What is a Syndicate?
A syndicate is a group of investors who come together to participate in a large transaction that they could not undertake individually. Syndicates allow investors to pool their capital to invest in deals with high minimums that would normally be unavailable to them.
The most common types of deals that syndicates invest in include real estate, companies going public via an initial public offering (IPO), and angel investing in startups. By pooling resources, syndicate members can achieve diversification and access to big-ticket deals.
Real Estate Syndicates
A real estate syndicate is formed when a group of investors collectively purchases a large real estate asset like an apartment building, office tower, industrial facility, medical complex, etc. The syndicate is overseen by a lead sponsor who sources the deal and brings together anywhere from a handful to hundreds of passive investors to fund the purchase.
The passive investors do not have to participate in the day-to-day management of the property. Those duties are handled by the sponsor or third-party property management company hired by the sponsor. Passive investors simply contribute their capital and receive a portion of the project’s cash flow and appreciation in return.
This allows the passive investors to benefit from real estate investment and diversification without having to personally source deals or manage tenants. The minimum investment to participate in a real estate syndicate typically ranges from $25,000 to $50,000.
IPO Syndicates
An IPO syndicate allows groups of investors to buy shares in an upcoming initial public offering together. The syndicate is organized by a lead broker dealer or investment bank who files the necessary SEC paperwork and facilitates the syndicate’s allocation of shares at the IPO price.
The minimum investment to participate in an IPO syndicate is typically $25,000 to $50,000. The chief benefits of joining an IPO syndicate include increased allocation size, guaranteed access to popular deals that may be oversubscribed, and the ability to buy pre-IPO shares at the IPO price versus having to wait to buy post-IPO when the stock starts trading on the market.
Angel Syndicates
Angel investor syndicates have emerged in recent years as a popular way for groups of angel investors to fund startups together. Just like angel investing solo, the purpose is to provide capital to early-stage ventures in exchange for equity ownership. But by pooling their capital and expertise, angel syndicates can make larger investments of $100,000 to $1 million into seed or Series A rounds that would be too risky for any single member to undertake.
The angel syndicate is typically managed by a lead angel who sources deals, conducts due diligence, negotiates terms, and oversees the investment’s operations. The passive angel investors benefit from the lead angel’s capabilities and the risk reduction achieved through diversification across multiple startups financed by the syndicate over time.
How does a Syndicate Work?
While syndicates take various legal forms and operating structures depending on their purpose, geography, regulations, and lead sponsor preferences, most follow a similar basic process:
1. Formation of the Syndicate
The sponsor takes the lead in forming the syndicate. If it is a broker-led IPO syndicate, this may be an investment bank. In an angel group, it may be an experienced angel investor. In a real estate syndicate, it is commonly a real estate developer, operator, or investment firm serving as the syndicate’s sponsor. The sponsor does the work of structuring the syndicate, compiling the legal agreements, securing any necessary licenses or approvals, and presenting the opportunity to potential investors.
2. Recruiting Investors
The sponsor markets the syndicate investment opportunity to their network of potential investors. Today, this often happens online through investment crowdfunding platforms as well as email, newsletters, social media, events, referrals, and word-of-mouth marketing. Investors are pitched on the details of the transaction and provided legal documents to review like the private placement memorandum, operating agreement, subscription agreement, etc.
The materials explain the investment strategy, key terms like projected returns and hold period, minimums and fees, and risk disclosures. Interested investors complete their due diligence process on the opportunity.
3. Capital Commitments
Qualified investors who wish to participate in the deal sign their subscription agreements and transfer funds to officially commit their capital. The sponsor collects the commitments and may establish an escrow account to hold the funds securely until the deal closes.
4. Deal Closing & Execution
Once the offering hits its minimum funding target with aggregated capital commitments from investors, the deal can close. The syndicate’s committed funds are used to purchase the IPO shares, invest in the startup, acquire the real estate asset, etc. The syndicate becomes official at closing.
Post-close, the sponsor handles ongoing execution and management of the investment as outlined in the operating agreement. The sponsor remains accountable to the investors to operate the syndicate in the investors’ best interests.
5. Profit Distribution
As the investment generates income and profits, the sponsor distributes each investor’s proportional share of the gains based on their ownership stake in the syndicate. This is usually done quarterly or annually and comes in the form of cash distributions. The timing, payment size, and frequency depend on the investment’s performance and the sponsor’s discretion.
6. Exit & Dissolution
At some point, the syndicate investment is exited and dissolved. For a startup investment, this may occur through an acquisition or IPO. Real estate assets may be sold or refinanced. The sponsor notifies investors of the exit, distributes the remaining profits owed to each investor, and terminates the syndicate’s operating agreement.
Common Structures of Syndicates
While there is variety in how syndicates can be structured, most fit into one of these basic frameworks:
Limited Partnerships
The most common structure used by real estate and private equity syndicates is a limited partnership. The sponsor serves as the general partner who makes the investment decisions and manages the day-to-day operations. The passive investors are the limited partners who contribute capital but have limited liability, control, and involvement in the partnership. The limited partners receive income distributions based on their ownership percentage.
Limited Liability Companies (LLCs)
LLCs are a popular corporate structure used by many syndicates, especially in real estate. They limit investor liability and allow the sponsor to retain operational control as the managing member. LLCs also provide pass-through taxation where income and losses flow directly to the individual investors’ tax returns in proportion to their ownership.
Investment Trusts
Another common structure is an investment trust which represents a pool of assets professionally managed by the sponsor trustees on behalf of the investor beneficiaries. The investors buy units in the trust that entitle them to a proportional share of cash distributions and net asset value upon dissolution. Investment trusts are commonly used in broker-led IPO syndicates.
Informal Club Deals
Angel investor networks often form loose affiliations to co-invest in startups together without any formal legal entity. Each participating angel simply commits their own capital and negotiates their own share of equity in the target startup. The arrangement is managed informally by the lead investor who brokers the deal.
Benefits of Joining a Syndicate
Participating in a syndicate offers investors several advantages versus investing independently:
Access to Exclusive Deals
Syndicates provide access to deals with high minimums that individual investors typically cannot meet on their own. For instance, the SEC restricts IPO share allocations to companies going public to large institutional investors unless you can participate through a syndicate.
Diversification
Rather than tying up all your capital in a single investment, syndicates allow you to deploy smaller amounts across multiple transactions, reducing risk through diversification. This spreads risk across multiple startups, properties, etc.
Leverage Expertise of Lead Sponsor
The lead sponsor sources deals, conducts due diligence, structures terms, and handles operational management. This leverages their experience and expertise versus having to do it all yourself as a solo investor.
Shared Transaction Costs
Syndicates can negotiate reduced legal, accounting, operational, and other costs associated with making large investments since these expenses are shared across a group versus an individual.
Passive Investment Opportunity
Investors can enjoy profits generated by skilled sponsors or profitable assets without having to be involved in oversight, management, or decision making for the underlying investments. The lead sponsor handles those duties.
Potential for Higher Returns
By investing in a portfolio of deals aggregated by the sponsor versus a single investment, syndicate investors may benefit from higher total returns over time thanks to diversification.
Drawbacks & Risks of Syndicates
Syndicate investing also comes with some downsides to consider:
Loss of Direct Control
Investors cede much of the control over investment decisions and management to the syndicate’s sponsor or manager. The quality of the sponsor is key.
Higher Fees
The sponsor typically charges fees for their work in organizing, managing, and overseeing the syndicate. This includes profit shares as well as upfront costs. Higher fees can eat into investor returns.
Lack of Liquidity
It may be years before the syndicate sponsor liquidates the investment and returns capital to investors. Money is locked up for the duration with limited liquidity.
Potential Disputes Between Members
With multiple investors involved, there is the potential for disagreements over how the sponsor manages the syndicate or when to exit the investment. Conflicts of interest can arise.
Not Guaranteed to Raise Capital
If the syndicate fails to attract the minimum committed capital from investors required to fund the investment transaction, the deal will not close.
Syndicate Due Diligence
Because syndicate investors rely heavily on the sponsor’s capabilities and trustworthiness, conducting thorough due diligence is important before committing capital. Investors should review:
Track Record
The sponsor’s history making similar investments, returns achieved, deals completed, bankruptcies or failures, etc. Look for relevant domain expertise.
Reputation
What partners, investors, and industry peers say about working with the sponsor. Look for endorsements. Beware red flags like lawsuits or investigations.
Credentials
The experience, education, licenses, and certifications held by the sponsor team to confirm they are qualified.
Investment Strategy
Evaluate the sponsor’s investment thesis, criteria for selecting deals, due diligence process, portfolio management strategy, and risk mitigation tactics. Ensure the strategy aligns with your goals.
Operations & Management
How will the sponsor oversee the investment’s ongoing operations? Do they handle everything internally or hire third-party property managers, etc.?
Financials
Review audited financial statements, operating costs, balance sheet strength, etc. to assess financial health and transparency. Look for regular reporting.
Fees
Compare the sponsor’s upfront costs, profit splits, management fees, carried interest, and other compensation versus industry averages.
Investor Rights & Disclosures
Review the offering documents for investor rights, sponsor obligations, liability limitations, investment timelines, risks, and conflicts of interest before investing.
Conclusion
Syndicates allow individual investors to participate in large transactions by pooling their capital and expertise. While syndicate structures vary, they typically have a lead sponsor who sources the deal, organizes investor capital, and manages the investment.
Investors can gain access to exclusive opportunities with high minimums as well as risk reduction through diversification across the syndicate’s aggregated investments. However, they sacrifice control and pay fees to the sponsor. Conducting due diligence on the sponsor is vital before joining a syndicate. When structured properly and led by an experienced sponsor, syndicates can provide individual investors with opportunities, diversification, and passive income that would otherwise be difficult to achieve independently.
