Often I’m asked by first-time founders if a lead investor is required before pitching to angel investors. The answer I give: maybe. It’s a lousy response, I know. The truth is it isn’t an easy ‘yes’ or ‘no’ answer, and many other factors need to be taken into consideration. The importance of a lead investor is so much more than just a check-the-box activity, and worth your time researching before you decide what the right path is for you and your company.
Often I’m asked by first-time founders if a lead investor is required before pitching to angel investors. The answer I give: maybe. It’s a lousy response, I know. The truth is it isn’t an easy ‘yes’ or ‘no’ answer, and many other factors need to be taken into consideration. The importance of a lead investor is so much more than just a check-the-box activity, and worth your time researching before you decide what the right path is for you and your company.
Before directly answering the question, it’s worth a quick review on how most angels participate in funding startups.
Angel Investors: Groups vs. Individuals
Entrepreneurs usually find angel investors either through organized angel groups or individual connections. Either route, angels typically operate in similar fashion. This group of early-stage funders make independent investment decisions, often seeking equity in exchange for capital.
Angel Groups
Organized angel groups provide members (accredited investors) access to high quality investment opportunities (often focused on local startups) while providing entrepreneurs an organized process for reaching numerous potential investors with one pitch. While the structure is in place to streamline investment activities from sourcing deal flow all the way to closing deals, individual angels make their own investment decisions and participate in deals only where they choose to.
These groups are usually managed by very small teams and heavily rely on volunteer help from current members. Operating budgets are often limited with the bulk of expenses going towards legal counsel, taxes, accounting, and general administrative fees. Without dedicated staffing, the process of moving investment opportunities from initial pitch through to final closing can be lengthy.
Every angel group will have its own preference on whether or not they take the lead investor position on deals. It is important to understand this preference prior to pitching to make the most use of your time, as well as improve your odds for receiving investment interest. If an angel group does not lead deals, it will be tough to garner interest without a signed term sheet and committed investment from a respectable lead investor prior to pitching the group.
Individual Angels
Many accredited investors choose to participate in funding startups independent of an organized group. These angels often find investment opportunities through personal connections, online platforms (i.e., AngelList), pitch competitions and other networking activities. Since these conversations are usually held between just the founder and investor, the entire process can often be completed in a much shorter window. Individual angels will likely want to know what the terms are prior to committing, although I have witnessed on numerous occasions where angels commit to participating in the round no matter what the terms end up at.
Importance of a lead investor with Angel rounds
All too often I see founders rush into a relationship with the first investor that either commits to their expected terms or will give them a term sheet. It’s understandable as securing a lead is often one of the first blocks that needs to fall in successfully raising capital. Some investors will not consider investment opportunities or even speak with entrepreneurs unless terms are already set. Other investors will only invest if they are the lead investor. It can feel like a game trying to figure out the players and the order in which you want things to fall. It’s important to keep top of mind what you want out of the relationship.
What role does a lead investor serve?
Yes, the lead investor will negotiate and agree to investment terms that you will then use with remaining investors to fill out the round. Yes, the lead will often complete significant due diligence and share their findings (usually in a memo format) with other potential investors. Yes, the lead investor will usually contribute a considerable amount to the round. (Tip: If not, they might not be the right fit.)
But let’s consider other questions worth exploring with potential investors before determining if they are a good fit to lead your round.
- What is their strategy for participating in follow-on rounds?
- How strong is their network? What other investors can they connect you to (for both current and future rounds)?
- What’s their level of involvement with their portfolio companies? Do they have in-house expertise that can add value to your company, or make connections to promising advisors or Board directors?
Think about the answers that best fit you and your company prior to having conversations with potential leads.
How do you find a lead investor?
It’s common for investors to participate in deals across large geographic areas. However, I encourage founders to start fundraising efforts within their local market. Find out who the major players are that fund high-growth companies and (maybe more importantly) how they play together in the space. Local investors to consider include angel groups, state-funded programs, corporate VCs, micro VCs, family offices and individual angels.
Once you have the lay of the land, begin conversations with key players to find out how each group prefers to invest. In addition to the questions listed above for sizing up potential leads, other questions to include in the conversations are:
- What sales traction is needed before they will consider an investment?
- What investment terms (preferred equity, convertible note, etc.) are they comfortable with?
- What is the range of check sizes they typically write for similar opportunities?
- Do they prefer to lead rounds or syndicate on pre-set terms?
- What other investors do they work closely with and will they make referrals?
Engaging in a handful of conversations with different groups should help you put the puzzle pieces together and determine your best approach for raising outside capital. You might also consider chatting with other local startups that have been successful at fundraising to get feedback on their approach to securing investors.
Angels as Lead Investors
Getting back to answering the ultimate question of “will angels lead my round or do I need a lead investor first?” As you can see, it really depends on your local angel groups’ preference. Initiate conversations and get the answers you need to prior to kicking off your fundraise. Angel groups can be great lead investors while some operate better as syndicate partners once a lead is in place.
Pro tip: Avoid the path of finding an individual angel to agree to your terms and use that as your “‘lead investor.” I’ve watched this happen many times and it never works. You might be able to secure a few checks this way, but most investment groups will want to see more structure around the lead role.
Every startup’s needs are different; consider what’s most important to you as a founder before setting out to find your ideal lead.
Disclaimer: The opinions expressed do not necessarily reflect those of the Nebraska Angels organization or its members.
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