There is an axiom in the venture industry that investor syndicates provide more stability for a young company, by avoiding a single point of failure. While this is true most of the time, it does not mean that from time to time, an investor within a syndicate may not develop a problem (catch a cold) that could create major challenges for an entrepreneurial company.
Today, these “colds” come in the form of sponsoring partner departures (no champion remaining in the partnership) to a shortage of capital reserves for follow-on investing and/or a combination of the two.
For the entrepreneur, a single investor failure in a syndicate can quickly become a financing crisis or “pneumonia.” In many cases, the remaining investors – facing their own reserve limitations – may not be able to cover the pro-rata capital expected from their under reserved compatriot. And if the sponsoring partner leaves, who will be at the table, when the tough decisions are being made to speak on the entrepreneur’s behalf? If the entrepreneur is not represented in this critical discussion, chances are he/she will end up at the bottom of the allocation priority list.
In today’s environment, it’s best for CEOs to take nothing for granted when it comes to their syndicates. While challenging, a broken syndicate can be successfully managed, if the entrepreneur plans ahead and makes the time to focus on it. How do you manage for this potential challenge?
- Try to build a broader base of support inside each of your investor partnerships – look for an opportunity to present to all of the Partners on a regular basis
- Always cultivate a small group of potential investors who like your story and might be interested in “stepping in” when there is an opportunity
- Don’t wait to the last minute to find out if you have a syndication problem.
How do you know you have a syndication problem? Force the discussion of potential financing as early as possible – a year in advance in today’s environment is reasonable. Finding one of your stronger investors to support you in this process will make it harder for a weak investor to try and kick the can down the road.
In many cases, an investor will not want to make the tough call until the last possible minute. Unfortunately, that will leave you without time to fix the problem, With 6 months notice and proper preparation, you can work through the broken syndicate challenge. Without enough runway, it’s very difficult to pull this off – particularly when new investment commitments are harder to come by in today’s environment.
While syndicate problems are not that common, they are more common in today’s environment than an entrepreneur would expect. Of course, the situation can be materially worse if you have a single investor and he/she catches a “cold”. That cold turns into pneumonia really fast.
Bob Ackerman is the founder and managing director of Allegis Capital (www.allegiscapital.com), a seed and early-stage venture firm headquartered in Palo Alto, California. Ackerman has worked with more than 50 corporate investment partners over the past 20 years as both a venture capitalist and a startup executive. Read his past peHUB posts here