One question that seed investors love to ask is if you have a lead investor in your seed round. I’ve written before about what every entrepreneur needs to clarify when answering this question.
But once you figure out why an investor is asking, tactically speaking, what do you do? Let’s say that you find out that an investor is asking because he/she does not invest without a lead investor in place. Let’s say the investor simply relies on other people to do due diligence and does not believe in party rounds.
Now what? Do you try to find a lead? Do you ignore an investor who will only invest if you have a lead?
At this point, you need to move on. Any investor who tells you, “We are definitely in if you have a lead!” or “We want to co-lead if you find another co-lead!” are not in your round. It may sound like they are in, but they really are not.
Next, you should not hold up your round, simply because you do not have a lead investor. Lots of seed rounds are done with party rounds these days, so it is not the end of the world if you do not have a lead investor. A few of my friends’ companies had no lead investors in their seed rounds, and they are now valued at hundreds of millions of dollars. Get a standard convertible note (or convertible security such as 500 Startups’ KISS A), and fill it out. Then start bringing checks in. Remember, with a convertible note, you can quickly get e-signatures, and investors can start sending you money that you can put to work right away even if you have not yet reached your target raise.
But what happens if you’re raising money on your note and then a lead investor wants to come into your round? This is a very good problem to have and is common and solvable. Typically, a lead investor will want to do a priced equity round, so you can convert your convertible notes into this equity round. Sometimes, though, I’ve seen lead investors respect the fact that a round is already happening and will just put a big chunk of money into a company on the same terms as the note. (This really depends on how much leverage you have / investor interest you have.) But regardless, the mechanics of this will work out, and in most cases, your existing smaller investors will actually be very excited that you have a lead investor (unless that lead is a big asshole), and will be accommodating to make the round work.
Now, there are pros and cons to having a lead investor. Some quick pros and cons:
Pros:
If the right person, he/she could be a great partner to get advice from and hold you accountable like a good coach
Could potentially lead your next round
Cons:
If the wrong person, he/she could make your life hell
If he/she doesn’t invest in the next round, it could be bad signaling
So, you’ll want to do your homework before agreeing to work with a lead investor. However, once you get a term sheet from a potential lead investor, you have a lot of leverage. You can use this as a forcing function to see if some other firm that typically leads would also be interesting in giving you a term sheet. This can help you increase your valuation if you have another firm also give you a term sheet and/or you could potentially get a co-lead to mitigate signaling issues if one firm does not join your next round.
But the bottom line is don’t hold up progress on your round because you get too fixated on having a lead – I see this happen all too often with founders.
Fundraising is a nebulous process that I aim to make more transparent. To learn more secrets and tips, subscribe to my newsletter.