After my post Only Doing Seed Investments Without Follow-On Funding I received a number of interesting comments. The one that resonated the most with me was that I shouldn’t have a one-and-done investing strategy, rather, I should set up a defined strategy for follow-on funding so that it’s transparent to all the entrepreneurs and it’s more methodical. Yes, if I do it, it would partially defeat the goal of seeding as many startups as possible, but if I did follow-on funding based on a strategy, and the strategy generated greater returns in a reasonable amount of time, then there’s more money available to seed startups. Having a defined strategy also helps with the signaling problem where subsequent investors would see it as a negative if I didn’t participate in the follow-on funding, assuming I did some follow-on funding with other investments.
Here are a few ideas around a defined strategy for follow-on funding as an angel investor:
- Decide on an investment ratio for follow-on dollars in the 1:20 range (e.g. if the startup raises another round of $1 million, only participate pro-rata up to $50,000 since it’s 1/20th of $1 million)
- Participate pro-rata in subsequent rounds until a defined cap is reached (e.g. no more than $750,000 total in any single company, much like venture capitalists have in their limited partner agreements that no more than a designated percentage of the fund can go into any single company)
- Require a certain annual recurring revenue threshold of $1 million to participate, so that pro-rata rights are only exercised once the startup reaches a certain size (even if that means skipping a round where they weren’t at the threshold yet)
Over time I’ll evaluate these ideas and others to decide if I want to do follow-on funding based on a defined strategy.
What else? What are some ideas to incorporate into a defined strategy for follow-on funding as an angel investor?