In Short
- Lead investors spearhead funding rounds, often providing the largest investment and guiding terms and due diligence.
- They build investor confidence, attracting other backers by endorsing the business and negotiating favorable terms.
- After investment, they may retain influence through board positions, safeguarding their stake and advising on key decisions.
Tips for Businesses
For capital raises, securing a lead investor can enhance credibility and streamline the investment process. Their endorsement attracts other investors and brings valuable expertise. Ensure alignment with their vision, as lead investors often seek a say in operational decisions to protect their investment.
For an Australian private company, securing substantial investment is often crucial for growth and expansion of the business. You may have come across the term "lead investor", you may have not. However, it is vital to understand what a lead investor is and what they do for your company. They also impact other investors investing in the same round. This article will discuss the role of a lead investor and how they can shape the future of your company and business.
What is a Lead Investor?
The lead investor plays a pivotal role and drives the investment round. They have the potential to shape the future trajectory of your company. A lead investor is the entity that takes the initiative in orchestrating an investment round in your company. They typically invest a significant sum of capital, often the largest among the investors in that round.
Beyond just providing financial investment, the lead investor assumes a proactive role in guiding the investment process. They influence key decisions during the investment process and throughout the operation of your business in the future.
Usually, lead investors are:
- venture capitalists;
- institutional investors; or
- high net worth individuals/entities.
What Does the Lead Investor Do for the Other Investors in the Same Round?
Lead investors play an important role in supporting minor investors who are participating in the same investment. The lead investor's endorsement of your company's potential can influence the decisions of other investors. This encourages them to participate in the round.
It is highly unusual for a lead investor to invest without extensive due diligence. This makes the investment process potentially lengthy but brings high reward for your business once the investment round completes.
Negotiating Investment Terms
As the primary investor in an investment round, lead investors often negotiate specific terms that align with their investment objectives. They seek to mitigate risk for themselves.
Typically, the lead investor will negotiate the important terms of the investment into a non-binding 'term sheet' (or a 'heads of agreement'). This term sheet is usually non-binding and sets the commercial terms. It outlines the basis on which the lead investor and other investors will invest into the company.
After you agree and sign the term sheet, you will negotiate the binding investment documents based on the terms outlined. This creates a foundation for preparing the investment documents and confirms that the lead investor and other investors are keen on investing in your company.
The terms they negotiate also intend to give the lead investor a certain degree to influence in your company's operations going forwards. Common terms they may negotiate include:
- determining your company's valuation and the corresponding equity stake the lead investor (and others) will receive in exchange for their investment;
- allowing the lead investor to appoint a director to your board or provide themselves with observer rights to actively participate in key decision-making processes and safeguard their investment interests;
- if you agree to let them appoint one of their representatives
to your board, lead investors will typically structure
decision-making at the board and shareholder levels to require a
vote in favour of certain critical decisions the company plans to
make;
- for example, if the company requires a loan from a bank of over $200,000.00, to go ahead and take out the loan it requires a 75% vote in favour from the directors and must include the vote of the lead investor's representative director; and
- establishing priority in the distribution of proceeds in the event of a liquidation or exit by negotiating preference shares, which come with additional rights.
Due Diligence
Lead investors usually conduct thorough due diligence to assess your company's financial health, market potential and operational capabilities.
Before they invest they will typically carry out various tasks such as:
- reviewing the company's corporate and equity-related documents such as the cap table, the constitution, any existing employee share option plans and any existing SAFE notes or convertible notes;
- reviewing financial statements and historical performance to evaluate your company's financial viability and growth potential;
- assessing the industry you operate in, competition, potential demand for the company's products or services and to gauge whether their investment is likely to produce returns for them (amongst others);
- perform legal due diligence to ensure you have been complying with the regulations of your industry and those regulating your company; and
- identify any potential legal risks or liabilities, such as whether or not your company owns the key intellectual property that underpins the business.
What Do They Do After the Investment Round Has Concluded?
If the lead investor negotiates the right to appoint a director to the board, they will influence how your company operates. They will also be in a position to provide guidance from a business, financial, and legal point of view. This depends on their representative director(s) expertise.
As the lead investor's general business practice will usually be investing in multiple opportunities over the long-term, they will have considerable experience with various businesses and industries. They will provide valuable insight to your business and company when you are looking to take the next steps and scale.
Key Takeaways
A lead investor and their role extends far beyond the financial investment they have offered. They will become strategic partners, mentors and catalysts for growth with the aim of driving the company towards success. Through a lead investor's expertise and assistance, they will likely play a vital role in shaping the growth of your company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
