Second Investment Strategy for a $20 Million Fund

After yesterday’s post Investment Strategy for a $20 Million Fund, several people reached out and said it was crazy to limit the fund to only eight total investments. After pointing out that if the desired ownership percentage is 20%, and the expected post-money valuation is in the $5 million range, mathematically there’s only room for eight investments. The general consensus was that the fund needs to invest in many more companies to get better diversification and an increased chance of finding a few winners where the capital reserves can be used to participate in future rounds. So, either the target ownership percentage or target post-money valuation needs to go down to increase the number of investments.

Here’s a potential second investment strategy for a $20 million fund:

  • Allocate 40% of the fund ($8 million) for new investments and reserve 60% for follow-on investments ($12 million in reserves)
  • Invest an average of $500,000 per company with a target ownership percentage of 10% for a total of 16 investments with an average post-money valuation of $5 million
  • Of the 16 investments, take the top four companies and participate heavily in the follow-on rounds using the reserves
  • To achieve $70 million of exit value, the majority of the returns come from the top four investments (e.g. ~$60 million in returns at an average of ownership stake of 10% for a total aggregate exit value of $600 million) and the remaining investments deliver more modest returns (e.g. ~$10 million in returns at an average ownership stake of 5% for a total aggregate exit value of $200 million)

This approach casts a much wider net and then goes deeper with a handful of portfolio companies. It still requires substantial exits but has more opportunities to find winners.

What else? What are some more thoughts on this second investment strategy for a $20 million fund?

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