If you are keen on angel investing but don’t have access to high quality startups or the time to evaluate multiple startups, it may be better for you to invest via syndicates.
Investing in startups, by its very nature of investing in very young, unlisted companies, is challenging. More so, if you are just starting up as an angel investor.
Do you have access to the best founders working on the most compelling opportunities, at an early stage and often, even before they have launched or announced their startup?
Do you have time to evaluate many startups and decide which startups to invest in and which ones to decline?
Do you have the time or energy to track the progress of your investments and help them, when needed?
In this blog, we will articulate the pros and cons of building your portfolio via Angel Syndicates and address some of the questions above.
WHAT IS A SYNDICATE?
A syndicate is a group of angels who pool in individual investments and collectively invest a more meaningful amount as a single entity. The Lead Investor of the Syndicate typically evaluates and finalises the investment opportunities, and individual angel investors in the syndicate have the option (but not the obligation) to participate with a small cheque, on a deal-by-deal basis.
THE BENEFITS OF INVESTING VIA ANGEL SYNDICATES
1. Get access to high-quality startups
Most individuals, when they are just getting started with angel investing, get access to an ad hoc startup pitch from a friend or a relative and often find it hard to decline it. Usually, these kinds of investments aren’t objectively driven and may not deliver great results, unless your network of friends includes active angels in the startup ecosystem.
Startups with solid founding teams usually go to well-known angels or VC funds. Many of these deals typically get sealed between a closed group of seasoned angels and early-stage funds and as a result, a typical individual investor has no access to these deals.
Without access to a good deal-flow to pick investment opportunities from, an individual investor is at a disadvantage.
Quite simply, if you don’t have the chance to see the best startups, you don’t have any chance to invest in them.
The single biggest advantage of joining a syndicate is access to a highly curated deal-flow. Lead investors of angel syndicates look at hundreds (if not thousands) of startup pitches in a year and invest in a few startups that they believe are the best bets.
To cast the net wide, a lead investor, among many other things, does the following:
a) Networks actively with the best angels and funds to collaborate in searching for and funding the best startups.
b) Follows various tech blogs to identify upcoming startups.
c) Attends demo days of various accelerators to access the startups that graduate.
d) Proactively reaches out and looks at multiple players in a broad space of interest.
2. Backing the best startups
Early-stage investments are based on insights into the category, tech trends and above all, intuition & judgement. Given that early-stage startups have limited or no data points, early-stage investing is more of an art than science and one learns with every new investment one makes.
Lead investors of syndicates typically have invested in multiple startups over a period of time and have evaluated a wide range of startup pitches. It helps them in picking the investment opportunities and hopefully, with a better chance of success.
Seeing a large number of startup pitches helps in relatively benchmarking founders, understanding the pros & cons of different models that may be possible, a sense of market size, what risks are acceptable and most importantly, taking a decision on whether the risk-reward equation (the entry valuation in the context of the risks) is fair or not.
3. With syndicates, you can start small
It is difficult to attract the best founders to engage with you, if your intended cheque size is small. When you invest via a syndicate, you may contribute a small cheque per deal but collectively, the investment by the syndicate is meaningful for the startups, thereby attracting good startups.
4. Syndicates have more negotiation power than individual investors
Individual investors, with a relatively small investment, have little or no negotiation power with the founders or other investors.
Syndicate, as a collective group of angel investors, owns a more meaningful % of the startup which enables it to secure the right deal terms on valuation and more importantly, key shareholder rights.
Most individual investors spend too much time on just the valuation number, whereas, Rights such as Information Rights, Pro Rata Rights, Tag Along Rights, Right of First Refusal, Right to nominate a Board Observer or Board Member etc., are crucial in protecting the value of the investment and securing an exit.
5. Monitoring portfolio
It’s much easier to invest but it’s much harder to track the progress of multiple small startups and secure an exit at an appropriate time.
Many people invest in dozens of startups directly and they don’t necessarily know how the portfolio companies are performing. When you invest via a syndicate, usually, the syndicate takes Information Rights that enables monitoring the progress of the startup.
In India, syndicates that run on SEBI-approved Angel Fund structures such as LetsVenture, typically get every investment valued on an annual basis and the NAV of the units (and therefore, Investment Value) are updated annually for each investment. You also get to see a portfolio summary where you can see all your investments in one place along with IRR.
6. Syndicates are better from a tax perspective
This section is more specific to the regulatory framework in India.
Investors in a syndicate are not direct investors in the startup but they are ‘contributors’ to an ‘investment scheme’ in a “Fund”. If the syndicate runs on a SEBI-approved fund, then:
a) As a participating investor (or Contributor), you only have to show your investment in the ‘Fund’ and not the individual investments in startups in your annual Income Tax Returns
b) There is no risk of “angel tax” (which is an indirect risk to your capital if your startup ends up paying this tax)
Recently, there was a proposal by Standing Committee on Finance which proposed that Long Term Capital Gains for startup investments be abolished, subject to (among other factors) such investments being routed through SEBI-approved fund structures.
7. Easier administration
Since the participating investors are not directly holding shares of the startup, they won’t be getting all the statutory shareholder notices, or the several documents that a startup requires each shareholder to sign off on. All such administrative matters will be taken care of by the Fund.
ON THE FLIP SIDE…
While there may be many advantages of investing via syndicates as articulated above, you should be aware of the following factors that impact your potential returns on investments.
Risk of adverse selection
While you can have the comfort that you are investing via a syndicate that is curating high quality deals, that doesn’t necessarily guarantee success.
Typically, 20% of investments in a portfolio generate bulk of the returns. So, it’s quite possible that you may have invested in 80% of the startups via the syndicate but chose to stay out of the startups that turned out to be the blockbuster hits.
Carry / Transaction Fees
Investing via syndicates means that there is typically a small transaction fee (~2% of investment amount) and there is a Carry (or Profit-share) of 20%, which is a world-wide standard.
That’s the price you pay for access to better deals, for the time involved in evaluating many startups to pick the best opportunities and for time involved in providing ongoing help / support to the startup till exit.
At least, you can be comfortable that it is entirely a performance-based fee.
Disclaimer: This document is being presented solely for informational purposes and it is not meant to be any investment advice. Please consult your legal, financial and tax advisors for your investment and fund-raising decisions.