How to raise money is a crucial question for startup founders. Due to the newness and riskiness of many startup ventures, most founders can’t access capital through traditional means such as bank loans.
For this reason, many startups turn to alternate funding sources, such as an angel investor or venture capitalists. VCs and angel investors are early-stage startup funders looking for smart investment opportunities. In exchange for a lump sum of cash, these investors receive equity in the business that they can sell (hopefully for more than their initial investment) at a later date.
There are a variety of different startup funding options within the world of angel investing and venture capital. One option is an investor syndicate (or investment syndicate). So what is an investor syndicate, exactly, and should tech startup founders be looking for syndicate funding?
What is an investment syndicate?
An investment syndicate is a group of smaller investors who join together in order to invest in startups. A startup syndicate provides access to opportunities that investors might not have individually. They are a great opportunity for people who want to invest smaller amounts of funding. They are also a great opportunity for startup founders looking to connect with smaller investors who want to get in on the ground floor.
An investment syndicate is like an ad-hoc venture capital firm whose members are united by a single common cause: making good syndicate investments. The members of an investment syndicate must be accredited investors. According to the U.S. Securities and Exchange Commission, accredited investors are those with $200,000 in annual income or a net worth of more than $1 million.
Investment syndicates also appoint a lead investor, who is typically an angel investor with significant experience in the startup community. Syndicate leaders are responsible for sourcing new investment opportunities, and are paid a percentage of the group’s profits for their efforts. That’s what’s known as the “carry”.
How do startup syndicates work?
Investors can join syndicates by browsing the listings on websites such as AngelList and applying for membership. A syndicate lead may also send invitations directly to investors.
Once investors have joined, the syndicate leader presents them with investment opportunities that are sourced from the leader’s contacts in the startup world. Investors can request more information about the deal in order to properly evaluate the opportunity. This includes information like the company’s business model, financial data, team members, and more.
If a startup appears promising, investors submit a proposal that describes the amount of money they want to provide, as well as a signed term sheet and other documents. To execute the investment, the syndicate creates an investment vehicle known as a special-purpose vehicle (SPV). An SPV is a legal entity created for a narrow or singular purpose—in this case, financing startups.
From this point on, the syndicate leader is responsible for managing the investment and making important decisions. The leader is also tasked with distributing profits to investors once the startup undergoes a successful exit or liquidation event.
Advantages and disadvantages of investor syndicates
Obtaining startup syndicate funding has benefits and drawbacks for both investors and startup founders. Here’s what investors should consider when participating in a startup syndicate:
- Diversified portfolio: A startup syndicate typically invests in multiple companies, which makes it easier to diversify your portfolio and hedge your bets. For example, investing $10,000 in 10 companies is a safer move than investing $100,000 in a single company. It also might not be possible without joining a syndicate.
- Peace of mind: Once they’ve sent in the funds, individual members in a syndicate don’t have to worry about overseeing their investment. This work is handled by the group’s leader. Of course, this comes at the cost of the “carry” that is paid to the syndicate head.
- Higher costs: Creating an SPV to handle the investment costs money. It involves processing, legal consultations, administration, and more. These expenses are lower per person when distributed among more people. However, adding more people to the venture also creates the risk of differing interests or expectations.
Meanwhile, startup founder should weigh the following pros and cons of startup syndicates:
- Less effort: Most of the heavy lifting in syndicate investing is handled by the group’s leader behind the scenes, limiting the effort required on the part of the founder. Of course, this could be a blessing or a curse, depending on the efficiency of the syndicate leader.
- Greater simplicity: A syndicate investment may consist of dozens or even hundreds of people, but only the SPV needs to be listed on the cap table. This greatly simplifies the process of seeking funds and communicating with investors.
- Loss of privacy: With syndicate investing, founders have less control over who views sensitive information like pitch decks. This is risky for early-stage companies that haven’t yet obtained the IP rights for their concept.
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