January 24th, 2008
“Those kind of ‘sit on the sideline’ investors are worthless to you if you want to get a financing done… if you are raising a financing of any kind, spend all of your time looking for a lead investor.”
Summary: Financings happen when you find a lead investor, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it. Alternatively, if you have a group of seed investors who aren’t asking you to find a lead, you can mass syndicate the round without a lead. Finally, ‘find a lead’ often means ‘no’.
So Bill the Cat writes in:
“We’re out on the warpath, with the aim of raising a Series A round in the $1M range. We’ve had a number of people say they are interested in participating, but nobody wants to lead because they know little/nothing about our market. Is there anything we can do about that, other than just keep searching for a lead? I’m pretty confident that at this point if we found one, we’d be set.”
What’s a lead investor?
From Fred Wilson‘s The “Lead Investor”:
“I got an email from a friend yesterday who… said that he’s got indications of interest from a number of investors but they are all waiting for a “lead investor”.
“I told him that what he has is a bunch of followers who have no real conviction about his business because if they did, they’d step up, negotiate a deal, and get their money into his company. But instead they are going to sit on the sidelines, wait until someone with conviction shows up, and then try to get in alongside the investor with conviction.
“Those kind of “sit on the sideline” investors are worthless to you if you want to get a financing done. They don’t impress the kind of investors who have conviction because investors with conviction are going to want all of the deal for themselves (or their friends they will bring in alongside of them).
“If you are raising a financing of any kind, spend all of your time looking for a lead investor.”
Lead investors want at least half the round—and they often want the entire thing. If they don’t want the entire round, they will help you find followers (and some leads will even close before you find followers). They believe your stock is worth more than they’re paying. They don’t need social proof or scarcity to make an investment decision. Like great entrepreneurs, they are mavericks.
Financings happen when you find a lead, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it.
Lead investors who bet on unproven markets, products, or teams (or all of the above) are rare. If you’re unproven, don’t be surprised if fund-raising takes time.
“Find a lead” might mean “no”. #
“Investors saying that they are waiting for a lead are also saying ‘no’ without saying no… They don’t want to miss out if this thing takes off (e.g., “Hey, we told you we were in, I hope you saved 10 percent for us!”), but they have no conviction and don’t want to say no in case they’re wrong.”
Instead of saying “no”, an investor might ask you to “find a lead”. Why? He wants to maintain an option to invest. If you find a great lead or the company starts kicking ass, the follower will say he intended to invest all along.
By telling you to find a lead, the follower is trying to extract a subtle commitment from you and manipulate your psychological desire to follow through on your commitments. Negotiators call this a consistency trap. We’ll show you how to avoid this trap in Part 2.
Professional investors (VCs) have two legitimate reasons to not lead: #
- Your business is too far away and they want you to find a local lead, e.g. you’re in Shanghai and your investors are in Boston.
- The investor’s typical investment is less than half of your round.
In either case, the follower should partner with you to find a lead. His level of effort will tell you if he really wants to find a lead or he just doesn’t want to say ‘no’.
You can mass syndicate seed rounds without a lead. #
Small seed funds that are investing their personal money and non-professional investors like angels may have other good reasons to not lead: they don’t want to deal with negotiating terms and hiring a lawyer, their portion of the financing is too small to lead, they like you but they don’t know the market, et cetera. #
If this is the case, you might not need a lead. If you have a group of seed investors who are not explicitly asking you to find a lead, you should:
- Generate a term sheet. Your advisers and lawyers can help with the terms.
- Get feedback on the terms from prospective investors at the end of the first meeting. They will ask about the terms if they’re at all interested.
- Incorporate the feedback into the term sheet.
- Once enough prospective investors have said ‘yes’, circulate the term sheet with a list of investors who have committed to the financing.
- Incorporate any additional feedback and send the closing documents to everyone. Set the closing date two weeks out.
How do you find a lead?
In Part 2, we’ll suggest some ways to find a lead if you can’t mass syndicate the round.
Related: VC Cliche of the Week: We are Passing, The Art of Saying “No” Parts 1 2 and 3, and More favorite VC phrases.