Follow on investment refers to the subsequent capital injection into a portfolio company that a VC or PE firm has already invested in. It is an important part of the investment strategy to support the growth of portfolio companies. There are several key factors to consider for follow on investments.
Assess the company’s development potential and additional funding needs
The VC/PE firm needs to objectively evaluate if the portfolio company still has growth potential that warrants additional funding. This involves assessing the market opportunities, competitive landscape, management team’s execution ability etc. The additional funding amount should match the company’s business expansion plans.
Ensure alignment of interest between investors and entrepreneurs
Follow on investments mean the VC/PE firm and entrepreneurs continue to share risks and rewards. So it is critical that key shareholders have alignment in vision and incentives. Communication must be maintained to exchange feedback and adjust strategies.
Balance risks across the investment portfolio
The investor needs to decide if follow on investment should go into this particular company or to other prospects. Diversification is still necessary despite conviction in a portfolio company. Risks should be balanced for optimal returns across the portfolio.
Follow on investment is an important tool for VCs/PE investors to support portfolio companies, but requires disciplined assessment of risks and returns compared to new investments.