Venture Financing Decoded: Understanding Lead and Non-Lead Investors
If you have invested in a startup, you might have heard about a 'lead investor'. But what does that mean, and why should you care?
- The lead investor contributes the most capital, evaluates the startup, and sets the investment terms.
- Non-lead investors, including angel operators, are key as well. They provide additional capital, expertise, and connections. In most cases, they must follow the terms negotiated by the lead investor.
Let’s deep dive into the differences.
The Lead Investor Explained
The lead investor is the one who contributes the largest amount of capital. As a result, they usually also set the terms of the investment. Often, they are the 'first in' for the round and their investment encourages other investors to join this round.
The lead investor in a given round could be a prior investor in the start-up. In this case, they were likely to be the lead investor of the prior round. It could also well be an investor who is investing in the company for the first time, bringing fresh capital and new perspectives.
In any case, the lead investor plays a crucial role in shaping the venture financing round!
The Role and Importance of a Lead Investor
There are three dimensions where the lead investor’s role is crucial:
- Due Diligence: The lead investor investigates the startup's business model, market potential, and team, to assess the potential investment returns.
- Negotiating Investment Terms: Here, the lead investor negotiates the specifics of their investment. They determine how much money they will put into the startup in exchange for which they will receive equity, with specific rights they negotiated. Those typically include pro-rata rights, preferential liquidation, board seats, etc. The negotiated terms will often bind other investors in the round.
- Syndication: The lead investor's commitment acts as a signal to other potential investors, encouraging them to invest in the company.
As you see, the lead investor’s role goes well beyond injecting funds. They have a significant impact on the financing round, as they set the company's valuation and influence its strategic direction.
Understanding the Role of a Non-Lead Investor
So, where does that leave non-lead investors?
While they contribute capital and are crucial to filling out the funding round, their financial contribution is not as large as the lead investor. But their contribution goes much beyond mere cash. They (especially angel operators) often bring valuable industry connections and expertise.
As they have not negotiated the terms of the investment, they are often bound by such negotiations. But they should pay attention to the negotiated terms and understand whether they get the same rights, or not, as the lead investor.
Although the lead investor does the bulk of the due diligence, it is not a bad idea for a non-lead investor to review the merits of the investment on its own!
Whether you're a lead investor, a non-lead investor, or a startup seeking funding, understanding these roles is key to a successful investment. It will reveal what's expected of you and what you can (or can't) anticipate from others