The Basics Of Startup Syndicate Funding
Category:Understanding startup investment
Last week was an important week for Startupxplore: we opened registration for backers on our platform, as we get ready to launch the first angel syndicate in Spain soon. Many of you may already know by now how syndicate funding works, but given the fact that its a new investment trend, we figured this would be the right time to explain with more depth what a syndicate is, how it works and why it can be interesting for both investors and startups.
In a recent post we already touched on this topic by describing the differences between angel syndicates, crowdfunding and boostrapping. And now well answer specific questions related to what Startupxplore is all about: syndicate funding for startups and investors.
Whats a syndicate?
A syndicate is an investment vehicle that allows investors to co-invest with relevant and reputable investors in the best startups in the market.
Whats a leader?
Syndicate leaders are business angels with vast experience in selecting investment opportunities and investing in then, in various technology sectors and with dealflow that most investors dont have access to. They tend to be angels -or successful startup founders- who have been part of the industry for many years and know its ins and outs.
What makes a good leader?
Naval Ravikant, co-founder of AngelList, has famously said that there are three characteristics a syndicate leader should meet:
Whats a backer?
Leaders:
Backers:
Startups:
The Structure Of A Syndicate
A syndicate lead investor is usually a person experienced in angel investing or venture capital. Angel investors and venture capitalists typically invest in the early stages of startups and earn their return once the startup makes it .
A great lead investor has a stellar reputation in their industry, a growing portfolio, connections, and access to a deal flow.
Usually, a lead investor will do the due diligence and find a startup they want to invest in. Forming a syndicate allows them to participate at lower individual investments to reach a collective minimum, then collect fees as well as carry .
Backers are investors who participate in a syndicate started by a lead investor. Backers need to be accredited investors. In the US, investors receive accreditation based on their net worth, income, or professional achievements. Find out more about requirements for accredited investors.
Syndicates generally use platforms like AngelList to present their deals and find backers. In turn, backers can explore different syndicates and pick one based on the syndicates values, entry requirements, and previous investments and deal flow. On AngelList, a backer can enter a syndicate with as little as $1k, but the entry point will vary with different syndicates.
How Do You Get Paid From Real Estate Syndication
Getting paid with real estate syndication isnt an exact science. There is a bit of nuance that must be taken into consideration. Keep in mind, there are two parties involved the sponsor of the deal, and the various investors.
As a deal sponsor, there are a few ways you can earn money:
The investor invests in a real estate syndication deal to get a piece of the profit the deal generates. Well dive deeper into this example below.
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What Is A Syndicate Lead
Each syndicate is headed by a lead investor. The lead is typically a part-time investor, someone with experience in the startup worldâoften a founder or former founder.
Rather than being paid a large management fee, like a venture capitalist, a syndicate lead earns most of their money by charging carry. Carry is a percentage of the syndicateâs profits. Itâs up to the lead to choose how much they charge, but on AngelList, 20% is a standard rate.
Example: You invest $10,000 in a fund, and the lead charges 20% carry. After a successful exit, your distribution is $100,000. The lead takes 20% of your profitsâtotal distribution, minus initial investment , or $90,000. Since 20% of 90,000 is 18,000, you walk away with $72,000 profit.
Unregulated Governmental And Industrial Insurance Syndicates
Because these arrangements are neither public nor regulated, they are hard to describe and attribute. But upon information and belief, there are thousands of such arrangements in existence around the world where risks are shared by affinity/governmental/industrial groups on a several liability basis.
Lottery syndicates are formed to pool tickets thus increasing the chances of winning. Lottery syndicates are more common in the UK and Europe in general. They are legal in the US, but legal problems are regularly reported.
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Reason #1 You Cant Take Your Money Out At Will
When you invest passively in a real estate syndication, your money is illiquid for the length of the project hold time. That means that, if the asset is going to be held for 5 years, you should expect to have your money in the investment for the entire 5 years.
This is very different from stocks and mutual funds, where you can decide to sell right now, and you could have your money back by the time you finish this blog article. Okay, maybe not that quickly, but you get my point. When you invest in stocks, your money is liquid.
Same thing with a checking or savings account. At any moment, you can decide to spend that money, move that money, or withdraw that money, and you would have complete freedom to do so.
When you invest in a real estate syndication, however, you cant withdraw your original investment at will.
In fact, when you enter into the investment, you must sign a lengthy legal document that spells out the details of the projected length of the hold time and the illiquidity of the investment.
So you have to be super sure that you will not need access to that money in the immediate future. If you have any doubts, or the idea of having $50,000 or more locked up for 5 years is giving you hives, turn around now.
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It Can Help You Save Money
Were really good at spending money, but were not really good at saving money in most cases. By spending money on property syndicates and on these investments that potentially generate you income, you could actually be saving by purchasing more syndicates rather than trying to save for a big deposit and then not experiencing any growth.
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What Is A Syndicated Property Investment
A syndicated property investment is a type of unlisted property investment that allows a small group of individuals to pool their funds together to purchase, manage and benefit from real estate which an individual may not have been able to buy on their own.
Managed property schemes are often referred to as property syndicates. However, there are a few things that differentiate managed investment schemes from simple syndicates.
Learn how syndicated property investments work and what makes them different from the typical managed investment property funds.
What Are The Risks With Syndicate Investing
Angel investing and venture capital are always risky. Syndicate investing allows investors to come together as a team and pool resources, but it doesnt alleviate the foundational risk of investing in startups.
Its always necessary to do due diligence and check the startup, founders, team, and vision. Lead investors will do their research and in some syndicates, they will share their results. However, backers need to do their own research as well, as the lead will never guarantee a return on the investment.
Backers should also be aware that the capital invested in startups may take 7+ years to access . Returns when investing in startups usually take years. Each syndicate has its own structure of fund allocation depending on whether the startup gets acquired or liquidated. And although syndicates make investing more simple and accessible, backers should always be aware of the conditions and risks theyre taking on.
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How Do Sponsors And Passive Investors Make Money In A Real Estate Syndication Deal
Real estate syndications earn money from rental income and property appreciation. Capital is distributed according to a tiered, sequential structure, known as a waterfall.
Waterfall structures and descriptions can be quite complex. Heres a simplified example:
- Return of capital First, all distributions go to passive investors until they recover their initial capital contributions.
- Preferred return Next, all further distributions go to passive investors until a certain minimuma preferred returnis reached, for example, 7% IRR.
- Carried interest Once the preferred return is reached, the sponsor is paid in the form of a promote . In this stage, a certain percentage of the cashflow goes to passive investors and the rest goes to the sponsor, for example, 80% to the passive LPs and 20% to the GP.
In addition to performance-based compensation, sponsors also make money through fees. The most common types of fees include:
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Unlisted Property Scheme Versus Property Syndicate
Fund management companies usually refer to their unlisted property investment products as property syndicates so many retail investors may automatically think of professionally managed funds.
Unlisted property schemes
Unlisted property schemes are medium and long-term indirect real estate investment products that are neither listed in the Australian Securities Exchange nor regulated by the Australian Securities and Investments Commission . However, ASIC has guidelines that unlisted funds must follow in the creation of its product disclosure statements .
These managed schemes offer investors the opportunity to earn distribution income from local and overseas retail, commercial and industrial properties for a fixed term. Distribution continues until maturity when the fund is wound up.
Unlisted property investments may also be held in perpetuity, but have an exit strategy for investors who want to pull their money out of the fund.
ASIC requires fund managers to acquire an Australian Financial Services license for managed property investments, no matter how few its fund members are.
Property syndicates
Property syndicates may be direct or indirect property investments and they dont require professional management. The most basic property syndicates are made up of a group of mum and dad investors who agreed to combine their capital to purchase and manage an investment property.
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About The 1855 Capital Angel Syndicate
1855 Capital is a State College-based venture investment firm that identifies high return investment opportunities and invests directly from its Limited Partnership, 1855 Capital Fund I. We create value in a deal when we expose great opportunities in the Penn State community to a broader audience. As a result, we seldom, if ever, are the sole investor on any deal, and typically syndicate the investment with other investors to bring financial breadth and strength to our portfolio companies.
To further our mission of broadening the investor base engaged with the Penn State community, we have created the 1855 Capital AngelList syndicate. The AngelList syndication process makes investments more accessible by lowering the bar to a minimum $1000 commitment on any individual deal.
We expect to make 2 to 3 deals available to our AngelList syndicate each year and will be launching our first deal in July 2020.
Building An Investor Community
Through a robust ecosystem serving both founders and investors, LAUNCH fosters a holistic capital network for doing deals. With education programs, industry content, and events, the growth of the syndicate and the increased deal volume are organic facets of a strong community.
Growth University provides founders the frameworks and strategies you need to grow your startups and get to scale.
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Meet With Deal Sponsors
As incredible as the internet is, theres still nothing like face to face. When you meet a handful of vetted deal sponsors in person, it gives you the invaluable opportunity to decide if this person is someone you actually want to work with. And dont underestimate that youll potentially be giving this person a good chunk of your money, can you look them in the eye and hand it over confidently?
Vetting Real Estate Syndication Companies
Trust is the essential foundation upon which every business transaction depends. Therefore, you must choose real estate syndication companies that you completely trust.
It is the most significant step that any investor takes and hence requires utmost due diligence and deliberation. Who you invest with is everything, because your real estate syndication company is directly responsible for the performance of your capital.
There are a few recommended points that are essential in the process of vetting real estate syndication companies:
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How To Profit From Real Estate Syndication
With real estate syndication, your profit is largely dependent on your role and the exit strategy.
Some groups elect to split profits equally, but many real estate syndicates do not. Its common for passive investors to receive about 70%, while the syndicator gets about 30%.
Investors usually earn more because they put in more money. A syndicator only contributes between 5-10% of the investment or nothing at all.
However, a syndicator may get a higher percentage if they manage a fix-and-flip or acts as the property manager for tenants. While the specific breakdown of capital will vary based on the specific real estate syndication, there are numerous ways that both syndicators and investors can increase their profits when moving forward with a syndication.
A Real Estate Syndication Example
Real estate syndications are structured so that the Sponsor is motivated to ensure the investment performs well for everyone. The more the Sponsor invests in the deal, the more aligned the sponsor is with Investors.
Lets look at an example of a preferred return.
Lets say youre a passive investor who invests $50k in a deal with a 10% preferred return. You could take home $5k each year once the property earns enough money to make payouts possible.
After each investor receives a preferred return, the remaining money is distributed between the Sponsor and the investors based on the syndications profit split structure.
If the profit split structure is 70/30 investors net 70% of the profits after receiving their preferred returns and the sponsor nets 30% after the preferred return.
For example, after everyone receives their preferred return in a 70/30 deal, and there is 1 million remaining, the investors would receive 700k and the Sponsor would receive 300k.
Below are some examples of various real estate syndication deals on the Fundrise platform. Today, Fundrise mostly focuses on private eREITs, diversified real estate funds. This way, non-accredited investors can invest in long-term, diversified real estate portfolios. I believe investing in a diversified eREIT is the way to go for most investors looking to gain exposure and earn income 100% passively.
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Angel Investors Vs Angel Syndicates
In a nutshell, an Angel Investor is a wealthy individual who invests his own money into early-stage companies. In contrast, an Angel Syndicate is a group of investors who may pool their capital to invest in promising early-stage companies. There are different types of Angel Investors and Angel Syndicates which we will cover in this article.
Although both terms refer to the same category of investors, there are differences in the approach, appetite and the operational process of investing their capital into early-stage startups.
Angel Investors
Angel investors are wealthy individuals who invest their own money into exciting new companies. Their criteria are as diverse as they are. Some will invest early before your product launches or even before you have proof of concept. But, more often than not, they will require evidence of at least some traction or other validation . The requirement for proof of traction is particularly true for businesses where the barriers to entry are low, and there is considerable competition in the marketplace.
You might have heard the terms “High Net Worth Individuals” or “Sophisticated Investors”. Most angel investors fall into one or both of these categories. While there is no minimum investment size to qualify as an angel investor , routine and frequent angels tend to be HNWIs.
How much do Angel Investors invest in startups?
£50k – £500k
What is a typical timeline for Angel Investors?
Where can you find information about Angel Investors?
Example Of A Real Estate Syndication
To better understand real estate syndication, and how everyone gets paid, consider the following example.
A sponsor identifies a real estate deal that costs $1,000,000. The sponsor does not have the money to purchase the property themselves, so they partner with 4 investors. Each investor invests $250,000.
That property produces an annual rate of return of 10%, or $100,000. Considering the fact that each investor invested an even amount, $250,000, each investor is entitled to $25,000 .
However, if the sponsor negotiated the right to the profit as well, that $100,000 annual profit may be split evenly between the 4 investors and the sponsor, so each individual would receive $20,000.
The sponsor would be required to manage the property, iron out the details of the deal, and raise enough capital to do the deal. The investor is hands-off, and is not responsible for managing the property.
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