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February 19, 2006

Syndication Science

VCs and entrepreneurs both seem to really struggle on a deal by deal basis with the question whether to syndicate or not syndicate a deal.  As an entrepreneur, I had my own biases (always syndicate – it’s obvious, I used to think, ignorant of all the nuances).  But now entering my fourth year on the other side of the table, I’ve come to see both sides of the argument.  Since I’m going through this issue on a particular deal right now, I thought it might be worth sharing a few perspectives.

From the entrepreneur’s perspective, often the more help and the more money around the table the better.  One VC has one set of networks for recruiting and business development assistance.  Two VCs have two sets of networks, usually with modest overlap.  And having two sets of deep pockets to tap when things are going good, bad or sideways can be very helpful.  Frankly, I also never liked the idea of being beholden to one VC.  As an entrepreneur, I figured having two or more VCs allowed for more diverse opinions and, in the end, more control to do as you saw fit even if you were in disagreement with one VC, who could be isolated as an “outlier”.  Of course, more VCs tends to mean more dilution.  A single VC should be happy at 30% ownership and, when pushed, will go down to the 20s.  Two VCs typically clamor for 20-25% each, sometimes more in very early-stage companies, and have to be pushed hard to go below 20%.  That said, I drank the kool-aid based on the three start-ups I worked for that having the right partners around the table would drive the right positive outcome more than a few extra points of ownership.  Many entrepreneurs will point out that there is extra overhead in managing two firms.  Although that is true, experienced entrepreneurs seem to not mind.  Manaing three or four VCs on the other hand...

From the VC’s perspective, though, I’ve come to appreciate that there are more nuances involved.  First, it's important to point out that there is an elitist caste system in the VC world.  Upper crust, top tier VCs rarely partner with those they view to be beneath them.  The flip side is that lower-tier VCs love to partner with upper crust VCs to help enhance their brand image.  One way to sniff this out is when a VC tells you about the deals they’re in, check to see whether they name-drop the co-investors before raving about the entrepreneurs and the business model!

On the other hand, greed (gasp) is a huge driver in the VC world.  Once you like a project and decide to invest in it, your partners look at you and ask:  “if we like it and are going to put all this work into it, why share it?  Let’s own 30% and forget about the other firm.  Besides, what incremental value are they really going to add?"

Then there is the dynamic of structuring the syndicate and how things are divided up.  Many VCs are religious about splitting everything evenly to preserve harmony.  Others take a more aggressive approach and take what they can get, squeezing out co-investors as much as possible to take an unequal share.  Entrepreneurs are trypically pretty bemused by the whole dance.  After working so hard to get a few firms to pay attention to their big idea, they are quite gleeful when the tables are turned and the VCs suddenly act like alley cats clawing over cap table scraps.

However the dance plays out, entrepreneurs should remember that ultimately, they are far more in the driver seat than they appreciate.  And so when it's time to pick partners, choose carefully, because you are going to be stuck with those partners for a long, long time.

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» To Syndicate or Not To Syndicate from Feld Thoughts
Jeff Bussgang a GP at IDG Ventures in Boston has a good post up on the dynamics from both an entrepreneurs perspective and a VC perspective on syndicating deals.... [Read More]

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Great post Jeff. As you mentioned, entrepreneurs need to remember that they are partnering with VCs for the long haul so their decision shouldn't be based only on the money a VC can bring in. Also, there are entrepreneurs out there who think they should outsource the money raising process in order to focus on the product. While this seems like a good idea on the surface, an entrepreneur really needs to find VCs that share his/her vision and will be there to help through thick and thin. Therefore, the entrepreneur should really be out there taking the VC meetings and picking his/her partners.

If you choose to syndicate and your comfortable with your current investor, make sure the new investor has gotten along with the current VC in the past or has a positive reputation (diligence your VC as much as the VC diligences you). There are many toxic VCs out there as well as the 'pigeon' board member. This is as much a game of egos as anything else, so adding a new head to the table can be just that...

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