Is Your VC a Chicken or a Pig? Part II: The Role of the Lead Investor – From Term Sheet to Closing (and Beyond)

In Part I we talked about the critical importance of focusing your fund raising efforts on identifying a lead investor – a “pig” – and reaching agreement on a term sheet with them before you spend significant time lining up “chickens” to “follow” along in the deal. Today, we’ll look at what role your lead investor plays post-term sheet agreement when it comes to getting your deal closed.

The first role of the lead investor post-term sheet is working with the company to build out the investment syndicate: that is, to find and close on chickens/followers. The lead becomes, in effect, a part of your pitch team – albeit, without abandoning its primary role as an arms-length investor/skeptic.

The “selling” role of the lead includes identifying, prioritizing, and even pitching potential followers. That typically includes folks the lead brings to the table from its own network as well as appropriate candidates the company suggests. While the company will still be front and center in pitching chickens, the lead is usually the primary due diligence source for potential followers, both “deal” and “legal” due diligence, and actively shares their own thinking on why the deal is compelling with various chickens.

This dual role, working with the company to build the syndicate while also being the principal due diligence resource for the syndicate, makes managing the company/lead relationship complicated as well as critical. The lead, at this point, wants the deal to happen and is committed to making it happen. But only to a point. The lead’s enthusiasm is tempered by its continuing obligation to act in the best interests of its own investors. In addition, its credibility is on the line with other investors, which is something that can cut both ways in terms of how it reacts to any bumps in the road on the journey to closing.

The lead also manages the “deal” part of the deal: that is, the concerns of followers about the terms of the deal. On that score, the lead should focus on convincing followers that the term sheet is “good to go” as is. Indeed, the company should resist any material changes to the term sheet based on follower concerns, just as it would if the lead was the only investor. The whole point of agreeing on a term sheet was to finalize the material terms of the deal. As a practical matter, one or more immaterial changes to accommodate a valuable follower may be acceptable. Any material changes, though, should be viewed as putting in play changes the company might want in exchange, or even grounds for the company backing out of the deal altogether.

The lead also manages the legal process associated with negotiation of closing documents and related legal requirements. Typically, there is one counsel for the investment syndicate, and that counsel works through the lead investor and is paid by the company out of closing proceeds from the financing. (If a follower wants to have an independent legal review, they should pay for it, and that counsel should work through the lead and its counsel in terms of communicating any concerns to the company.) If a lead can’t persuade followers to work through the lead and its counsel, that’s a good sign that the lead is not up to the job.

Once the deal is closed, the lead is usually the “point” investor for the rest of the investment syndicate. If the investors have a director on the Board, it will usually be someone from the lead investor. (Someone that should have been identified at the term sheet stage). When the company has news to share with the investors – good, bad, or indifferent – the lead is usually the first to get it, and often has input on what to share with the rest of the syndicate, when, and how. As with the period of time from the term sheet to the closing, this dual role of investor/advisor can be complex and must be managed carefully.

Lead investors make deals happen, and typically play central roles even after the closing. Smart entrepreneurs know that raising money is first and foremost about getting a credible lead’s name on a solid term sheet. Be a smart entrepreneur: don’t waste time and energy collecting followers until you’ve got a lead for them to follow.

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Jones: Hard truth about angel investing

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Jones: Hard truths about angel investing” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“Angel investing is a critical part of the high impact startup world, particularly outside of the big venture capital centers. A good portion of Wisconsin startup success stories achieved liftoff with critical assistance from angel investors and their capital.

But what about the angel investors themselves? How does angel investing work for them?

Well, you don’t have to look very hard to find blogs, books and speakers extolling the virtues of angel investing for the angels. And a lot of them make a pretty good case that the angel investing community makes a nice profit for its efforts. A good case, but also a misleading case.”

Click here to read more.

You’re So Vain

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “You’re So Vain” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

I am often asked what some of the big obstacles are in terms of building a self-sustaining high impact entrepreneurship and investing sector in the Badger State. Two of the popular candidate answers, not that popularity means a lot, are a lack of capital and a lack of talent.”

 Click here to read more.

What if the Age of the Unicorn is Over?

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “What if the Age of the Unicorn is Over?” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:
The years 2014 and 2015 were good to high impact entrepreneurs. VC investments soared, and pricing and other financing terms were as friendly as they have been since the dot-com bubble burst.

It’s the age of the Unicorn. And conventional wisdom, supported by some recent data (declines in venture funding, particularly startup and early stage capital, and the “de-horning” of several Unicorns) suggests that it is coming to an end. What will that mean for high impact startups in 2016?”

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Measuring Startup Investing Returns Part III: An Apples to Apples Solution?

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Measuring Startup Investing Returns Part III: An Apples to Apples Solution?,” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“In the first blog in this series, I argued that internal rate of return (“IRR”) is too sensitive to market timing distortions to be a good metric for the investment acumen of seed/early stage angel and venture capital investors. In Part II, I suggested that a metric that compared cash-on-cash (“CoC”) returns was better, but still subject to significant distortions associated with the timing, intensity and duration of market cycles. Today, I’ll explore another way to approach the problem; an approach that addresses the timing problem as encountered in both the IRR and the CoC metrics.”

Click here to read more.

Measuring Startup Investing Returns

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Measuring Startup Investing Returns,” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

Part I: The Problem with IRR

Ask angels in the seed/early stage high impact investing market about returns, and they’ll usually answer in terms of internal rates of return (“IRR”). Which is unfortunate, since IRR is really not a very good way to measure returns and, more to the point, is a pretty poor way to measure the prowess of seed/early stage investors.”

Click here to read more.

Seed and Early Stage Due Diligence: Part 1

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, is a regular contributor of OnRamp Labs, the Milwaukee Journal Sentinel‘s blog covering start-ups and other Wisconsin technology news.

Paul’s most recent contributed piece Seed and Early Stage Due Diligence: Part 1 can be found under their Business Tab in the Business Blog section.

Here is a short excerpt: Investing in seed and early stage high impact businesses can be fun, and now and again even financially rewarding. One of the tricks of the trade is appreciating how due diligence – the pre-investment process of determining whether a particular deal is what it says it is, and whether what it says it is has any value – for seed and early stage investing is different from due diligence when the potential investment is in a more established business, public or private. Herewith a couple of the key differences. Next time, a look at the “big four” due diligence enquiries for seed and early stage high impact business investors.