Fundraising

The Role of a Lead Investor

October 10, 2020 /

Raising money for high-potential startups is always a challenge.  Finding the right lead investor is an essential step along the path.

Raising a round of funding requires many things. However, at the top of the list of a fundraising CEO’s priorities is recruiting a lead investor.  In fact, when I am fundraising for a VC-led round, I focus most of my fundraising attention on finding the right lead investor for the round.  Everything else flows from securing that one relationship. This is critically important because of the role of a lead investor.

What is a Lead Investor?

A lead investor is able and willing to independently complete the initial diligence to vet a business opportunity, propose and negotiate the terms of an investment, and lead the recruitment of a syndicate of investors.  Being a lead investor requires a willingness to take the risk of making an independent investment decision, expertise and confidence in a particular space, comfort level with setting terms, and just the boldness to step out and lead. They are the ones who will jump off the cliff by themselves!

Not all investors choose to be lead investors. Some would rather participate in syndicates by following someone else’s lead. Sometimes this is situational, especially when an investor group is exploring a new area and developing expertise. Sometimes investors will choose to co-lead with another investor to combine both knowledge and resources.

From an entrepreneur’s point of view, the important thing is that to coalesce an investment round, you need to find a lead investor who is willing to propose and negotiate terms, and then commit to leading your investment round.

Focus First on Finding a Lead Investor

Some investors always lead. Some investors sometimes lead. Some investors typically do not lead.  

When you are talking to investors who are not interested in leading an investment but are intrigued by your opportunity, they may indicate that they are interested once you find a lead investor. The challenge is that these investors can soak up a lot of your fundraising time and energy, yet they will not be enough to initiate your round.

To be efficient and effective with your finite fundraising time and energy, you need to quickly sort the investors you meet based on the role they prefer to play and scale your time investment accordingly. This is why you should focus 80% of your attention on finding a lead investor, and spend only 20% of your attention talking to investors who are unlikely to lead. Sometimes when I am fundraising and hearing plenty of “no’s”, I remind myself that I only need to secure one lead investor.

The Tell-Tale Signs of a Lead Investor

Sometimes lead investors make it easy to recognize them. They may claim the role when introducing themselves and describing what investing role their fund prefers.  Some even spell it out on their website. They may talk about proposing a term sheet. If an investor does not offer the information directly, I will sometimes ask if they prefer to lead or be part of a syndicate.

Other indicators that make it more likely an investor will take a lead role are:

  • Their expertise and experience in your space. For example, if you are building a regulated medical device startup and the investor you are talking to has not invested in similar companies before, they are unlikely to lead. I had one healthcare investor who spent quite a bit of time investigating our opportunity (usually a good sign), before finally declaring that they did not know enough about the space to be comfortable leading. That proved to be a colossal waste of my time, and I should have been more protective of my cycles. However, I liked the investor and hoped to persuade him to try something new. That was not my wisest decision!

  • The investor’s preferred initial investment amount range. There needs to be a fit between the size of the investors’ fund, which will drive their desired initial investment amount, and the size of the round you are trying to raise. Since they are setting the terms of the investment, a lead investor needs to be willing and able to claim a dominating share of the round.  While there is some flexibility in the percentage of a round contributed by the lead, it does need to be credible for recruiting the syndicate.  If a lead investor’s amount is small for the round size, sometimes co-leads are a workable solution.

  • Where the VC is at in their fund lifecycle. Even investors who are willing to lead need to be at the right stage in their fund lifecycle to invest in your round. For more on how this works, check out my post on finding the VC fund timing sweet spot.

Keep in mind that it is always wise to be cultivating multiple potential lead investors simultaneously. You want to have multiple shots on goal because it is hard to land a lead investor. If you are lucky, you can simultaneously persuade more than one to be interested in leading, which gives you negotiating leverage if handled well. Just remember that the investing community is small, so try not to share which other potential leads you might be talking to. If you do, you may find that the potential leads decide they would be just as happy co-leading, and you will lose your leverage.

Wait Until You Have a Lead to Build A Syndicate

When a group of investors joins forces to fund an investment round, the group is known as a syndicate. Recruiting investors into the group is known as syndicating the investment.

Note that leads often have strong views on how they want to structure an investment syndicate. They often prefer to invest alongside certain investors they have had good relationships with while avoiding other investors. The web of relationships amongst investors is often complicated and nuanced and can be quite challenging to learn about, so the best course is to be aware that it is an important factor and ask your lead to lead in this area. With regard to existing investors, while leads will often allow existing investors to continue to invest alongside them as this indicates existing investor support, they may very well refuse to allow new angel investors to join into the round to keep the number of participating investors low.

The key thing for the CEO is to develop interest amongst potential syndicate investors (those who opt not to lead), however, do not make any promises because the lead investor will expect to have a significant say in who gets to join the fundraising round.  The lead investor will like the fact that you have been able to generate interest amongst other investors. However, they may well want to offer the investment opportunity to a fund that they partner with regularly or brings particular expertise or resources to the Company. Note that these relationships can often mean that a round comes together relatively quickly once a strong lead is in the mix. This is why you want to be careful how much of your time is spent developing potential syndicate partners instead of finding your one lead.

Once the lead investor and the Company (represented by the CEO and Board of Directors) have agreed upon terms, building out the syndicate from there becomes a joint effort.  Never forget, however, that, until the funds are in the Company’s bank account and the documents are signed, the lead investor can always choose to abandon or renegotiate the round if something significantly concerning comes up along the path to closing.

The bottom line?  You only need one good lead investor, so focus on finding them first.

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