When you’re raising your first rounds of capital—especially at the pre-seed or seed stage—small investors, often called business angels, can be a game-changer. These individuals not only provide capital but also often bring valuable expertise, connections, and insights, collectively known as “smart money”.
However, small investors need to diversify their portfolios to mitigate the high risks associated with startup investing. For them, diversification means spreading their capital across ideally 10+ investments and reserving at least 50% of their capital for future follow-on rounds. The total amount they invest in startups should not be more than 2-8% of their net wealth (excluding principal residence). As a result, someone with a net wealth of €5 million usually can commit to your startup in any given round tends to range from €5k to €20k.
On the surface, you might think that taking on multiple small investments could clutter your cap table, increase governance work and complicate future financing rounds, especially with institutional investors. But this doesn’t mean you should dismiss small investors entirely. There is a win-win solution: syndication.
The Power of Syndicates
Syndicates allow small investors to pool their resources and appear as a single name on your cap table. This approach gets you access to smart money from multiple angels, and avoids having a crowded cap table.
In practice, syndicates can be set up right from your first equity funding round, or you could bring individual investors on board with an understanding that they’ll likely be pooled into a syndicate later on. Either way, it gives you flexibility and control over your cap table, while making it easier for small investors to join your journey.
Setting Up a Syndicate
Once you’ve decided to welcome small investors through a syndicate, there are a few important steps to follow.
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Legal Structure and Documentation
The first decision revolves around the legal structure of the syndicate. Different syndication platforms offer various templates and options. In essence, there are three primary ways to structure it:
- Agreement between Investors: Each investor appears individually on your cap table but grants Power of Attorney to one of them who becomes a “lead investor” or representative, simplifying governance.
- Trustee or Fiduciary: A trustee is listed on your cap table and holds the shares on behalf of all the investors, representing them collectively on your cap table.
- Special Purpose Vehicle (SPV): A legal entity is created specifically for the investment, and the investors hold shares in the SPV, which in turn holds the shares in your startup.
Each structure has its pros and cons, depending on your and the investor’s needs and the regulatory environment in the country where the entity raising funds is located, and possibly where the investors are coming from. While some platforms make the process easier by providing templates, remember that setting up a syndicate can involve legal complexities, so it’s a good idea to consult with experienced advisors.
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Roles and Responsibilities in the Syndicate
A syndicate typically involves four key roles:
- The Platform/Vehicle: The tool or structure used to pool investors.
- Syndicate Manager: the role can be played by you (ideal) or an experienced angel investor or by a Business Angel Network (BAN), managing the day-to-day operations and investment processes.
- Investor Representative: One of the investors, usually the most experienced or one sitting on your board, serves as a liaison between the syndicate and your startup.
- Syndicate Members: The individual angel investors participating in the syndicate.
Clearly defining who does what is crucial for the smooth running of the syndicate. The syndicate manager and investor representative should be people you trust, as they will play a key role in managing investor relations and decision-making.
Managing the Syndicate Throughout the Investment
Establishing the syndicate is only the first step. Managing it throughout the lifecycle of the investment—usually 5 to 10 years—is just as important. Here are a few things to consider:
- Follow-on Rounds: Ideally, you can use the same syndicate structure for follow-on rounds. This setup allows new investors to join without dismantling the existing structure, making future capital raises smoother.
- Governance: Over the years, there may be changes in the syndicate’s composition—investors may want to exit, or the syndicate manager might need to be replaced. It’s essential to have governance processes in place to handle these changes, ensuring transparency and smooth transitions.
- Costs and Economics: Syndicates come with ongoing costs, from legal fees to compensation for the time of the syndicate manager. Some costs are incurred upfront, while others come on an ongoing basis and at the exit and winding down syndicate. Aligning expectations around these costs with the investors upfront is important and can prevent surprises later. You need to decide which costs you as the startup will pay and what will be borne by investors. Ideally, you pay them all.
Syndicates Are a Win-Win for Entrepreneurs and Investors
As described, syndicates can be a win-win for both entrepreneurs and investors. For entrepreneurs, they provide access to a diverse pool of capital, expertise, and networks without the drawback of a crowded cap table. Investors, in turn, gain the opportunity to diversify and participate in startups that require a higher minimum investment ticket than what they can afford on their own.
While setting up and managing a syndicate requires attention and has costs, the benefits outweigh the complexities. Success hinges on choosing the right type of syndicate, having clear roles, well-documented and simple processes and goodwill from all parties involved. With the right setup, syndicates can help entrepreneurs raise more capital, build stronger relationships, and keep their businesses poised for growth.
