Follow on investment refers to additional investments made in a company after an initial investment. It is a popular strategy used by venture capital and private equity firms to continue funding startup and growth companies. Making follow on investments allows investors to double down on winning bets and maintain ownership stakes. This article will explore what follow on investments are, their key types and strategies. We will cover topics like reasons for making follow ons, pros and cons, and how it helps businesses grow. There will be multiple examples of follow on investment rounds like Series A, B, C etc. Understanding follow on investing is crucial for businesses seeking growth capital and investors looking to support their portfolio companies.
Reasons investors make follow on investments
There are several key reasons why venture capital and private equity firms make follow on investments in their portfolio companies:
– To avoid dilution – Making follow ons allows existing investors to maintain their ownership percentage and control. If they don’t invest, their stakes get diluted when new investors come in.
– Double down on winners – Investors who have confidence in the growth potential of a portfolio company will want to increase their exposure by making follow ons.
– Provide capital for growth – Follow on capital helps companies expand operations, enter new markets, hire talent and achieve scale. Lack of capital can stall growth.
– Increase value of investment – Follow ons at higher valuations increase the value of an investor’s initial investment. Early investors get the benefit of marking their investment to the latest price.
– Maintain incentives – Investors want the management team to have skin in the game. Follow ons allow the team’s equity to retain value and keep them motivated.
– Signal confidence – A new follow on round acts as a positive signal and helps attract interest from new investors. It shows the company has backing from existing investors.
Types of follow on investment rounds
Some key types of follow on investment rounds are:
– Series A, B, C etc – These are follow on rounds made after initial seed funding. Series A is often new investor led, while B and C allow existing investors to double down.
– Bridge financing – Short term capital to help a startup before a future round. Helps the company extend its runway.
– Debt financing – Some follow ons involve debt instruments like venture debt or convertible notes. This provides cheaper capital than equity.
– PIPEs – Private investment in public equity involves buying stock directly from a public company. Used for later stage follow ons.
– Rights issue – A rights issue allows existing shareholders to buy additional shares at a discount to the market price. It lets investors avoid dilution from a new equity issuance.
– IPO – An initial public offering marks the final follow on round before a company goes public. Late stage private investors often get allocations.
Pros and cons of follow on investing
There are several benefits as well as drawbacks associated with making follow on investments compared to funding new companies:
Pros:
– Lower risk – The company’s business model and traction are proven. Follow ons have a higher chance of success than new investments.
– Information advantage – Existing investors already have an in-depth understanding of the market and company. This lowers diligence costs.
– Portfolio synergy – Investors can double down on their top performers and build category leaders within their portfolio.
– Deal access and terms – Insiders often get better terms, liquidation preferences and information rights on follow on rounds.
Cons:
– Opportunity cost – Follow ons divert capital that could be used to fund new companies and opportunities.
– Signaling risk – Having to raise frequent follow ons can signal that the company isn’t financially disciplined or executing well.
– Ownership dilution – While follow ons help avoid dilution, each round still leads to some dilution for existing shareholders.
– Lock-up period – Investors may be locked up for 6-12 months after an IPO and unable to exit a company that is underperforming.
Follow on investments help businesses grow
For startup and growth stage companies, follow on investment rounds serve many important purposes:
– Fund growth plans – Follow on capital from existing investors funds expansion into new geographies, product development, hiring etc.
– Avoid down rounds – Additional funding avoids startups from raising ‘down rounds’ at lower valuations due to lack of capital.
– Extend runway – Money raised from follow on rounds provides additional cushion and extends the company’s cash runway.
– Hit milestones – Follow on capital helps achieve key business milestones like launching new products, crossing revenue thresholds etc.
– Signal validation – Follow on investment by reputed investors serves as a validation and helps attract investment from others.
– Higher valuations – Businesses utilize follow on rounds to increase their valuation step-up compared to prior rounds.
– Minimize dilution – Founders can minimize dilution by raising follow ons from existing investors before approaching new investors.
In summary, strategic follow on investing is crucial for investors to support their portfolio companies and for businesses to fund their growth journeys. However, businesses should optimize follow on timing and frequency based on their growth needs.
Follow on investment refers to additional investment rounds made by existing investors in a company after the initial round. It allows investors to maintain ownership, avoid dilution and double down on top performers. For businesses, follow on capital helps fund growth plans, extend runway and achieve milestones while minimizing dilution. Common follow on rounds are Series A, B, C as well as options like debt, PIPEs and rights issues.