With a record $125B poured into global venture funding in early 2021, VC activity is advancing at a white-hot velocity with no signs of slowing down. Startup founders have an extraordinary opportunity to get in front of investors and pitch even the wildest ideas.
Among all the critical questions that startup founders need to answer regarding potential investors, one is especially important - are they willing to lead the round?
But what exactly is a lead investor, and what happens if a firm offers to co-lead instead? In my experience as a fundraising coach interacting with startup founders daily, the latter scenario is occurring at a high clip and is often a smoke signal that founders need to be wary of.
One of the most common misconceptions founders have is that lead investors have specific, binding responsibilities and obligations. In reality, as is the case with much of the vernacular around venture capital (what it means to “close a round,” for example)- there is no strict legal definition for what a lead investor is.
In broad strokes, a lead investor is the party that has the greatest conviction and support for the investment. What determines conviction? Most of the time, when multiple investors are involved, it’s simply whoever writes the largest check in the round. The lead investor also typically plays a key role in the negotiations of the overall agreement- valuing the company and helping set the valuation cap. If it’s a convertible note or SAFE and not a priced equity round, the lead investor will take on the dirty work of negotiating with the founder and saying, for example, the valuation is $8M instead of $10M.
In the most traditional sense, a pure lead investor is 1) going to have at least 50% of the round and 2) will set the terms. Those are the two main things that happen with a traditional lead.
The proliferation of non-lead funds has made it challenging for some founders to find traditional leads, pushing them instead to try to pull together rounds without leads. These party rounds create a grey area of lead status, especially in seed / early financings that use notes or SAFEs. For example, for a $2M round, there can be three or four institutional investors each with check sizes of $500,000 to $750,000 investing in a note whose cap was set by the entrepreneur. In this scenario, no single investor has over 50% of the round and none would be considered a traditional lead. Those fundraises can be very long and drawn out as it can be challenging for a founder to galvanize momentum without a definitive “lead.” This is because founders will pitch investors who are “syndicate” or “follow-on” investors who either because of limited resources or willpower, don’t want to do the time-consuming diligence in determining whether a company is investable. Instead, they’ll ask who the lead is because they want to know which fund has committed to putting their reputational stamp on the deal, signaling that it’s worthy.
When faced with the prospect of trying to fill out a round without a true lead, I encourage founders to anoint a lead out of the current investors. In most cases, being able to point to a firm as the lead will positively impact the process. If asked details about their being a small check you can declare, “We discussed the cap with this fund and they agreed on the investment and the terms.”
What is a co-lead investor?
In my experience, the current trends around “co-leading” are not positive. Co-lead investors desire the recognition of being a lead without taking on the associated risks and responsibilities, while also wanting a larger allocation in the round than if they were just a follow-on investor. They don't want to take on all the work and commitment on their own. They will offer to co-lead and promise hefty checks but with a consequential caveat- only if the founder can find another firm they can co-lead with.
To me, saying they will co-lead is a way for investors to shirk responsibilities and wait for others to validate the investment before they have the fortitude to truly demonstrate conviction in the deal. Rather than indicating a sign of confidence with their postponed, conditional investment, they ride on the coattails of other investors’ diligence and clout. First-time founders can be especially ecstatic the first time an investor agrees to invest. But if they’re only willing to co-lead, this excitement can be misguided. I caution founders that despite all the time and effort they’ve devoted to get an investor on board, the interest from a co-lead could be a red herring. Offering to co-lead without assisting founders in finding a complementary fund is actually a diluted signal of interest. Founders should treat these investors as non-leads until other action or behavior warrants otherwise. My worry is always that founders will be confused and stop pushing ahead with other leads because they think they’ve found a real lead. Instead, a founder should stay the course and look for an investor with more conviction and is ready to actually “lead.”
When an investor says “We’ll consider co-leading the deal,” it often actually means, “We’re not that excited- go find somebody else”
An important qualifier- this is not to say that all co-lead investor scenarios are detrimental. If a firm tells you they are willing to co-lead, they should lean in, help find another fund, and be motivated and thrilled to get the deal done. At the end of the day, an investor’s job is to aggressively pursue deals they like. It will be obvious when they are sincerely excited to be your partner.
To be clear, co-leading can be done with conviction. There are many cases when two firms that traditionally lead deals on their own are attempting to invest in the same deal and realize that the other also brings tremendous value to the company. They are willing to take less allocation. For example, Andreessen Horowitz and Sequoia Capital recently co-led a $35M Series B round for Tecton, bringing the total amount raised to $60M. However, I haven’t been seeing a lot of that in earlier stage deals recently. Saying “we could co-lead” is thrown around- particularly at the early stages of fundraising- as an excuse or another way of saying “we’re not interested right now.”