After reading the previous post about the advantages of being the lead investor, you may have been left wondering why so many people – individual angel investors, angel groups, micro-VCs, or even formal venture funds very often don’t lead deals. Below we’ll take a look a few of the negatives of leading an early stage investment round.
Setting the terms
Setting the terms is a blessing and a curse. While the lead investor is able to negotiate a valuation and set terms that they view as fair, everyone else will almost certainly disagree! This can be hard to face. Plus, there is no room for error; every other potential investor will see the term sheet and deal documents, so if something goes awry because of the deal structure down the line, you can see who will get the blame.
Valuing companies takes time. Coming to an agreement on valuation takes time. Negotiating the terms of the deal takes time. Helping find other investors takes (a lot of!) time. Working with attorneys takes time. And once the investment is made, serving on the board of the company takes time. Being a lead investor is a lot of work (and, not to brag too much, requires some skill and knowledge).
Being the lead investor for a syndicate of investors is a process that requires patience. Everyone will be at different stages of their investment and diligence processes, which often causes the round to drag on long past your own investment window. For a recent company added to our portfolio, we were the lead investor and took over half of the round, but it still took eight more months for the round to close completely.
An inevitable consequence of being the lead investor is that other angels and VCs ask to see your diligence materials, which can lead to two issues.
First, a thorough diligence process takes time (and often experience), which is why many investors cannot do it. It can feel like you are subsidizing people if you do all the work for them. (This is a particularly problem in the VentureSouth model: sharing internal diligence work with people that are not paying members does not give a great impression for our dues-paying members.)
Second, other investors should not make decisions based on diligence work that others do. But they probably do anyway – even if subconsciously. This is part of a wide ranging debate about sharing diligence materials in the early stage ecosystem. We pride ourselves on running a rigorous due diligence process at VentureSouth, but when we share our diligence report, we highly encourage the potential investor to do their own due diligence.
Follow on signaling
During the next round of financing, whether it be a bridge round or Series A/B round, potential investors and existing investors will pay attention to whether the lead from the previous round is participating and to what extent. The lead investor not participating gives the market a negative signal about the company, regardless of whether it is justified. This can end up being a burden, and smart lead investors are acutely aware of the possible implications.
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We don’t mean to sound like complainers, being the lead investor has positives and negatives, but doesn’t everything? At VentureSouth, we believe the positives far outweigh the negatives!