Issue 06- The Complication Issue

Hello to Our Readers

Welcome to the sixth issue of Reflecting on Venturing, the complication Issue.

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Syndicators Complicate Rescues, Bail Outs, and Cram Downs

As capital gets harder to raise, startups and investors are going back to the playbook from 2008 and 2000.? The rise of SAFEs and syndicators is making this more complex.

In earlier crashes, investors and founders would sometimes agree to “Pay or Play” deals.? All earlier investors would participate, proportionately to their original investment, in a rescue of the company.? To avoid free riders, the new terms would include a “Pay or Play” clause - any investor who did not participate in the rescue would have the terms of its original investment changed to reduce its value.? You play in the new round or you pay out or your original investment.

There were occasional problems with this - sometimes a fund would have already invested all of its money or would not be allowed to invest more in this startup because it had already hit its maximum for a single investment, but this usually worked for a social reason.? Writing down an investment is embarrassing.? Those who play do not need to write down their original investment.? Those who do not, must.??

Today, this model is hitting problems because of the rise of syndicators.

Syndicators are not funds.? Each syndicate investment is made by a separate legal entity that almost always has different investors from every previous syndicate. Syndicators have separate fiduciary duties to the investors in each investment entity.? They cannot force investors in an existing syndicate to invest more money and if some do and some do not the syndicator has no ability to penalize free riders. Syndicators also have difficulty soliciting new investors to make an investment when a big part of the benefit will go to original investors.? It is ethically iffy and legally risky.? Syndicators will usually be unable to participate in Pay or Play deals and will usually oppose them because their investors will end up treated worse than other investors that invested on the same terms.

The alternative is to cram down all earlier investors and have investors who bring in new money (whether current investors or new investors) get equity at the expense of crammed down earlier investors.? Syndicators can agree to this because their investors are being treated the same as other similarly situated investors and a cram down is better than a failed investment.? However, this is more complicated for the startup and other investors.

1. Some existing investors may decide that if they need to write down their first investment in a company anyway they prefer not to make a second investment.
2. The amount each existing investor should invest in the rescue round is no longer clear. ? It is no longer an agreed on multiple of original investment.? Getting agreement from each investor on how much they will invest and making sure that total is enough to give the company a real future rather than just throwing good money after bad will take longer and be more complicated.

Founders who have a high percentage of funding from syndicates will need to navigate these waters very carefully.

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Reflect Ventures is hiring an MIS staff:

1. MIS with GraphQL, Google API, Slack API skills. See job description. Apply.

All roles are 100% remote.

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A Last Word

Reflect Ventures helps accredited investors build diversified emerging markets startup portfolios with small or medium sized tickets.??

We invest in B2B and B2B2C startups focusing on logistics, supply chain, and distribution - areas that are big enough to produce big companies in a single geographic market.? We identify attractive verticals that are likely to be oligopolies or monopolies, determine the business model that we believe will succeed in each vertical, and then invest in companies executing that model in different markets.

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