March 5, 2012

One area of fundraising that is not that straightforward is how to put together a syndicate of investors for your seed round.  Although there have been an increase in the number of seed stage investors, seed rounds are still typically composed of at least a handful of different investors, who each have their own processes and incentives.  It can be a little puzzling for entrepreneurs to make sense of this, especially since the landscape of seed investors is emerging and different seed investors act quite differently from one another.  Here are a couple things I typically suggest when putting your seed round syndicate together.

1. Understand the difference between and a lead and a follower.  Lead investors are those that typically write a relatively large check (usually at least 25% of the round or more) and are willing to negotiate with you to come to terms for your round.  Investors that are not leads will typically invest smaller chunks, and will usually commit to the round once the lead and terms are set.  Lead investors will usually do more extensive due diligence and have a more thorough process.  Often, other investors that follow will do less work because they trust that the lead has thoroughly vetted a deal and identified the main concerns around the company.

The challenge these days is that it’s not always obvious who is and isn’t a lead investor.  As angels institutionalize, you see a lot of them acting somewhere in between – they’ll lead the odd deal here or there, but are mainly in follower mode.  This means that one could end up burning a lot of time with an investor, who’s constitution really isn’t to step up and lead a round.  My recommendation is typically to get a sense of an investor’s parameters early.  If they are writing checks that could make them at least 25% of your round, and writing few-enough checks that they have time to lead many of their deals, then they are a good candidate to invest time with.  If not, I’d take one of the two following tactics.

2. Get soft-commitments early. There are some investors that aren’t comfortable leading, but sometimes are very early “soft commitments”.  These are often people who know you or have a natural affinity for what you are doing.  But this could also be some funds that are just used to behaving this way (eg: 500 Startups).  This goes for angels as well.  My thought is that it’s helpful to approach a few investors early that you think you have a very good chance getting a commitment from.  Your goal is to get that investor to a point where they say “as long as terms are reasonable, I’m in”.  It could even be for a pretty small amount, but you want a commitment that they would confirm if other investors call them.  This can happen fast, and provides good signal value to potential lead investors out there.  Typically, I recommend that entrepreneurs focus their time on lead investors and angels/smaller seed investors they already know to try to push the ball forward.  I wouldn’t pursue a seed investor in this category without a pre-existing relationship, because in most cases, an angel or seed investor would most likely want to be a follower.

3. Fill in the round with value-added followers.  The amazing thing about raising money is that you can go for months with no demand, but the minute a round is coming together with a credible lead, you will be over-subscribed.  It’s kind of puzzling, but then again, I guess it’s not surprising that human beings tend to just follow. But if you are successful with #1 and #2, you probably already have at least half your round committed by a lead and some other investors.  You also have terms that other angels can wrap their heads around and drive to a decision on.  At this point, I would make my dream list of angels and smaller scale investors and try to get them into the round.  The goal here is to find the people that are likely to be the most helpful to the company, even if their dollars invested is really small.  My preference on investor types would be for individual angels or seed funds that write small checks for a living. I would usually avoid larger funds that want to “chip in” at this point to help fill out the round.  If the fund didn’t have the conviction to lead, then they shouldn’t be given the chance to take a flier on your seed only to potentially hurt your chances or raising follow-on capital later.

Here’s how I see a typical (if there is such a thing) fundraise shaping up for a $800K seed round:

Phase 1: Talk to leads and angels that know you.  Get ~$150K of soft commitments from good folks who know you (hopefully fast)

Phase 2: Close your lead.  Get ~$400K from the lead and set terms for everyone else. (could take weeks or over a month)

Phase 3: Fill in the rest.  Maybe with $150K from another seed investor, and $100K from 3 angels that are directly relevant to what you are building (hopefully fast).

Parting thought 1: Some seed rounds can come together with no lead.  At NextView, we call these “headless rounds”.  In some cases, one of the angels has negotiated terms, but in some, the founder just puts together some basic terms and gets investors to rally around that deal.  This can be effective in getting a deal done.  But I think it’s also potentially fraught wil peril.  But that’s a subject of another post.

Parting thought 2: As a firm, we have a bias for leading or co-leading rounds.  We try to quickly drive to an independent decision, and we think that we have a decent enough pulse on the market to appropriately price seed deals and come to the right terms.  In some relatively rare cases, we’ll also act as a follower or give a soft commitment early.  But that is usually a situation where a) we saw the investment too late to take a lead role, b) the investment is outside of our core NY/New England geographic focus, or c) the company is in a sector that is slightly outside our core areas of expertise.

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