The Debate Over Follow-On Investments in Early Stage Investing

First Cheque

Episode Summary:

In this thought-provoking episode of First Cheque experienced investors Cheryl Mack and Maxine Minter delve into the meticulous world of follow-on investment strategies. The episode serves as a beacon for those who wish to refine their approaches in early-stage investing, especially as they grapple with the decision of whether to follow on or not in subsequent investment rounds. The conversation explores the intricate balance between optimizing returns and supporting growing companies at various funding stages.

Cheryl represents the school of thought advocating for doubling down on winners, focusing on reserving funds for follow-on investments based on the company's performance. Maxine, on the other hand, takes a contrarian view, emphasizing the importance of an initial strong pre-seed commitment without reserving for follow-on. Together, they unpack the underpinnings of each method, providing listeners with an insightful analysis centred on investment strategy, fund management, and the implications of the power-law in startup investing.

Key Takeaways:

• A follow-on investment strategy involves investing additional funds in a company during later financing rounds, usually at a different share price.
• Traditional wisdom encourages investors to reserve funds to double down on winning companies, but Maxine challenges this idea, promoting initial, larger investments at the pre-seed stage.
• Discussion on the importance of pro rata rights and the potential signaling risks associated with not following on in subsequent rounds.
• Cheryl shares her angel investment approach, which emphasizes growth metrics evaluation, fund allocation decisions against other opportunities, and backing companies that have shown significant progress.
• The conversation highlights the need for personalized investment strategies that reflect individual goals and resources, as well as the potential influence of received wisdom on investment decisions.

Notable Quotes:

• "The conventional wisdom... you want to reserve follow on money in order to double down on your winners." - Cheryl Mack
• "If you want to maximize IRR, then it's deploying all of your capital in that first check." - Maxine Minter
• "The power law operates in our industry... it's not necessarily a one for one trade off... you need to make resource allocation trade offs." - Maxine Minter
• "I really have to believe that I'm still going to get outsized value from this valuation further on." - Cheryl Mack
• "The only thing that stops you from getting squeezed out over time is adding enormous value and having a great relationship with the founders." - Maxine Minter

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