Angel Investing – Follow-on Rounds

DecisionIn my last post, I discussed planning your angel investment strategy for 2013 and taking into consideration not only new portfolio additions but also participations in “follow-on” rounds emanating from your current portfolio. So how do you decide, if you have the option to invest, whether or not to participate in a “follow-on” round? When I am considering this question for my own portfolio, I first determine what type of “follow-on” round this investment opportunity represents. I use the following three categories:

  • The “anticipated” round:  When investing in very early stage company, oftentimes there is an initial investment made to test the product/service. At the time of the initial investment, milestones are established to determine the criteria for whether a larger second round will be raised.  For me, when I invest in this type of situation, I will include a potential next round in my investment planning outlook. Once the milestones have been achieved, I will review the “follow-on” opportunity to see if I am still in agreement with both the company’s strategy going forward as well as the valuation of the round.
  • The “positive” round: In this situation, the company may decide to raise additional capital to capture a new market opportunity, ramp up sales more quickly, acquire a new technology….. or a myriad of other opportunities to drive revenues or market share more quickly. In evaluating this type of investment, I will first evaluate the new strategy/initiative as well as the revised financial projections to decide if I am in agreement with the change in direction being contemplated. Can the current team take on the new initiative and, if not, have they identified who they would need to bring on board?  Finally I will review the valuation as well as the minimum investment amount of the new round to determine if it is a fit for my portfolio.
  • The “negative” round: Unfortunately, many of the “follow-on” rounds result from a cash crunch due to a shortfall in projected revenues or an increase in expenses. Capital infusions that were, at the time of investment, poised to fund a company for 12-18 months run out in a much shorter time. As an investor in this situation, the first question I need to answer is: “With all the benefits of hindsight, would I make this investment again?” Do I still believe in the CEO and the idea? How confident am I that the company will be able to raise enough funds to provide a sufficient runway and that the revised financial projections can be met so that I won’t be looking at another “cash crunch” in the near-term?

Not matter which category a “follow-on” round represents, there is no magic formula and each specific opportunity needs to be evaluated to determine if the investment still fits within your own set of investment parameters. With each check we write as angel investors, we are making a bet on the ability of the CEO and her team to deliver future revenues and profits. In the words of legendary investor Warren Buffett, “In the business world, the rear-view mirror is always clearer than the windshield.”

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