Communicate when you Syndicate

Below is the “Tip of the Week” transcript from the Podcast:  Episode 4: The Startup Ecosystem… Key players in the Venture Industry (feat. Howard Tullman)
We talked a lot today about the various players in the space, but we didn’t spend a lot of time talking about other investors.  These people need to be your partners and allies, not your competition.  When you are working on a deal with a startup, it is critical to talk with that startup about the other investors that are involved and to try and connect with them.  This really serves both the startup and investors.  In full disclosure, the very first deal I structured… failed to close.  I had spent weeks negotiating and structuring.  The deal did have some unique, non-traditional, contingent provisions… so I had spent close to $2k on legal.  I actually knew the other investors in the deal… including the lead b/c the lead had decided to switch from a traditional equity structure, to this proposed structure…  but I did a poor job of keeping in close contact.  So, ultimately we agreed on terms and then stumbled at the finish line.  There was one provision that the founder got hung-up on, that we went back-and-forth on.  Meanwhile, unbeknownst to me, he floated the deal structure, without this provision, to his other interested investors who knew that I structured it.  They were in and the round was oversubscribed in a couple weeks.  By the time the founder and I agreed on final terms, he no longer needed the money… and I was left out in the cold.  I still have investors in town that got in on that deal that have a good laugh when we see each other.  Apparently it has performed well so far.
The advantages are:

  1. More brain power:  Pooling due diligence often results in more thorough review and evaluation of the startup.  Of course, with that comes more negotiation power.  Clearly, you’ll have more leverage if you come to the table with $250k and five investors, instead of $50k by yourself.
  2. Speed:  If the investor group is aligned and feels comfortable, the deal can get done much more quickly.  I can’t tell you how many startups I meet that are chasing down 30 different investors that have been “on the fence” about investing for 6+ months.  If this group had gotten together, reviewed the criteria and agreed on terms… they tend to close much faster and feel much more confident in doing so.
  3. Better and more appropriate terms:  It seems that when groups of experienced investors get together, the deal structure and key terms are much more appropriate then when individual angels negotiate for themselves.  This is much better for both the startup and the investors.  Clearly, there could be a clause, or absence of a clause, that could be very damaging to the investor’s future equity position…  and with another pair of eyes, it could have been avoided.  I’ve also seen cases where an individual angel got his ideal terms in a convertible note, but didn’t realize that this would never hold up in a subsequent fundraise.  When that startup goes to raise their Series A, no VC would allow such a term… which either hurts the startups ability to raise and/or causes the term to get struck completley during the subsequent fundraise… which can be a very turbulent situation between the investor and the startup.  While financially, the right thing to do for the investor is to allow the term to be struck, emotions get in the way and it can put the entire fundraise at risk. Take for instance a Full Ratchet… clearly this is the deal term that I borrowed for the name of the show and may be somewhat amusing that limits dealmaking moreso than it promotes it.  I don’t want to get into details on deal terms today…  but simply a full ratchet secures the percentage equity position for the investors…  so if an investor receives 10% equity, during a future down-round (at lower valuation) that 10% can not be diluted down.  So, either the investors in a subsequent down-round or much more often the founders will receive a reduced stake as the full-ratchet investors will be granted the necessary stock to maintain their ownership percentage .  As you can expect, this can impact the founder’s future ability to raise unless they are willing to take all of that dilution theirselves.  So to wrap up this point, it’s often to your advantage to have multiple experienced investors to review terms and weigh-in before a decision that adversely impacts the investors, the startup or both is made.  I can’t tell you how many times I’ve been introduced to a startup, after terms are set, and it’s confounding why they selected the structure they did.