The basics of startup syndicate funding
Category: Understanding startup investment
Last week was an important week for Startupxplore: we opened registration for ‘backers’ on our platform, as we get ready to launch the first angel syndicate in Spain soon. Many of you may already know by now how syndicate funding works, but given the fact that it’s a new (and growing) investment trend, we figured this would be the right time to explain with more depth what a syndicate is, how it works and why it can be interesting for both investors and startups.
In a recent post we already touched on this topic by describing the differences between angel syndicates, crowdfunding and boostrapping. And now we’ll answer specific questions related to what Startupxplore is all about: syndicate funding for startups and investors.
What’s a syndicate?
A syndicate is an investment vehicle that allows investors (backers) to co-invest with relevant and reputable investors (leaders) in the best startups in the market.
What’s a leader?
Syndicate leaders are business angels with vast experience in selecting investment opportunities and investing in then, in various technology sectors and with dealflow that most investors don’t have access to. They tend to be angels -or successful startup founders- who have been part of the industry for many years and know its ins and outs.
What makes a good leader?
Naval Ravikant, co-founder of AngelList, has famously said that there are three characteristics a syndicate leader should meet:
- Access to capital: business angels with a good track record or successful startup founders that have the capital necessary to invest in startups.
- Propietary dealflow: dealflow refers to the to the rate at which investors receive business proposals or investment offers. If this dealflow is propietary -as in, exclusive to the investor- the chances of scoring good deals increases.
- Good judgement: knowledge and market experience that might result key in making the right investments
It’s worth noting that the fact that an investor meets this requirements doesn’t guarantee his or her success. Investing in startups is hard and risky, but co-investing might decrease the risk associated to it.
What’s a backer?
A backer is an investor that either does not have a lot of experience in startup investing or, even if he or she does, he’d rather allow someone else -the leader- manage the investments and choose the startups in which to invest.
What’s an accredited investor according to Spanish law?
Angel syndicate investing will soon become a regulated activity in Spain, thus protecting both investors and startups. There are some minimum requirements that any investor needs to meet in order to be able to participate in syndicates.
What are the advantages for all parties involved?
Syndicates offer great advantages to both leaders and backers.
- They can invest more money per deal.
- They can reach startups that might have high minimum commitments they couldn’t match on their own.
- By investing more capital per deal they might have access to better investor rights.
- They also get paid a carry (capital gains generated by an exit or dividends paid) in return for their ‘leadership’ on a project they would invested in anyway.
- Better dealflow by having access to investment opportunities they might not be able to find by themselves.
- Transparent negotiation process.
- Aligned interest with the leader
- Less paperwork than if they were investing on their own.
- Less risk: leaders have vast experience in investing and thus can differentiate good from bad deals.
- Access to higher sums of capital.
- Not having to deal with numerous and different investors.
- Leaders take advantage of the fundraising process and they are responsible for managing their relationship with backers.
- There’s only one investor in the startup’s cap table as the investment is done through a vehicle.
How do syndicates work?
We can distinguish 5 phases:
1. Opening: The lead investor chooses a startup that he considers a great investment opportunity. He opens the opportunity to other investors on Startupxplore, offering relevant data related to the deal (valuation, amount to be raised, etc) and he specifies the amount of time available to close the investment (by default, 1 month).
2. Investment: Startupxplore lets other relevant investors on its platform -those that have specified an interest in a certain type of company or sector- know about the deal and where they can find more information about it.
If the investor is interested, it can request more info about the deal and Startupxplore will provide all relevant details in order to analyze the investment opportunity properly (milestones reached, business model, market size, team, financial data, etc), as well as the term sheet that will determine and regulate the relationship between investors once the investment vehicle has been materialized.
If the backer is interested, it will specify the amount he or she is willing to invest and three signed documents: term sheet, investment agreement and a document in which the investor claims to understand the risk associated to startup investing and confirms he’s an accredited investor.
Once reached the time limit, there are two possible scenarios:
- If the minimum investment size is NOT reached, the investment won’t take place.
- If the desired investment size IS reached, the following happens.
3. Closure: To make the deal happen an investment vehicle will be created, which will be the party that will execute the investment in the startup. The important decisions will be made by the leader, and Startupxplore will be in charge of the bureaucracy associated to the investment. The expenses related to the creation of the investment vehicle will be equally paid by the investors, regardless of the amount invested.
Once the vehicle has been created, the investors will have to transfer the money and the vehicle will make the investment. Startupxplore will then invoice the startup for 5% of the amount raised.
4. Monitoring: From that moment on, the leader will manage the investment, meeting with the startup and providing information related to the performance of the startup. This information, as well as other business metrics, will be sent by Startupxplore to all the investors in the vehicle.
5. Liquidation: if the investment does not go well, the vehicle will disolve. If there are benefits (dividends, buyback or partial or total acquisition of the startup), all the investors will receive the amount they invested and 89% of the capital gains generated. Of the remaining part, the leader will receive 10% and Startupxlore 1%.
What’s a carry?
Lead investors invest their own capital into the startups and they charge backers 10% of the capital gains generated by an exit or dividends. A carry is only paid in the case of a successful investment.
What’s the cost for a startup?
Startupxplore invoices the startup for 5% of the amount raised -in the moment the startup receives the money- and 1% in the case of an exit, dividends or total or partial acquisition of the startup.
How are syndicates structured? Where do syndicates take place?
Platforms such as Startupxplore or AngelList offer the best way for startups and investors to meet and invest.
As we have explained in the past, investors are able to specify their investment criteria on their Startupxplore profiles and startups can then decide which ones to reach out to. On the other hand, startups can offer specific details about their business in order to facilitate investors’ work.
All parties involved benefit from these type of investment vehicles and startup financing options: investment reaches more startups, investors are encouraged to co-invest and the investment ecosystem accelerates.
Would you like to co-invest in the best startups with top investors?
Photo | Arcaris