Fundraising is a crucial part of any business, especially for Startups, as access to capital is essential for the growth and continuity of its operations.
In view of the economic downturn and challenges encountered by startups in achieving their growth expectations, Venture Capitalists (VCs) have become more risk averse. Recently, VCs are utilizing the syndicate structure to manage their risk in investments.
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In this article, we provide more information on this Syndicate investment structure.
1. What is a VC Syndicate and how are they structured?
A VC Syndicate is a group of venture capitalists coming together for the purpose of investing in a Startup. The collaboration is typically carried out through a special-purpose vehicle (SPV). An SPV is a company incorporated specifically for the purpose of the investment project.
2. How is a Syndicate formed and what kind of documentation is required?
A syndicate to invest in a startup is typically formed by a group of investors who are interested in pooling their resources to invest. The syndicate can be set up by either setting up an SPV, particularly for this purpose, or setting up a Joint Venture.
The transaction documentation required to set up the syndicate includes:
i. Joint Venture Agreement: This outlines the key terms and conditions of the proposed investment, such as the amount of funding being offered, the valuation of the startup, the rights and preferences of the investors, and specific terms or conditions that apply.
ii. Shareholders Agreement: This is a legal document that formalizes the commitment of each investor to participate in the syndicate. It includes the rights of the investors, the amount of money being invested, the equity stake proportionate to the investment made, etc.
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3. Who is a Syndicate lead/member?
A Syndicate lead typically takes the lead in structuring the syndicate and negotiating terms with the startup. The lead is usually an institutional or individual investor with vast experience in investing in startups, selecting investment opportunities and suitable co-investors to invest in such opportunities.
A syndicate lead is usually entitled to compensation or fee for a syndicate investment, where the investment generates a profit, which is termed a “Carry”.
A Syndicate member is typically an individual investor or VC who joins the syndicate to invest in the startup. Syndicate members typically rely on the lead investor to negotiate terms and conduct due diligence.
4. What are the advantages of fundraising through a Syndicate?
There are numerous advantages to raising through a Syndicate, which include:
i. access to higher sums of capital: syndicates allow startups to tap into a larger pool of capital than they might be able to access through traditional funding channels;
ii. removal of investment barriers, as a syndicate of investors, gives the startup the opportunity to pool a variety of investors with varying knowledge and expertise to join an investment round;
iii. a less time-consuming process of investment, as the founders do not have to negotiate with multiple investors;
iv. raising funds through a syndicate may also increase the visibility of the startup, as the syndicate’s investors may promote the startup to their networks and help to build traction around the startup; and
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v. efficiency of the startup’s cap table as the investment is done through an SPV, thereby limiting the number of investors on the cap table.
5. What should a startup consider before raising through a Syndicate?
i. Syndicate lead: Startups should conduct adequate due diligence on potential lead investors to ensure that they have a commendable reputation and are of good standing in the startup community and possess the expertise required to add value to the investment.
ii. Dilution: Fundraising through a syndicate can result in significant dilution of the startup’s equity. Startups should carefully consider the size of the investment and the percentage of equity that the syndicate will receive to ensure that they are comfortable with the level of dilution.
iii. Syndicate terms: The terms of the transaction documents will require legal and financial expertise to navigate. Startups should engage experienced professionals to negotiate the terms of the transaction to ensure that it resonates with the vision and objective of the startup.
6. What do Syndicates typically expect/require from a startup upon investment?
i. Equity Stake: In exchange for their investment, the syndicate typically requests for an equity stake in the startup. The percentage of equity that the syndicate receives is dependent on the size of its investment and the valuation of the startup.
ii. Governance: The governance structure of the startup may be influenced by the syndicate’s investment. The syndicate may request a seat on the startup’s board of directors, or that a board observer attend its meetings to monitor the startup’s progress.
iii. Syndicate transaction documents: A typical transaction document to be executed between the syndicate and the startup may include: i) antidilution provisions; ii) reporting/information requirements to receive financial reports; iii) investor rights to participate in future funding rounds; iv) a clear exit strategy to ensure that they can get a return on their investment, etc. It is important that startups ensure that their legal advisers take a critical look at these investment terms before proceeding with the investments.
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Raising funds through a syndicate can be a great way for a startup to secure funding and gain access to a network of investors. It is imperative that parties to the transaction, i.e the syndicate and startup engage legal counsel to ensure that they enter into suitable agreements that protect their interests and meet their investment needs.