Growth Equity: What is the right number of investors?

We’re often asked what the “right” number of investors is for a growth equity financing. Is there a right number of investors? Absolutely!

History of Syndication in Venture Capital

In the early days of the venture capital business, deal syndication was a hallmark of the industry.  Those of us who participated in many of the early syndications would characterize those syndications as quite positive for a number of reasons.

1)    More good minds, eyes and ears focused on creating value with the entrepreneur.

2)    Substantially more capital available for expansion; few investors had enough capital to fully fund an opportunity.

3)    Your co- investors were effectively “off the table” in competitive opportunities.

4)    The camaraderie and strong relationships among investors led to reciprocal deal flow.

Megafunds Mean Less Syndication

Younger investors today cannot envision a world where syndication was often necessary in order to raise even a million dollars.  As fund sizes started to increase (remember when a “megafund” referred to funds in excess of $100 million?) and leveraged buy-out and control acquisitions became more popular, syndication became increasingly less important.  Investors with larger funds needed to “put money to work”, an imperative that soon outweighed syndication benefits, and control investors rarely syndicated.  Over time, this led to a more competitive and less cohesive industry and served to reduce the number of investors in a given portfolio company.

Benefits of Syndication Endure

We at Meritage believe that there are still significant benefits to be realized from syndication.  In addition to the obvious benefits of having both additional capabilities and additional capital around the table, from the entrepreneur’s perspective, syndication prevents the company from being “single-threaded”.  When a company has a single investor, its governance and access to additional capital is dependent upon the cooperation of the investor and upon the capabilities of the individual partners assigned to the investment.  You don’t have to dig deeply to find vast differences in capabilities of investment firms and the individual partners within those firms.  The fact of the matter is:  when seeking capital, it never has been, nor should it be, just about the money.

Meritage Funds’ Perspective on Syndication

We typically advise entrepreneurs that approach us for capital, even in those circumstances where Meritage can comfortably take the entire investment, to consider bringing in a second investor to provide additional resources, capital and wisdom.  Syndication also tends to promote a better working relationship with the entrepreneur, as a balance has been established with no single investor “calling the shots.”

If one investor is too few, how many investors are too many?  We strongly believe that when a syndicate grows beyond three investors, diminishing marginal utility sets in.  What this typically means is that one or more investors become passive and less involved, thereby negating one of the primary benefits of syndication – additional capabilities around the table.  In addition, larger syndicates often suffer from “new money versus old money” issues, where early investors are reluctant to take dilution or to cede governance to newer investors, sometimes leading to gridlock.  Finally, larger syndicates can create communication issues, as it may be much more difficult to schedule meetings and much more difficult for the Chief Executive Officer to keep everybody informed and to solicit input in a timely manner.

Therefore, our advice to entrepreneurs seeking Growth Equity, regardless of whether the new capital buys a majority or a minority interest, is that companies are best served by having more than a single investor but no more than three investors.  You can have too few or too many investors!