Only Doing Seed Investments Without Follow-On Funding

Written by

After doing half a dozen investments in the last 12 months I’ve had the chance to better formulate an investment strategy going forward. My favorite spot is seed investments as I have an opportunity to help entrepreneurs get a new idea off the ground and start the search for product/market fit (see The Four Stages of a B2B Startup). Seed investments also happen to be the area that markets like Atlanta have the most need. Once a startup has some modest traction and good metrics it’s easy to raise money. Only, there’s almost no money to help an entrepreneur get an idea off the ground.

Now that I’ve done a number of seed investments, I’ve also been in the game long enough to see a few investments need to raise another round of financing. While I’ve participated in some of these, I’ve come to realize that I’m not interested in doing follow-on funding — I’d rather use my capital to help entrepreneurs get started and then let that initial investment ride. Like Dharmesh Shah outlines in his strategy on angel investing, I’m avoiding follow-on investments.

I realize that participating pro-rata and doubling down on the winners is how many institutional investors generate most of their returns. Right now, I’m willing to forgo putting more money into the ones doing well in order to cast a wider net and get involved with more details. It might not make the most money but I believe it’ll have the most impact in the community.

What else? What are your thoughts on only doing seed investments without follow-on funding?

Comments

6 responses to “Only Doing Seed Investments Without Follow-On Funding”

June 22, 2014

Dick Reeves

David, I do understand your wish for maximum community impact, and laud you for it. You point out that most institutional investors make their gains in follow-on rounds. Studies of angel outcomes seem to indicate that those who stick to initial rounds only have better returns. However, I believe the “avoid follow-on round” policy is a damaging one for most angel investors. Most stick to smaller amounts in initial rounds due to the much higher perceived risk, and put higher amounts only in follow-on rounds in a company on an up-tick. They need the higher dollar deals in order to do well for their circumstances. In my experience, if they fail to participate in the larger later rounds they will eventually drop out for lack of adequate returns in absolute dollar terms.

Reply
June 22, 2014

businesssolutionsmerlin

I would look at the metrics and the strategic plan to determine where the business is positioned in relation to its road map. A business that is essentially on track and may need a little heave over the hump or to take advantage of an unfolding opportunity may just be deserving of some follow on funding.

Reply
June 23, 2014

John Marshall

David, I applaud you pursuing your passion rather than singularly focused on the bank account.

Cheers,
John Marshall

Reply
June 23, 2014

jason

Ultimately it is your money and you make the rules. Seed/Angel money is sorely lacking in Atlanta. But the initial concept of getting a business off the ground should fall to the entrepreneur.(i.e. bootstrap). To cut someone off from funding as they are hopefully gaining traction is a worse environment than not being able to raise funds after proof of concept.

Reply
June 23, 2014

Lance Weatherby

By taking such a stance you also help the companies that you invested in avoid the potentially painful question from later investors. “Is David going to participate?” If that answer is a well known general rule as opposed to a situational response the answer will not prevent a company from raising a later round.

Reply
June 23, 2014

Andrew Stith

Strikes me as more like gambling than investing, particularly when combined with some of Shah’s other rules.

Reply