Why we invest through syndicates

About half of our investments in the US are through syndicates where we pay an average of a 20% carry to the syndicate lead. This is in contrast to the other half which consist of direct investments where we don’t pay carry to a syndicate lead.

When I share this fact, many people question our approach. They want to know why we agree to pay 20% carry to a syndicate lead.

The reason is that, in markets with abundant VC capital like the US, success comes much more from having access than it does from having a unique analytical insight. There is more smart money chasing great startups than money that these great startups can put to good use. As a result, a lot of the money that wants to invest in a great startup isn’t able to get in.

This makes the VC asset class rather different than asset classes like public market stocks and bonds which are far less supply constrained.

To access a great startup, you first need to see it. You then need to get the startup’s founder to accept your investment.

In a recent talk with a friend who works at one of the leading VC’s investing in the Bay Area, he shared that his firm keeps a record of the Bay Area startups that get funded by top-tier VC’s and then calculates the number of companies in this list that the firm had the opportunity to see. Using this approach, the firm estimates that it sees 60% of the Bay Area startups that get funded by top-tier VC’s.

However, the firm doesn’t invest in each of these startups. Specifically, it doesn’t offer a term sheet to some startups and some startups to whom it does offer a term sheet accept alternative offers. From this set we exclude only the latter group because the firm doesn’t identify the former as great startups.

This means that the percentage of the great Bay Area startups that the firm invests in is less than 60%. I don’t know whether this figure is 10% or 50%. For the sake of argument, let’s take the midpoint of this range and say that it’s 30%. This means that even the leading VC funds in the Bay Area get the opportunity to invest in (see the deal and convince the entrepreneur to take the fund’s money) less than one third of the great startups in their geography.

The natural question is how you access the other two thirds of great startups, or more if you happen to not be one of the top 5 funds in the Bay Area.

Especially at their early stages, startups look to have multiple investors participating in a single round in order to have more brains and connections around the table. Investors also often prefer to invest together to lower their risk exposure to a company that has yet to achieve product-market fit, discover a scaleable growth engine, and demonstrate that it can achieve positive unit economics.

And when you have multiple investors investing in a company, chances are that one of them has an allocation that they can’t fill with their own capital. So they launch a syndicate.

In a very competitive market environment where even leading Bay Area VC funds get to invest in less than a third of the great startups in their geography, if we believe that a startup is a great startup, we’d rather have access to it by paying a 20% carry than not have access to it at all.

Also published on Medium.