Should You Syndicate an Investment?

November 9, 2010

I am a member of ExpertCEO, a great forum for technology CEOs. It is a place where fellow CEOs can pose questions and get the perspective of their peers. Think of it as the forum for mentoring software CEOs.

I responded to a discussion where a start-up CEO was asking about investment syndication. Apparently, he managed to get a verbal offer from a VC, but the offer was contingent on the CEO finding another VC to co-invest in the round. My response to him was the following:

There are three primary drivers for software venture capital syndication

1. Investor’s fund is too small

In this instance, the fund is too small to support the capital needs of the company all the way to a future exit. There’s nothing worse in software venture capital than a company whose VC is not able to lead or participate in future rounds, and nothing worse for a VC than not being able to participate in future rounds. The risk to the company is the VC blocking future rounds, which creates an ugly catch-22. So make sure your investor can support you through an exit by evaluating the following:

  • Size of fund the investment is coming from
  • Average deal size of first investments in that fund
  • Total amount the investor can put into any one company
  • How much of the fund has already been deployed
  • How much is being held in reserve for follow-on rounds in the current portfolio companies

2. Investor’s risk profile is limited

In this case, the investor likes to syndicate to reduce the amount of capital invested in any one company. The pro for you here is that you, in turn, can reduce the influence of your investor (two investors will keep each other honest, and one investor can’t exert inordinate influence.) The con is the flip side of that coin. The more investors you have, the more the complexity of managing potentially conflicting investor viewpoints and interests. This will manifest itself in your board meetings, and in subsequent follow-on rounds, exit opportunities, etc. If you go down the path of a syndicate:

  • Make sure the two investors’ investment models and return objectives are aligned. You don’t want a short-term IRR focused investor coupled with a long term, multiple-return focused investor.
  • Make sure the two investors funds are somewhat alike in their profiles (per the diligence list I provided you above). You don’t want one investor to invest from a fresh fund, and another in the latter years of his fund.

3. The investor has no clue what you do

In this situation, the investor doesn’t understand your market, doesn’t understand your customer and needs another investor to do the hard work to figure your business out. Avoid such an investor like you would avoid the plague.

Now all this depends on the stage of your company. If you are in the start-up phase (pre- to below $2M in revenue), it should not surprise you that an investor wants to syndicate. Investing in start-ups is all about investing in a portfolio of ideas, knowing that most of them are going to fail or wither on the vine. So in the start-up phase, investors are somewhat forced to spread that risk. The more focused an investor on a particular sector and the more knowledgeable he is in investing in it and taking companies to reasonable exits, the less likely he would want to syndicate. The reverse is true. But my point is, don’t hold an investor in too negative of a light if you’re a start-up. Just know you have an investor that is somewhat risk averse and needs to spread that risk a bit.

If you are beyond the start-up phase, you should really try to focus on fewer (say one) investors. Again, the more venture capital investors on your board and on your cap table, the more complicated your life.

My closing advice to this CEO was to go out and find another investor to invest in his company. With the goal of finding another who is more interested in doing the deal alone, and an investor who is is a better fit.

For more mentoring software CEO ideas, check out these posts:

The Chief Executive Officer

Firas was previously a venture capitalist at Openview. He has returned to his operational roots and now works as The Chief Executive Officer of Everteam and is also the Founder of <a href="http://nsquaredadvisory.com/">nsquared advisory</a>. Previously, he helped launch a VC fund, start and grow a successful software company and also served time as an obscenely expensive consultant, where he helped multi-billion-dollar companies get their operations back on track.