Scientist asks a VC: How is a decision made around who leads a round?

Welcome to a new part of a Venture Capital Primer for Scientists series based on hundreds of workshops I have given during my work as a deep tech VC at Main Sequence.

Securing a lead investor is the most infuriating, confounding part of raising capital. It is very important to understand, so buckle up.

What does it mean to ‘lead’ a round?

It is common for venture rounds to include multiple investors in a syndicate.

The syndicate is led by one investor who negotiates the terms (including valuation) on behalf of the others.

A lead investor will have a stronger conviction than the others in the syndicate. This justifies the additional effort to make the investment. For a lead investor there is:

• a considerable time commitment — it often takes months to complete a transaction
• a financial cost for legal fees, etc that is only paid back from a successful transaction
• reputation risk because they are setting terms for their peers in the round

For this reason, it is hard to get a lead.

Without a lead, a round can’t move forward, even if you have lots of interest.

Be specific in your hunt for the lead

Take your time building investor relationships and keep an eye open for leads as you do (#5).

Ask directly if a firm leads rounds and how they would approach a company like yours.

In your own mind, measure their conviction. You will get a feel for the passengers and the drivers.

What happens when you don’t have a lead?

It is common that startups build a qualified list of investors, totalling a round that is potentially oversubscribed, but impossible to close because no one has stepped up to lead.

I have seen startups trapped in this loop for months then close very quickly with a fight for allocation.

Some tips for building a ‘lead book’

Here are some approaches I have found work well to make this process smoother.

#1: Take potential leads on a journey from the moment you close the round before

Probably 18 months before your next capital raise, start building relationships for the next round. You will have likely discovered these investors in the round you just closed. They are the ones that said “We love what you are doing but our minimum cheque size is $xm.”

Tell them what you intend to deliver in the company over the next phase and get their opinion on your objectives. Does it sound exciting? Can you keep then involved in the journey? Start working with them to deliver a company that they understand and have deep conviction on.

#2: A lead is likely a firm that already knows this investment category

In deep tech, it is non-trivial to lead an investment. e.g. A firm that has not invested ever in quantum technology, optics, hardware is unlikely to lead a quantum computing round. There might only be 5 investors on earth that understand enough what you do to lead a round.

Work hard to find them.

#3: Get VCs talking to each other

Entrepreneurs are often surprised to understand how much VCs promote startups to each other.

Your objective is to be so clear with your pitch that investors are so convicted that they mention you as an example of an exciting trend to their peers.

“Have you seen Company X? What do you think?”

At this point, positive or negative contagion of your company’s value is possible.

The strongest lead candidate will likely reach out to you rather than visa versa. How can you cause that to happen?

#4: Show up in their dashboards with ‘breadcrumbs of traction’

Investors are constantly scanning the market for companies to invest in. This is especially true for later stage funds who are investing into demonstrable traction.

Do you show up? Are you leaving breadcrumbs of traction that they can find?

• When scanning the media for news around a certain theme, do you show up frequently? Are you being deliberate with your messaging to deliver constant traction news to the market? Design for this in your Slam Dunk Financing.
• When searching databases of startups, what does the data say about your startup? Investors use quantitative data on services like Crunchbase and Pitchbook to discover things like companies with the fastest growing teams. If you look at your company from the outside what do you see?

You will have a stronger relationship with your lead and you should have higher expectations of them

A lead investor is likely to join your board after the round closes.

Make sure you love working with them.

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Every day, I write about what I am learning in deep tech venture building. I hope you will follow me if this is valuable to you ⇢ @philmorle

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