Making Syndication Work

Editor’s Note: Syndication is one of the topics that remains at the forefront of many angel group priority lists—and for good reason—syndication is a critical component of angel investing success. When we look back 5+ years since ACA held its first collaboration committee meeting, established with the goal of improving syndication best practices across the nation, we can revel in how far we’ve come: From the leading syndication practices of some geographies like what we’ve seen in New England (which led to developing the ACA Syndication Guide in 2009), to the steady increase in angel group co-investing which for 2012 included 70 percent of deals evidenced by data in the 2012 HALO Report, we can pat ourselves on the back for the progress we’ve made. But despite this progress, there is more work yet to be done to tailor and refine practices to the differing needs across distinct angel groups, industry sectors, and geographies.

Below, Dick Reeves, ACA Board Member & Executive Director of the Huntsville Angel Network shares his personal views on the challenges and opportunities left to overcome in his realm.

If syndication is the answer to so many problems, why are we having such a hard time making it work well?

Those of us who live in the hinterlands spend most of our time dealing with the facts that we have a small flow of qualified capital seeking candidates, we are volunteer-led, we don’t have all the skills and domain expertise needed to adequately deal with many of the candidates that do show up, and we soon tire out the limited supply of diligence labor we do have. There are only 30-40 members in the group, not enough to raise an initial round for many companies, not to mention follow-on rounds. Our members do not see enough deals per year to build a diverse portfolio in 4-5 years, so their portfolio ends up being of low quality and concentrated in a few companies and industry segments. Members burn out after 3-4 years, and the angel group peters out over a year or two.

Syndication would seem to offer solutions to many of these problems: more deals, greater diversity, more investors participating so higher amounts of money can be raised and the risks can be spread, and more people to participate in the diligence process … what’s not to like about this?

Yet, outside of the major cities, it seldom seems to work very well. Most of these syndication efforts concentrate on expanding the list of angel groups for the company to talk to, and the lack of established trust relationships between the groups leads to each group wanting to do its own due diligence process. This leads to a very long and uncertain fund raising cycle for the company, and inefficiencies for all concerned. It should not take 6-9 months to raise a $1 million round.

Almost every angel group I talk to has a different flow development, screening, diligence, and deal investment process, a situation that insures this circumstance will remain unchanged. The definition of insanity is …

How about some different practices that would lead to better outcomes for all:

  1. All participating groups agree that they will collaborate on deals that are candidates for syndication. 2/3 vote to go to diligence.
  2. One group agrees to be the Lead, and the diligence committee has members from every group, so every group has someone who can stand up in the home group meeting and say they watched the process and it was good. Committee chairs are trained in the standardized diligence process. All parties agree to hold others harmless.
  3. If the diligence results exceed an agreed minimum, the deal is automatically acceptable for presentation at all the groups, with no further work. The company goes on a road show to all groups within a week or three.
  4. The lead group manages a common set of subscription documents and local group managers herd the cats to get checks in.
  5. The groups agree to use a common investment LLC, with a standard Operating Agreement.
  6. The Lead supervises the portfolio company, and reports to all investors at least quarterly.

The Lead needs to be compensated for its work, and perhaps so do the diligence committee members. Some groups use a carry. How should we do this?

The results? Potentially, a deal syndication process that can move deals from initial screen to closed deal in 90-100 days, and that can raise $1 million rounds routinely.

Where are the flaws in this? How can we overcome them? What alternative practices are there that can meet the objectives?