Why You Need a Lead Investor for Your Funding Round

Other investors require a lead. What are they looking for?

You’ve pitched your startup. Investors are interested. They’re telling you to contact them after you find a lead investor.

Fortunately, one of your early supporters steps up and says he’s willing to be the lead. Excited, you return to the other investors to tell them you’re ready to close the round and ask if they want to join.

When you tell them who the lead is, you never hear from them again.

What is this lead investor, and why is it so important to other investors? Who is an acceptable lead investor, and how do you find one?

Why Investors Need a Lead Investor

Let’s start by looking at your situation from the investor’s point of view.

When you pitch to me personally, I may be excited about what you’re doing, but I don’t have the time or expertise to dig into the details and determine if this is a good investment or not.

While your pitch makes sense, that’s not enough to invest with any hope of success. Someone needs to do a thorough examination of the product, market, and competition. An expert needs to review the patents. A financial professional needs to dive into the spreadsheets. And someone needs to negotiate the investment terms with you, including the valuation. Then, an attorney needs to draft the investment documents. Sorry, that won’t be me.

The friends and family round usually doesn’t have a lead investor. Investors at this stage don’t obsess over the trade-offs between convertible notes and SAFEs or know if the company should be valued at $5M or $50M. The friends and family round, as the name implies, are people who are writing cheques not as financial investments but to support you and your mission.

But from the pre-seed round, when you’re reaching out to venture capital firms and serious angel investors like me, we’re looking at this as a financial transaction and need confidence that it’s a good investment.

Is the company a scam? Or is it way overvalued? Does the product work as promised, and does it solve a real customer problem? Does the team have the skills to execute, and the business plan makes sense? Are there existing competitors or new startups that are likely to wipe them out? Is there a good exit potential, and how long will that take?

These are just a few of the questions that need to be answered before it makes sense to invest. As an individual, I don’t have the time or expertise to answer them all myself. So before I invest, I need to be sure that someone else has asked these questions and gotten favorable enough answers that they’re moving forward with a sizeable investment.

In the simplest terms, I need someone I can trust to evaluate the deal, do a thorough diligence process, negotiate terms, and make a significant investment.

But that’s just the beginning for the lead investor. I also need them to represent my point of view on the company’s board. I need them to help guide the company to success, not just putting in cash but finding other investors in this round and the next. In other words, the lead investor needs to partner with the startup.

Here’s what I’m looking for from a lead investor:

• They are making a substantial investment (at least 25% of the round)
• They’ve completed a thorough diligence process and are willing to share the details with me
• Has sufficient industry expertise to evaluate the business
• They actively negotiated the terms of the round with terms that were suitable for all investors rather than favoring themselves over small investors
• They will be serving on the company’s board
• Capable of helping the startup find other investors in this round and the next round

Who is a suitable lead investor?

You found that lead investor. Hurray! You shoot me a message asking if I’m ready to invest now. Unfortunately, I have to say sorry, no.

I see a lot of lead investors that aren’t really lead investors. If they can’t fulfill the above requirements, then whether they call themselves the lead or not, they don’t solve my problem to make it possible for me to invest.

I frequently see the following put forth as lead investors who aren’t able to meet what I need:

• Individuals without the resources to do a full diligence process
• Strategic investors with interests beyond the financial success of an investment in the startup’s stock
• Investors offering in-kind services instead of cash
• Lead investors from previous rounds who are not investing in the current round
• Incubators and accelerators
• Economic development agencies and government organizations

All of the above are great investors to have, but they’re not lead investors who can assure me that I’m getting a fair deal. If their interests are not aligned with mine, they’re not a lead investor.

In the pre-seed and seed rounds, the lead investor will usually be either:

• A small VC focused on a specific industry or vertical
• A large angel group with the resources to do a detailed diligence process

Of the two angel groups where I actively participate, Chemical Angels only acts as a deal follower, while TCA Venture Group can be a deal lead or follower.

While Chemical Angels has deep expertise in chemistry and materials technology, the group is too small to make a large investment and too specialized to run a full diligence process, so the group only considers investing once a deal lead is in place.

TCA Venture Group is far larger, with about 400 members across the Los Angeles area, 3 separate funds associated with individual chapters, and a wide range of expertise. That makes it possible for us to put together a team to evaluate the startup, negotiate terms, and have a suitable member serve on the company’s board.

Many other large angel groups have similar skills. I’ve invested in rounds led by SWAN, CTAN, Golden Seeds, Keiretsu, Harvard Angels, and others.

More common, though, are deals led by small VCs that specialize in the industry. They have money to invest, know the space, and are well-suited to support the startup going forward. Some VCs, however, are hesitant to share their diligence findings with other investors, especially individuals, and that can be a stumbling block to signing up other investors.

Large VCs as the lead can be problematic for small investors. Although they have plenty of cash to lead the startup through multiple rounds, they too often use an investment in the early rounds as a way to give themselves preferential treatment in later rounds, riding roughshod over small investors. In other words, their interests are usually not aligned with mine, making it difficult for me to trust them to do what’s best for me. In that case, I might need a co-lead to evaluate the terms for small investors and have at least a board observer role.

When looking for an investor to lead your round, it’s important to choose wisely. They will be your partner going forward and need to support not only the company and founders but also other investors.

Would Bitecoin Ventures make a suitable deal lead for the startup, SüprDüpr, with Satoshi Nakamoto joining the board? With the startup’s founder in a romantic relationship with the king of crypto, that spells big trouble for other investors, employees, and even the local elephants. Read more about Satoshi’s billion dollar investment in my Silicon Valley novel, To Kill a Unicorn.