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In our 6th talk, it's time to get serious about syndicates. What are they, what are they for, what advantages do they give to investors? Do syndicates reduce investment risks? Our hosts Sergey Beliayev and Ivan Lomakin discussed these and more questions with Sergey Dashkov.
Startup Jedi
We talk to startups and investors, you get the value.
Sergey Dashkov is an annual nominee for the ratings of the most active business angels in Russia, one of the founding fathers of the Angelsdeck club, co-founder of Phystech Accelerator, Adboost.tech, SDS-Foods, the exclusive partner of Ahmad Tea Ltd in Russia, CEO of the Double-b coffee chain.
A syndicate is one of the varieties of an investor club, characterized by its structure and monetization method, where a lead investor manages transactions and finances projects together with co-investors.
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— Yes, I am an early investor in Local Kitchen, a company that the former Rocketbank team had a hand in.
“Local Kitchen” is a home-made food delivery service that operates within a 2 km radius. The project does not have restaurant halls, only cooking shops scattered throughout the city, and couriers who get around on foot or bicycles. This enables them to reduce the delivery time to 15–30 minutes (which is on average faster than what aggregators offer), cut the costs of maintaining restaurants, reduce retail prices and at the same time increase profit margins.
Rocketbank is a mobile application banking service. They promoted banking products under their own brand and had original customer service (communication in messengers, cat emoticons and heart-to-heart talks). In April 2016, it was purchased by FC Otkritie Bank from the founders of the company and the venture capital fund Runa Capital (according to RBC estimates for $4.5 million). In early October 2017, the Qiwi Group acquired the Rocketbank brand and software from Otkritie Bank, and in the spring of 2018, the process of integrating it into the Qiwi ecosystem began.
“Local Kitchen” came to my physics and technology network as a candidate for investment at an early stage with a wonderful team. I must point out that at an early stage it is generally important to pay attention to 2 things: the team and the market. I remember it took me long to get used to how many people are ready to change their habits.
I was once in the “Local Kitchen’s” office and saw an order for an omelet at 9 am. It was a revelation for me that there are people who wake up and instead of going to the kitchen, breaking a couple of eggs and making breakfast, press a couple of buttons and order it.
I realized that since this surprises me, it may hook others, which means that you can make money on this — and you need to invest in these guys.
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— You can put it this way: Angelsdeck is not just a showcase, a marketplace with startups that raise money. Club members only get deals in which one of the syndicators (the syndicator can be either one of the founding fathers or someone who has received their approval) says: “I like this startup, I’m ready to invest in it, I invite you to share risks and rewards”. I think Angelsdeck is a huge opportunity for investors.
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— We can distinguish several interested potential groups around the syndicate: experienced investors (syndicators), novice investors and startups.
Let’s take a look at what a syndicate is for experienced investors. The first thing to understand is that there are few of them. A very small number of people invest in Russia, and you can’t compare it with Europe, the USA, and Asia. Most likely, this is due to historical inertia, with the fact that investments are, in principle, a fairly young thing. In general, capitalism in our country is fairly young on a historical scale.
In my opinion, not enough time has passed since the beginning of the investment process, therefore there are few investors, especially experienced ones, which is very bad, since investments are the fuel of progress.
Investors are usually people who have:
Capital, since it’s a prerequisite to invest;
Experience (entrepreneurial, managerial).
It is very easy to be an investor in Russia with few investors and a lot of startups. You can see this in the supply-demand ratio. For example, a Seed-stage startup in Russia costs $ 1.5–2 million, and it’s $ 5–7 million in the US. This difference in the assessment of startups in the early stages clearly illustrates the difference between the structure of supply and demand in different countries.
Suppose you have decided you are an investor, you have a certain amount of money for this, and there are also a huge number of startups that contact you with an offer to invest in them.
But by the laws of the genre, most startups die. According to statistics, 65% of companies that raised the first round of investment in the United States do not live to see the next round, and not all of those 30–35% who survived will succeed.
When you invest, it is important to have a large number of portfolio companies (20 to 50), simply because the chance of a mistake is high. This means that you must have a small check.
On the other hand, a startup needs to close the round, but who will close the rest of the space in this round? Fortunately, there are people who have not yet learned how to invest, who do not understand where to start. These are those novice investors who come to the more experienced ones and ask to work together. From the point of view of an experienced investor, this is an opportunity to contribute money to a round with the help of follow-investors and raise a round. From the point of view of novice investors it’s an opportunity to get space for a deal.
Investing is an activity that has its own specific risks. For example, there is a risk of cognitive biases. When you say “I’m an investor,” you start to seem very smart to yourself. When a huge number of people are running around you, asking for your opinion on this or that issue, you start to “fall into sin”.
It takes a lot of inner discipline to separate what you are told from what you actually know. I have a special internal procedure for this, special people in my team who walk around with certain checklists and collect facts.
A young investor does not know this, therefore, the safest way to start a business is to join syndicates.
A syndicate is a secure way to enter and access trades that are of interest to an investor. This prevents you from making stupid mistakes that all novice investors make: investing large sums, not checking facts, doing work for the founder (which is strongly forbidden!). There is a list of classic mistakes that everyone has made and then realized that it was not necessary.
— It’s not the club, it’s the syndicator who does. Angelsdeck identifies the following responsibilities of a syndicator:
Finding a good company / startup;
Doing all the work needed to make a decision (deal structuring);
Bringing the deal to the point where the syndicator is ready to invest their own money in it;
Saying: “I have prepared this deal, come to me: here is my space, here is the founder, here is my decision. I undertake, using the authority given to me, to be responsible for maintaining the required level of corporate governance, including worrying about the interests of other syndicators.”
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— Investors know that all founders lie, but not all lies are the same. I can forgive when a founder indulges in wishful thinking. A typical story that I am ready to take no notice of is when they say: “Such and such corporation is inviting me for a test”. And when you ask to show an agreement, a contract you get a refusal. I can forgive this, people are not robots, they live by their dreams, and this is what makes them move on. It’s a different story when they share facts from the past, this is a stop factor.
Investors can be mysteriously silent, promising to send money, but not sending it. It even happened that an investor signed legally binding documents whose conditions he did not fulfill in the future.
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— I believe that it’s right to use such platforms, we still have to learn how to do this. AngelList has an SPV, a special purpose vehicle, the primary goals of which are the implementation and maintenance of a certain project, mainly for the implementation of a specific transaction, where the SPV acts as a borrower acquiring certain property rights or obligations from the project beneficiary — Startup Jedi) for each project, where all syndicators and follow-investors enter, and the same SPV has one title in the portfolio company.
SPV can be viewed as a financial instrument created for a specific purpose — investment in a specific company and light corporate governance organizations. This is convenient for a startup, because when it enters a crowdfunding platform, there are not 8–10 accounts it can communicate with, but just one.
And it is especially important to introduce this practice into Russian law. Today, the classics of Russian law are early stage startups in the form of limited liability companies, which are quite unsuitable for SPVs.
Our team is not yet doing SPVs, since it is not clear what tool we can use to do this in Russia. As far as I know, now they are only going to introduce a convertible loan into the legal field.
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A warrant is a security that gives the holder the right to buy a proportional number of shares at a specified price for a specified period of time, usually at a lower price than the current market price. That is, a warrant is a certificate that gives the right to purchase securities. — Startup Jedi.
— At the startup level, warrants are used much less frequently than in developed venture ecosystems. For example, I have 4 Israeli companies in my portfolio, and in order to get their warrants, I had to check 30–40 companies I could potentially invest in. And there was some kind of warrant in each of them, but things are different in Russia.
I had the experience of meeting with the founder, when a fairly typical situation arose: the founder wants my money, and I want to add this company to my portfolio, but we can’t agree on the price, while the difference in our estimates is 2 times. I noted that in this situation the lawyer present at the transaction said that it is normal when there is a difference between what a person wants to receive and what you are ready to give. And there is a list of tools that help you eliminate these differences: a warrant is one of such tools when buying and selling a project.
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— Your own fund is a very serious commitment. I am one of the managers of one international fund where I share this “burden” with 50 other people. In a classic fund, there are usually 2–3 General Partners, who take on serious obligations at least 10 years ahead, and adjust their plans for the future taking into account the people who have invested money in their fund.
A syndicate is a simpler thing when all people have a “direct” title and understandable obligations. All syndicators communicate with startups, not just the main one.
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The “right” venture capitalist is curious. A startup can die, but it has no right not to tell the investor how it is fighting for the viability of its business model. The founder must supply the investor with any news.
If a startup does not send reports, the chance that it will survive tends to zero. This happens if the startup is so busy that it does not find time to send reports, or when it is already dead. I would advise sending reports even if things are bad.
I have a portfolio company in the United States that helps select caregivers. During the pandemic, their operating volume increased 20 times. Now they don’t send reports, and I can understand that :)
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— I have not had such cases, but I would not recommend giving money a second time. The problem is not that the startup did not succeed, it’s when the founder takes the money and is silent, meaning he does not send reports, does not inform about what is happening in the project, and then asks for money again for some reason. It is difficult for an investor to control where the money given to the “silent” founder goes.
There are several methods to prevent the investment process from turning into a casino, one of which is: investing today, have a budget for follow-up investments. At the same time, the investor monitors how their teams “run”, and those teams that move boldly can receive additional investments. While the investor simply forgets companies that do not perform.
When an investor wants to invest in a startup that someone has already invested in, the first thing they do is ask previous investors for reference. The startup founder may also ask about the investor’s background. And this is where the clean venture reputation of both parties is important!
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