Gil Penchina joins Nick on The Full Ratchet to discuss Syndicate Investing, including:
- Can you first provide an overview of your angel portfolio performance?
- Why is it that you decided not to raise a fund?
- How does the syndicate approach work on AngelList and why did you adopt this approach toward angel investing?
- How many backers do you have, what does the composition look like and what is the average deal size for one of your syndicate investments?
- So, I am a recent member of your group that helps evaluate and triage deal-flow… but for those in the audience that aren’t aware, can you talk about how evaluation and diligence works in your decentralized model?
- How do you explain creating the biggest following on AngelList?
- How long does your process typically take from first introduction to either a pass or an investment?
- With the size of investments that you are doing, it seems you are in the Series A territory… potentially even B. Have you transitioned to more A or even B deals from seed?
- Do you lead rounds?
- You have a track record of having very positive relationships w/ entrepreneurs and, at times, have competed w/ VCs to lead rounds. Can you illustrate why so many entrepreneurs pursue you for investment and also why they choose you over VCs?
- You’ve had the experience of being re-capped to zero. Can you explain how this happens and what early investors can do to avoid it?
1- Syndicate Origination
Gil talked about how Syndicates emerged from the JOBS Act, which allowed an investor and up to 99 other investors, to group their investment into a Special Purpose Vehicle, like an LLC. This permits one check to be written to the startup as opposed to 99 separate checks.
And AngelList, in particular, then handles all the electronic documentation and financial facilitation, such that the syndicate members don’t have to each spend the same overhead and time on the transaction that they often would.
2- Why Not Raise a Venture Fund?
Gil has the network, resources and background of many VC’s out in the valley. Yet, he opted for the road less traveled and did not raise a traditional venture fund. Gil mentioned that he probably would have raised a fund if it did not involve all of the lawyers, accountants and family offices. And there’s also an amount of bureaucratic inertia that accompanies a fund. Certain guidelines about % of ownership or control provisions might be required by LPs, for every investment. And, realizing that he didn’t need a $1M check via a fund to make startup investments, Gil could avoid these burdens and limitations.
Of course, more recently, with new legislation and the evolution of Angel List Syndicates, he can now work with a group of 2,000 angels…. providing access to well-vetted deals and getting the benefit of a larger pool of smart individuals that can help companies become successful. So, effectively, he can exploit the benefits of a venture fund without suffering the commonly cited challenges. And his co-investor followers always have the final decision on investments that they make. So, as opposed to a blind bet on Gil, it’s more of an informed vote-of-confidence. Investors can say, I want to monitor Gil’s activity, process and deal-flow, but I still reserve final decision to invest or not.
And we haven’t even talked about the role of the entrepreneur. In this situation w/o hard and fast rights and control provisions, the syndicate investment allows more flexibility, speed and founder-friendly terms.
3- The Recap to Zero
This is a big watch out and I’m glad we had Gil, with his many years of experience, to weigh-in on it. As discussed w/ Joanne Wilson, this can happen in a predatory fashion where the startup is not experiencing extreme hardship, yet a VC mandates a re-cap to zero in order to take more equity. When early stage investors don’t have any dilution protections or a pro-rata in place, they can be completely watered-out. However, the scenario we talked about today was related to a situation where there is no choice. The startup either dies or all the previous investors agree to the re-cap. Due to external market factors or otherwise, the valuation of a startup may plummet, mandating an extreme down-round. Now, clearly there are external factors that can not be controlled, like in Gil’s example, where Facebook shut off the ability to embed videos in the feed and, effectively, ended the business. And his story here does illustrate a situation for early-stage investors to look out for when evaluating startups. And that leads into our tip of the week, called The Channel Choke.
Tip of the Week: The Channel Choke