Being able to do bigger deals. Being able to benefit from being alongside smart, sector-focused investors. Being able to hold back a portion of your own funds to participate in follow-on rounds. What's not to like about syndication?
It is one of the most significant trends in the angel investing scene right now. This year's UKBAA/Deloitte research, Taking the Pulse of the Angel Market, showed that 73 per cent of angels were co-investing alongside other angels in deals. Everywhere you look, syndicated deals are happening.
In an interesting Anglo-Scottish tie-up, Rivers Capital Partners, managers of the North East Angel Fund, and Melrose-based TRI Cap invested together in Newcastle web marketing software outfit 4th Aspect.
At the end of 2012, a syndicate of 20 angels, including a founder of Rackspace and a former head of engineering at Skype, backed Bristol-based cloud infrastructure venture Hybrid Cluster This spring, the company raised a further £300,000.
Best Female backed Business of the Year at the recent UKBAA Awards, MOVE Guides https://www.moveguides.com,an HR tech cloud platform for global mobility set up by woman entrepreneur Brynne Herbert, attracted the backing of a syndicate of a high profile women investors: Sherry Coutu, Dale Murray and Maria Dramalioti-Taylor who co-invested alongside experienced European angels, including Kevin Eyres (ex-LinkedIn).
A syndicate of 13 business angels, including several from Worcestershire group The Claret Club, has funded an online peer-to-peer lending platform, Thincats.com. founded by Kevin Caley from Advantage Early Growth Fund. The syndicate of angels not only provided Caley with the seed funding and the technical expertise for the lending platform, but also the initial liquidity by lending money through it.
“Syndication is a very significant trend,” says George Whitehead of Octopus Ventures, a firm that often invests alongside angels. “It means that angel groups are acting in a more sophisticated manner. Angels can learn from the practices of the VCs. Why does a firm such as Octopus, with £200m under management, almost invariably choose to syndicate?. Why would we do that, when we could afford to every deal by ourselves? Because to grow a really successful global business requires more than one round of funding. Yet if you look at angels, they will often go it alone – and only then later learn that going it alone is a high risk way of doing it.”
It is increasingly common for VC firms to invest alongside individual investors. Of the £23m invested by MMC Ventures since January 2012, a further £38m of co-investment has been poured in. While most of that will come from other seed, venture and growth funds, some has come from angels.
One reason behind the growth in syndication is the impact of the Angel CoFund, which won't invest unless the lead angel is part of a syndicate. In its 20 months of operation it has undeniably raised the syndication game. It already has 32 companies in its investment portfolio. In two out of three times it has co-invested with two - and often three - angel syndicates. It has participated in follow-on rounds in eight of its investments.
The average deal size featuring the CoFund lies between £1.1m- £1.5m. This compares to the UKBAA/Deloitte research of the average angel round size being £350k. (There is one outlier in the CoFund data: the PlayJam deal that comprised 50 angel investors, with two major syndicates, a smaller syndicate and two institutional investors. )
“The average round size of the CoFund is much higher than I anticipated,” says George Whitehead of Octopus Investments and chairman of the Angel CoFund. “It has really surprised me. We are seeing quite chunky rounds. We are seeing angels, VCs and the CoFund coming together – and this level of syndication means much deeper pockets.”
Syndication is becoming more popular in Scotland, too. According to David Grahame at LINC Scotland, more than 70 per cent of the deals in 2012 involved Scottish Enterprise's Scottish CoInvestment Fund with more than one-third of the deals also involving more than one angel group. And there is evidence to suggest that syndication leads to larger deals: in 2012 the average Scottish deal size was £320,000 but almost all those syndicated were over £500,000.
The new breed of syndicating angel
A new breed of active angel investors is emerging for whom deal syndication is a core part of their investing strategy.
One such is Rajat Malhotra of Wren Capital and who was awarded the title of Angel of the Year 2013 at this year’s UKBAA Awards. Wren always co-invests, typically in round sizes between £250,000 to £1.5m. “It is a core part of our model,” says Malhotra. “We are 100 per cent behind the UKBAA that co-investment is absolutely crucial. The most important part of my job as a professional angel investor is not to find great companies but to find great co-investors. Knowing great co-investors leads to better deal flow. It is that way around. We learned this very quickly. For Wren, this is especially important because of the scale that we want to get to. We love to invest alongside someone who only wants to do three or four deals but in their particular sector and who want to be really hands-on in their investment. As we regularly invest in six figures and above, we can provide firepower and leverage to that lead angel, who doesn't have to cobble together endless lots of 15 grand.”
Greater follow-on capacity
There's a growing recognition among angels that they need to be committed to several investment rounds, particularly across all technology sectors. In a follow-on round, it can be quite challenging for angels to drive a better deal, so syndication is a response to a market need to fund companies further through the cycle.
“We are definitely doing bigger deals,” says Nathan Hill of Qi3 Accelerator. But, he adds, it is often more about companies going through more rounds. Plenty of his 13 companies are fund raising at present, he says, and the rounds are “relatively large” for angel rounds. “We're talking about £2m angel rounds and I am not shuddering to think of that being a follow-on round,” he says.
One of Qi3 Accelerator's portfolio companies has already raised two rounds of £1.15m and £1.6m and is considering a third that could potentially be another angel round. Hill believes that the inflow of money coming into the angel market as a result of EIS is one reason why angels can carry on funding. “I see angel investment as a three-round deal,” he says.
Syndication also gives a growth company extra pace. If a company is motoring, more financial fuel can be added without the management team being distracted by further rounds of fund-raising.
Even then, companies will run out of funding steam. At this later stage, new syndicates such as Julian Hickman and Edward Rudd's Juno Capital are coming into play. Explicitly focused on later-stage investments, Juno identifies companies that are running out of investor appetite. “They will either be companies in whom some of our members have already invested, or they will come through other venture investors who have not got enough left in their fund,” explains Hickman.
Leverage expertise and contacts
Another key advantage of syndication is that it enables angels to invest alongside people and firms with additional industry expertise and contacts. It's more than just about money.
“It works when there are mutual benefits, both to the investing parties and to the company,” says Whitehead. Octopus is doing an increasing number of seed rounds and will do them with angel groups – such as Y Plan, where it invested alongside super-angels Brent Hoberman and Sherry Coutu in an early stage deal. (Just one year later, Y Plan has gone on to raise a further $10m in the US.)
For Qi3 Accelerator's Nathan Hill, syndication takes the risk out of backing an interesting company that operates in a sector, such as medical technology, in which he and his colleagues don't have all the requisite technical understanding or contacts.
The all-important lead angel
An effect of the growth in the number of syndicated deals is the requirement for a lead angel investor.
This is the angel who steps up to the plate, who leads on the due diligence, communicates with all parties, negotiates terms, and who can exploit the combined strengths of the syndicate effectively. A syndicate will succeed or fail on the back of its lead angel. So what are their characteristics and attributes?
They have to feel they can make a difference, have the time and see the potential of the syndicate. They will tend to be individuals who are now devoting more of their time to angel investing. They will often be sector focused and want to be active in a sub-set of investments in their portfolio.
“They are naturally commercially minded and who won't take the company's word for it,” adds Whitehead. “They are the smarter investors who want to make hands-on, informed decisions. They are not the ones who are too busy elsewhere.”
“The lead investor has relevant track record and an appetite to get involved,” says Scott Haughton. “They usually have experience of growing a business and exiting from it. They have already invested in other companies. They ensure that shareholders receive adequate reports. They will be seasoned, have the time and have the appetite. We'll never advise to invest unless there is someone prepared to take on the key role.”
It's a skill; an art, not a science. It's an important – but often thankless – task!…
“The average angel investor hates doing the due diligence and legals,” says Malhotra. “There is always the moment when, once an entrepreneur has been grilled and the interested angels are deciding to back a particular business, someone says: 'does anyone want to lead this?' And I can promise you there is rarely a volunteer. It is a massive crunch point. There is often that silence in the room. Nobody wants to take the responsibility: even if you don't have legal responsibility, if you are a stand-up sort of guy you will feel morally responsible. Anyone who has been in angel investing for more than ten minutes knows that leading is a hell of a lot of work for what can seem like no reward.”
So you have to ask: why do it? There's not much reward for all the work apart from the gratitude of the long tail of passive investors. Some lead angels will become non-executives on the board of the investee company, so they may receive remuneration that way.
"It is hard to find a structure for compensating the lead angel,” says Nathan Hill. “It is usually a few options. If you were paid for your time it would probably wipe out the investment. If you were paid properly, you would look like a corporate finance person. Offering to lead means doing a lot of the work, whereas most angels are interested in investing and getting a return; Angels are not being paid like a corporate finance house to do all the work.”
Hill sounds a note of caution. “There will be people who have led on two or three deals and who are now exhausted and want to sit in the background for a time. You have to be a bit mad or irrational to want to lead a deal. So it does depend on more angels coming into the market. We need a constant flow of inmates into this particular asylum.” And Envestors' Scott Haughton acknowledges that among the Envestors’ members, such lead angels are in the minority
One of my criticisms of some syndicates is that everyone leans on each other,” observes Whitehead. “No-one really gets to know the business well. People see a pitch, then they talk to the guy next to them, and then they just do it. But this is just scraping the surface.
Being the lead investor for the Angel CoFund is a serious undertaking,” Malhotra acknowledges. “If you are just putting a deal together with other angels they don't require you to write a paper. In that sense, the CoFund is like working with a VC. It is definitely worth it for the right deal because of the massive leverage the CoFund brings.”
Malhotra is a lawyer, with many years' experience in competition law gained at Norton Rose and Ashurst. It makes him an unusual angel but it's a background that really helps when it comes to leading deals. “It is where we do add value. We know how to get deals done. We absolutely can and do take a lead on documents, due diligence, structuring deals and negotiating deals. That is where our co-investors get a lot of value from us. They leverage our man-hours. I have just completed a deal with 20 or so investors in a large, complex deal. There were 2.5 lead angels working on it and I reckon we spent 1,500 man hours over eight months on that deal.”
Managing the Syndication Process
There are, of course, other approaches to address the stresses of syndication management.
Envestors, for example, raises money via its angel members but also provides corporate finance advisory services to the companies that are raising the funds. The company raises its money in a formalised approach, with a mini-prospectus, valuations and timescales. This gives comfort to the management team and investors alike.
In Scotland, explains David Grahame, the groups are established entities with some degree of deal execution infrastructure. Each group has a core of active professional angels and the core group offer their deal flow to the outer group of private, passive investors. The lead structure and execution will be done by the same team each time; a small group may pay its part-time chairman /gatekeeper for the work while a larger group will have a full-time team.
It was Scotland's Archangel group that provided the inspiration for Juno Syndicate, the angel investor group founded by Julian Hickman and Edward Rudd in 2011. Juno has built up a membership base of 120 members to date and is currently engaged in its ninth deal. Each of its investments has involved between ten to 50 of its members. To date, says Hickman, Juno has been keen to do business with the Angel CoFund because “it's a very good counter-party.” One example of such a deal was the backing of Sky Medical Technologies, a firm already backed by Longbow and Spark Ventures.
The Angel CoFund now has the mandate to co-invest in deals across the UK. How this will affect the Scottish market remains to be seen, but it does enable English angel groups or one-off angel groups within Scotland to make Scottish investments outside of the framework of the Scottish Co-Investment Fund. And it enables established Scottish angel groups to invest in England – such as TRI Cap's investment in 4th Aspect. So there is potential for more syndication within the UK.
“Angel investing is normalising,” says George Whitehead. “It is not just for a rare group of dragons or the super-wealthy. Understanding that syndication is a big part in this, it is a great way of making it more interesting and reducing your risk. It is a sign of the growing sophistication and maturing of the angel market.”
30 September 2013