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Investment Documents - Syndication Agreement

In the final part of my investment documents -series, we take a look at the syndication agreement. While this is an agreement between the syndicate members it is useful also for the founders to understand the syndication agreement and how a syndicate works. And even in those syndicates where a syndicate agreement is not made, agreeing on the key elements is crucially for a successful syndicate, especially if the syndicate has several members.

In this article, we examine the typical elements of a syndication agreement. However, it should be noted that unlike with e.g. the term sheet or the shareholders’ agreement, the contents of the syndication agreement may vary a lot from case to case.

Purpose of the Agreement

Whereas the term sheet and shareholders’ agreement governs the relationship between the founders and the investors (as well as the company), a syndication agreement sets out the roles and responsibilities of the investors towards each other. The syndication agreement has two main purposes: For one, it is aimed to facilitate the investment process by defining the roles of investors, their objectives, investments and the framework for the negotiations. Secondly, the syndication agreement sets out the guidelines for the post-investment activities of the investors.

A syndication agreement typically consists of two parts: One governing the acts of the syndicate while contemplating an investment and another governing the acts of the syndicate after the investment.

Before the Investment

First part of the syndication agreement sets out the framework for the acts of the syndicate before the investment.

Preparing the Investment

The key pre-deal parts set out the role of the parties. These typically include who is the deal lead and how are the syndicate investors. Some of the syndicate members may also be appointed as co-leads or subject matter experts who assist the lead investor as agreed.

The lead investor has the authority to negotiate the deal on behalf of the syndicate. The underlying conditions for the authorization can be outlined in the agreement. With this authorization, the lead investor negotiates the term sheet with the company.

Besides negotiating the term sheet, the lead investor is typically responsible for representing the syndicate when preparing the shareholders’ agreement and the investment agreement.

The Investment Tickets and Instrument

The investors joining the syndicate commit funds for the investment. These investments, called tickets, are detailed in the syndication agreement. The agreement also stipulates the form of the investment, the investment made into the equity of the company in exchange for shares or as a convertible note.

The Role of the Lead Investor

The lead investor leads the negotiations between the syndicate and the company. Other team syndicate members may support the lead in the negotiations, especially if certain subject matter know-how is required.

The preparation of the investment documents is typically also the responsibility of the lead. If this activity is outsourced to e.g. an outside law firm, the deal lead is still responsible for coordinating the work of the law firm on behalf of the syndicate.

One of the keys to successful startup investments is to perform proper due diligence. While all of the investors are responsible for their own due diligence, it is the role of the lead investor to ensure that the due diligence is made. The lead is often supported with other syndicate members, who have an in-depth understanding of the technology and/or business or who are experienced in reviewing the financial and legal aspects of startups. The roles and responsibilities of the different due diligence team members are outlined in a syndication agreement.

The most important role of the lead of the syndicate is to ensure the communication between the syndicate and the startup. It is a good practice to set-up an outline for the communication in the syndication agreement. This can be e.g. a weekly update call between the syndicate members.

Use of Experts

Every now and then the syndicate needs external expertise. Most commonly this is legal assistance relating to the shareholders’ agreement and investment documents but can include other services as well (e.g. due diligence services).

If the syndicate plans to use outside experts, it is a good practice to define the use of the services in the syndication agreement. This should include rules on how the services are acquired, how the experts are engaged and how costs for their services are covered.

The experts may be chosen by the lead investor, who is then responsible for the coordination of their work. In cost compensation, different rules may apply if the investment is closed and if it falls apart (e.g. the company may cover the costs within pre-determined budget if the investment is made, but the investors cover the costs pro rata with their planned tickets if the syndicate decides not to invest).

Remuneration to the Lead Investor

If there is compensation for the lead investors, it should be agreed upon in the syndication agreement. And even if there is no compensation, it would also make sense to write that down in the agreement.

The remuneration for the lead investor can be e.g. lead investor fee, lead investor carry or compensation for the advisory or board work.

After the Investment

The second purpose of the syndication agreement is to set a foundation on the acts of the parties after the investment is made.

Communication Between the Parties

Efficient communication between the parties is key to building trust that helps to create winning startups. While the communication between the startup and the investors is stated in the shareholders' agreement, the syndication agreement may specify how the syndicate members communicate between themselves.

Items of communication to address in the syndication agreement include how the lead investor or a board member representing the syndicate passes on information from the company to the syndicate members, how the syndicate members can submit their ideas and concerns to the company and how the syndicate members are prepared for general meetings and other material decisions.

The flow of information should be fluent, yet one of the roles of the lead investors is to act as a filter between the syndicate members. Especially in larger syndicates, the investors might provide the founders with an overwhelming amount of initiatives, and it is the role of the lead to filter these and bring forward the ones that truly help the company to succeed in the must-win battles.

Member of the Board of Directors

If the syndicate is entitled to elect a board member, it should be specified in the syndication agreement how the election is made and how the board member is replaced. If the board member is someone else than the deal lead, the communication facilitation responsibilities discussed above usually apply also to the board member.

Voting in Shareholders’ Meetings

One of the benefits of making the syndicate formal via a syndication agreement is that it makes the syndicate one major shareholder instead of a bunch of smaller shareholders. Therefore, to fully gain the benefits of such arrangements, the syndicate members need to act unanimously.

Unanimous acting can be achieved by setting up a procedure, where the syndicate members form their common understanding before a material decision is made and act accordingly in the actual decision making. E.g. it may be stipulated that all in all decisions that would require a qualified majority under the shareholders’ agreement, the syndicate members act as one if two-thirds of the shares held by the syndicate so vote.

Point of View

While I have dealt with the syndication agreement as a part of my investment documents series, it is not an investment document in a traditional sense. It is more of a pre- and post-investment document: It lays the foundation for the syndicate to act when contemplating an investment and it acts as a framework for the efforts of the syndicate in growing the business. In some cases, the syndication may cover only one or the other of these two phases.

A sound syndicate agreement helps to create a syndicate that is stronger than the sum of its parts. It also helps to mitigate the issues of the long cap table, when despite the number of investors they all act as one. Thus, having a syndication agreement in place can often be in the interest of both the investors as well as the founders; especially if the syndicate is large.

Interested in other investment documents? Find out more below:

Term sheet

Shareholders' agreement

Investment agreement

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