Bryan Shaw

In the early months of 2020 and during Covid lockdown, access to capital for early-stage and scaling businesses became more difficult as investors’ risk appetite waned due to the unprecedented uncertain economic conditions only a once-in-a-century global pandemic brings to an economy.

However, those investors that were able to stick their head above the pulpit were still spotting opportunities. Rather than leveraging these investments with traditional debt, we are now seeing more institutional investors, along with angels, syndicate these opportunities.

Why syndicate?

The benefits to syndicating an investment, from an investors’ perspective include:

• Knowledge sharing on both the portfolio company, but also knowledge sharing between investors more generally;
• Savings on costs of investment;
• Allows investor diversification across a wider spectrum of portfolio companies; and
• Reduction of investors’ risk.

From a portfolio company’s perspective, having multiple institutional investors allows it greater access to knowledge, experience and potentially greater access to new markets and opportunities as each investor brings with it its own network.

Legal considerations

With all the positives that syndications bring to investors and to the company, there are also significant challenges that should be addressed at an early stage. We consider some of the more common pain points in syndicated deals and some suggested strategies to resolve any roadblocks:

• Negotiations: There is nothing more frustrating for a company raising funds where their investors’ interests are not aligned. This can drag negotiations on for months. We suggest an efficient solution to this roadblock are for the investors to appoint a Lead Investor, typically the investor with the largest cheque. The other investors simply fall into line.

• Most Favoured Nation: If the investors are unable or unwilling to agree on a Lead Investor to negotiate the deal, an alternative approach could be for a company to give each investor a “most favoured nation” provision in their investment terms. In other words, whichever investor can strike the best deal with the company, all investors will invest on those same terms. This is a risky approach as the company may give away more rights than needed, however it may be an efficient way to move the deal forward to a conclusion.

• Board representation: Depending on the size of the investment, each investor in the syndicate may want a board seat. This could mean the company has a board that is too big and unmanageable. Our suggestion is that the syndicate, as a whole, has the right to appoint 1 director only, and the other investors have observer rights only (at best).

• Reserved Matters: Similar to the above, each investor may want certain veto rights over decisions made by the board. If the list of reserved matters becomes too large, the board may not be able to function effectively. In order to manage this process, companies should try to keep the list of reserved matters to a minimum, or alternatively, structure the veto rights through the syndicated appointed director only.

• Invest through a Special Purpose Vehicle or Nominee: Many syndicates will invest via their own special purpose vehicle (SPV) or nominee entity. The SPV will have its own set of rules between the investors, however from a company’s perspective, there will only be one shareholder in its books (the SPV) and many of the roadblocks outlined above will not relevant. We suggest, from a company’s perspective, this is probably the preferred investment structure for syndicated investments.

Government Syndication

There are government schemes available that encourage co-investment and syndication, from the Enterprise Capital Funds (ECFs) to the Future Fund Convertible Note, both being government matched funding to private investment. In these examples, the government takes a passive approach and relies on private fund managers to negotiate acceptable market terms of investment. This approach is heartening to see and allows for smoother and efficient deals, when compared to private investor syndication.

Conclusion

Towards the end of 2019, we were seeing investors wanting to make investments on their own, largely because we were in the midst of a funding frenzy where there was competition, rather than collaboration. When the Covid pandemic struck and the recession hit, confidence was sapped from the market, and investors wanted/needed other co-investors to leverage their investments. From a company’s perspective, whilst a syndicate brings many benefits, it is important to consider the legal implications of syndication and how best to manage investors’ competing interests.

• Bryan Shaw is a corporate partner at MBM Commercial.