on the agreement, the syndicate lead will be in charge of decision making and bureaucracy, such as expenses of forming the entity. Reporting on the performance of the startup is also one of the lead investor’s responsibilities.
4. Exit or Liquidation
After the investment goals have been completed, all syndicate members receive the invested amount, plus the percentage of the capital gains defined in a term sheet. The lead investor also receives a carry (syndicate management fee; see the section 1.3.) that is subtracted from the capital gains.
If the investment fails to meet its goals, the SPV is usually dissolved.
5. Legal and Tax Implications
5.1. Investment Syndicate Legal Requirements
Since the investment syndicate is a legal entity, it has to be compliant with the laws of a state or a country in which it is to be formed. In the United States, it would generally require the following:
- Registration of an LLC within the chosen state
- An operating agreement that defines syndicate governance needs to be signed. This document outlines how the syndicate will be governed (e.g. whether the decision making will be delegated to the syndicate lead, or it will be based on voting rights).
- Obtaining an EIN (taxpayer identification number) from the IRS
- Each syndicate member’s accreditation, according to Rule 501, Regulation D of the SEC)
- A bank account in which the syndicate funds will be kept
- All the records related to financial activities need to be maintained during the lifetime of the investment syndicate
- A tax return needs to be filed. A K-1 tax form must be sent to all the members; each member will have to report on the impact of K1s on their personal tax returns.
Each of these actions will imply different expenses, such as the cost of setting up an LLC, or accounting and bookkeeping services.
5.2. Investment Syndicate Tax Requirements
The syndicate’s investment in a startup is considered a taxable event in the United States. The investment syndicate needs to file a Form 8948 with the IRS, and pay the taxes. Since the syndicate is considered a legal entity for tax purposes, additional taxable events are implied:
- Income and capital gains
- Distributions the syndicate makes to its members
- Exits and the company’s dissolution
6. Risks & Rewards
6.1. Syndicate Investing Pros
Ensuring better terms for your investment. When you engage in an SPV and join forces with numerous other investors, the check size will be significantly bigger. Consequently, the startup reps will take this investment seriously and be willing to accept deals that are more favorable to the syndicate. For example, the syndicate lead can negotiate better allocations, information rights, and other terms.
Building a diversified portfolio. Engaging in a syndicate allows lower minimum investment limits. By investing less, you’ll be able to play more safely – instead of investing $50k into a single startup, you can reserve $5k for a syndicate investment, and allocate the rest into other promising companies in different setups. Given the statistically low success rate of startups, diversifying your portfolio by backing multiple early-stage companies can help maximize your returns.
Networking with influential investors. Syndicate investing allows smaller investors to join the top ones. This contributes to building a network that would be of great value in future endeavors. Moreover, this opens the door to supporting more interesting startups, increasing the possibility to stumble upon the next game-changer.
Less effort for members and low legal complexity. As you can see in the sections 5.1. and 5.2., starting a syndicate does require some paperwork, but it isn’t something too demanding. From the perspective of syndicate members, this kind of setup requires much less effort than investing individually, since syndicate leads are the ones that monitor the investment.
6.2. Syndicate Investing Cons
Carry. One of the rare drawbacks of syndicate investing is a lead investor’s incentive in the form of the percentage taken from each investor’s capital gains, in return for managing the syndicate. The industry standard for the carry is 20%.
Expenses can be high. Forming an SPV implies various expenses, such as legal entity formation, administration, or tax requirements. Having numerous syndicate members can further increase those costs.
7. Syndicate Investing and Web3
7.1. Introduction to Web3 Investment Syndicates
The new iteration of the World Wide Web, commonly known as Web3, has yet to unleash its full potential. With the help of blockchain technology, Web3 allows individuals to create content, develop products, and perform transactions while fully controlling their data and assets.
Web3 has the potential to revolutionize the investment landscape by offering enhanced security for investors, facilitating easier access to capital for founders, resolving legal ambiguities, and simplifying tax and compliance matters.
In recent years, several exciting startups have emerged. For example, Syndicate.io is a service that enables investors to pool their capital and establish an investment syndicate in the form of a Decentralized Autonomous Organization (DAO).
Similar to offline investing, platform users can vote on Web3 projects to invest in. Additionally, the platform aims to solve compliance issues by allowing users to connect real-life legal entities with DAOs, thus limiting liability to the investment vehicle.
Another highly innovative example is the Unique.vc platform. Unlike similar Web3 services that only support SPV formation using smart contracts on a single blockchain, Unique.vc provides a comprehensive set of features with cross-chain functionality. From forming an investment vehicle to setting up and managing a fund, every feature is powered by blockchain technology.
Unique.vc caters to the needs of both investors and startup founders. Investors can join syndicates and gain access to deal flows, or create their own syndicates to co-invest. Syndicate leads or investment managers can set up multiple investment clubs for each of their investments.
On the other hand, startup founders can establish fundraising vehicles, customize their fundraising terms, invite investors, and track progress towards the targeted amounts. All of these processes, from start to finish, can be completed on the platform.
Thanks to the automation of the entire investment process and the implementation of blockchain technology to address regulatory and tax requirements, Unique.vc resolves trust issues, minimizes risks, and simplifies investment syndicate administration to a degree previously unattainable.
