Follow on investment is an important investment strategy, especially for venture capital and private equity firms. It refers to the practice of investing additional capital in a portfolio company that has already received an initial round of funding. This strategy allows investors to double down on their top performers and maximize overall returns. With proper implementation, follow on investment can greatly benefit both investors and entrepreneurs.
Follow on investment builds on initial success and momentum
The logic behind follow on investment is that once a portfolio company demonstrates strong metrics and traction after the first round, investors can accelerate growth by injecting more capital. This takes advantage of the company’s proven product-market fit and allows it to scale faster. Additional funding supports needs like hiring key personnel, ramping up marketing, expanding to new markets, and upgrading technology infrastructure – all of which are key to growth.
Follow on investment signals investor confidence
When existing investors commit additional capital to a portfolio company, it signals their continued confidence in the team and business model. This vote of confidence can then attract new investors who may be swayed by the lead investor’s commitment. Founders also welcome follow on investment from those who know the business best, rather than pursuing new capital from unknown parties.
Follow on investment allows for greater ownership and control
By investing more capital into top performers, venture funds can consolidate their ownership stake and influence. This allows them to better guide the strategic direction of portfolio companies. With greater control, investors can ensure proper governance, manage risks, and align incentives between shareholders and management.
Follow on investment sustains portfolio company momentum
The biggest risk for any start-up or growth-stage business is running out of cash. Follow on funding mitigates this risk by providing necessary growth capital right when the company needs it most. The cash infusion arrives at a critical juncture when the previous round is running low. By sustaining momentum, follow on investment significantly improves a company’s odds of success.
In summary, follow on investment allows investors to double down on winners, signal confidence, gain greater control, and sustain momentum for portfolio companies. When executed prudently, it is a highly effective strategy to optimize returns and minimize risks.