The Mechanics of AngelList Syndicates

for Investors & Startups, by David E. Weekly, written mid-2016

Hi! I help run two separate syndicates on AngelList; drone.vc (focused on drone tech) and neuron.vc (focused on applied deep learning). Many people are unfamiliar with how AngelList Syndicates work — what makes them similar and different to working with either individual angels, an “angel group”, or working with a traditional venture capital institution. This guide hopes to clarify that for you. If you’d like a basic primer in startup stocks and the like, I’d recommend my free Guide to Stocks & Options as a resource.

Disclaimers Galore: I’m not a lawyer. None of the below should be constituted as legal or tax advice, for which you should seek the services of a licensed professional. The below was written with US investors investing in US-incorporated technology startups: rules, restrictions, and considerations may vary considerably from the below advice for other geographies. I don’t work for or represent AngelList and may have materially misrepresented their program. Investing in startups is dangerous. Also, don’t run with scissors.

Angels

“Angels” are what we call people who invest their own money. The SEC puts restrictions around what kind of investments people can make if they’re not rich yet — to keep, say, grandparents from getting tricked out of their retirement savings by a huckster — so most angels need to be rich by the SEC’s bar. If you meet this bar, the SEC will consider you an accredited investor. These definitions haven’t changed in a while, but when we talk angels, we’re not talking institutions, we’re talking individuals — humans. With motivations. And there are good and bad motivations to being an angel.

The first thing an investor should ask themselves is what they’re hoping to get out of their investments. If an angel is hoping to “get rich quick”, “help steer an early stage company” or even “get a front row seat into a company’s operations” by angel investing, they’re may well be disappointed with the process. Angels very rarely get special rights, like a Board seat or even observer rights. Angels that try to too aggressively interfere with a company’s operations get a bad name, and for good reason — you’ll likely hurt more than you’ll help.

Good angels often have a broad portfolio of companies and act as a passive “service provider”, helping startups when they ask for it. Ron Conway, the “godfather” of Silicon Valley, pioneered this approach, meeting with huge numbers of companies, making quick decisions about investment, investing in a very large number of companies, and generally not asking for control/observation — there was just no way he’d have the time to sit on that many boards! While some derided this as “spray & pray” and prefer to see investment as “smart money” where companies receive both capital and active advice, Ron’s returns speak for themselves. Ron can get access to pretty much any deal because Ron has removed every reasonable objection you might have to taking his money. The returns you’ll realize are going to map to whether you are able to get in on the best deals, likely ones where lots of other investors are vying for entry to the deal as well. If you establish a reputation for being helpful and easy to work with, you make it easier to get in on any deal you want.

Now lest I frame passive investors too passively, Ron would move mountains for a portfolio company that had a specific ask of him — even if you’d need to spend the first thirty seconds on a phone call reminding him that you were CEO of a company he invested in. ;) I’ll disclaim that Ron invested in my first company, PBwiki, and was a wonderful supporter.

The portfolio approach is important from a returns perspective. It can be very difficult to predict which companies will do really well and which will flounder. A humble “black swan” style approach is for an investor to admit they’re probably going to get this wrong a lot and so to have a wide range of bets in the hope that one will be a breakout hit. Investor returns are typically on an extreme power law curve — if one company does really well, it will do so well that it literally won’t matter what happened with any other company in your portfolio. So a good angel investor will seek to build to a portfolio of e.g. 30+ startups. Your probabilistic returns are much higher to make thirty $10k investments versus one $300k investment. Put another way, if your only involvement in angel investment is writing one check, you’re probably going to be disappointed with the outcome and conclude that angel investing isn’t for you. Pace yourself! Allocate a certain yearly budget for investment and seek to regularly make small bets.

Another good reason to be an angel investor is that you like meeting with founders, who can teach you about new industries, emerging best practices, and clever approaches to problem solving and teambuilding. Founder energy is fun and infectious and can inspire you.

Finally, it’s great to give back. A lot of people in Silicon Valley (maybe most of them!) made it big when others “took a bet” on them and thus they want to “pay it forward” by blessing newcomers with capital, advice, and networking. This is one of the most powerful and poorly held secrets of Silicon Valley; I attribute it to the area’s hippy history. :-)

Syndicates

AngelList, a privately-held company in SF, offers a wide range of services to enable companies, individuals, and angels to connect. Startups can post jobs available, angels can seek companies to invest in, and companies can seek funding. One of the features AngelList has added in the past few years is the ability for an individual well-connected angel to create a syndicate to allow other angels access to deals the lead is participating in, on the same terms. Angel participants can “soft commit” to seriously consider funding companies alongside these influential angels. This has interesting follow-on effects: startups now have more motivation to meet with these “super angel” syndicate leads since they represent a collective of investors, which means these syndicates get more and better deal flow than they would as an unorganized group of individual investors. Over time, the size of such a syndicate may give an individual angel decision-making power equivalent to a traditional small venture capital firm with almost none of the typical investment overhead of a fund. Let’s walk through the math.

If I wanted to be a syndicate lead, I’d announce “I’m planning on investing $10,000 of my own money in 3–4 companies a year”. I might find thirty friends who are each willing to tentatively commit to putting in $10,000 of their own money into such deals on the same terms as me. Now I’ve got $10k of my own money with $300k of other people’s money that I can offer for investment in a company. This obviously makes it much more interesting for a company to meet with me versus if I could have only cut them a $10k check. For those of you paying attention, you’ll note that the $300k is only tentatively committed. In reality, only ~60% of syndicate backers will actually close on a deal. So with $300k in syndicate backing, I can reasonably expect to offer $180k in funding to a company.

When the syndicate lead finds a specific deal that they’re excited about, they agree on the terms of investment with the startup (“leading” the deal) or they join other investors who are investing in the company at the same time, on the same terms (“following”). They indicate the deal to AngelList, which triggers some AL folks reaching out to both the syndicate lead and startup to confirm terms and help the startup get their AngelList page into proper shape to “launch” the deal. Once the deal has been approved for launch by AngelList, it’s up to the syndicate lead to publicize.

The lead then writes up why they were interested in this particular company and shares those thoughts and data confidentially with syndicate participants. Participating angels in the syndicate can then review the deal and decide if they would like to opt-in to the deal. An individual syndicate deal can only have up to 99 accredited investors participate; if 100 or more investors want to join, it will be up to the syndicate lead who they want to allow into the deal. Typically investors who choose to “pre-fund” their syndicate participation are first in line; these investors have to actively opt-out of deals. They’re followed by investors willing to invest larger amounts, e.g. $10k vs $5k, then everyone else.

With the deal launched, AngelList sets up an escrow into which syndicate participants can ACH transfer or wire their funds, and collects electronic signatures from the startup, syndicate lead, and syndicate participants. AngelList charges a fixed $8k for the deal to manage all of the backoffice. So if in the above example there was a $180k syndicate raise, $8k of that would get paid to AngelList and $172k would be wired to the startup. AngelList creates a new Delaware LLC as a single-purpose corporate vehicle to make and manage the investment. The name of this LLC is typically a jumbled combo of the name of the syndicate and the name of the startup being invested in; in the case of drone.vc’s investment in PRENAV, for instance, the entity created was called “AngelList-Prav-Fund, a series of AngelList-DrVc-Funds, LLC”. Yeah, that’s a mouthful. To make things even more fun, AngelList actually outsources the management of these LLCs to a company called Assure Fund Management.

From the startup’s perspective it’s pretty good, since they only get two new shareholders on their cap table; the syndicate lead, who makes their investment directly as an individual, and the LLC. So PRENAV got “David E. Weekly” as a shareholder as well as the above mouthful of an LLC. Because there is meaningful ongoing backoffice work that needs to be done for every shareholder a company has, minimizing cap table entries is a great time and money saver for startups.

Most of the deals I see use pretty vanilla terms: a Series Seed (equity), a SAFE note, or otherwise templated convertible notes (debt) with a clear cap and discount. I’ve heard a few stories of early stage investors being pretty badly abused with a SAFE note, so I’m gently nudging people towards using Series Seed, since it’s pretty easy for the startup and offers investors the safety of actual equity.

The deal is only live for a fixed period of time, typically 20-30 days. This gives the lead enough time to discuss the deal with participants, gives investors a chance to ask questions (or come back from vacation!) and to wire their money in. I’ll note that for most deals, you’ll know within four days of launch about how well the deal will do. Here below are three real deals I closed with drone.vc. Note that committed capital can dip week to week if a prefunded investor chooses to opt out.

Something to be aware of: AngelList has syndicate amplification funds like Maiden Lane and CSC Upshot that can further financially amplify a syndicated deal with significant traction. Typically these funds will make a go/no-go decision on investment in a few days. They are looking for deals that have strong “signal”, meaning several notable investors or firms are already participating in the deal beyond the syndicate. So a deal led by a syndicate with only syndicate members participating is unlikely to be able to access these funds. If the fund does decide to participate in a deal, they’ll come in at the same terms, through the syndicate vehicle.

If you’re a syndicate lead, you’ll need to not only hype a company but also candidly disclose potential risks. It’s really important to do this thoroughly; if it can be shown that you knew about certain material risks to a startup’s success and didn’t disclose them to fellow investors, you could end up in hot water. Finally, you’ll need to disclose any variations — if the startup is actually run by your brother, if you have been given advisory shares, if you’re already a shareholder, if you’re getting a different deal than syndicate participants, etc. Needless to say, it’s best if your deal has no variations.

Carry

So far, so good, but you might ask what’s in it for the syndicate lead other than getting better deal exposure and getting to help their friends? A syndicate lead isn’t paid a penny of the $8k that goes to AngelList. Indeed, the only movement regarding their bank account is the outbound money being invested in the startup!

The payout to a syndicate lead happens when a company invested in by the syndicate has a liquidity event (e.g. someone buys the company or the company goes public). At this point, the shares held by the LLC get exchanged for cash. The cash that investors put in is returned to them and money returned to the LLC beyond funds invested is then called carry, which is basically the profit off of the investment. Of the carry, AngelList takes 5% and typically syndicate leads take around 15%. The total amount, e.g. 20%, is listed clearly on a syndicate’s page when investors sign up to the syndicate or a syndicated deal.

Thanks for reading this guide to AngelList Syndicates! Let me know if it was useful to you and/or what I got wrong at [email protected]. Finally, if you’re an accredited investor in interested in drones, I’d love to welcome you to my drone.vc syndicate; if into deep learning, neuron.vc.

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