There are many benefits to being the lead investor in a round, we’re going to touch on a few advantages that we’ve realized by being a lead investor in the Southeast.
Setting the terms
The first reason is obvious: the lead sets the terms of the round. Negotiating deal terms can be time consuming, but it allows the lead investor to establish the important terms for the deal. The term sheet is then presented to other investors, generally as a “take it or leave it.” Being the lead investor lets you avoid situations where a company is attractive, but the lead investor negotiated terms that are unattractive to you – a valuation that’s too high, a weird (or no) liquidation preference, or any other hypothetical deal-killing term. Getting “investor friendly” terms is important but sometimes more important is avoiding a poorly structured deal that can hamper future growth.
Relationships with exciting entrepreneurs
Getting to know smart and passionate entrepreneurs is a great part of being an angel investor. Being the lead offers the best chance to create those relationships. Through conversations with entrepreneurs (and their attorneys!) we constantly pick up new knowledge and best practices – on business operations, market deal practices, clever solutions to complicated deal structuring questions, and more.
A related benefit is deal flow: entrepreneurs that we invest in are typically well-established in their industry or their city’s entrepreneurial ecosystem; who do they generally send good deal referrals to? Their lead.
The lead investor typically takes a board seat, providing oversight of how the business is operating and ensuring the investment capital is being used responsibly (for all shareholders in the company). Serving on boards for rapidly growing company provides great information when evaluating further funding – and can be extremely exciting and fulfilling (when things go well), or highly educational (when they do not).
Many areas, including the Southeast, do not have an abundance of investors willing to lead rounds, so firms that lead rounds tend to become more visible to investors and entrepreneurs alike. Having a strong reputation in the market can lead to better deal flow: the strongest entrepreneurs specifically seek out potential lead investors, so those capable of leading get to see the best opportunities.
This goes the other way as well, as filling out a round can be difficult and is typically something a lead investor helps with. A lead investor that is well-known and has a solid reputation can use their network of potential “syndication partners” to provide validation to the deal and help fill the round.
It is a thoroughly discussed topic among early stage investors that communications and reporting from portfolio companies can be less than perfect. Though it is typically a requirement in the deal documents, entrepreneurs are busy people (without an investor relations team), so reporting can often fall by the wayside. Being the lead investor typically mitigates this, as leads tend to be closest to the company – and, because the entrepreneur understands that they will likely need to raise more capital in the future, higher up the list of people to get updates!
Lastly, being a lead gives a unique opportunity to see how the entrepreneur behaves. Negotiating the terms provide an insight into the entrepreneur’s character, reasonableness, ability to take advice, and more. (It provides the same in exchange for the entrepreneur.) This is the same reason why we only invest in preferred equity: we want to see a negotiation and how entrepreneurs respond.
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If there are so many advantages to leading the investment, why don’t more investors do it? In the next blog post we will dive into the cons of being the lead investor.