VC Fund Basics: How to supercharge your portfolio with follow-on rounds

Balancing a portfolio is one of the best ways to improve the odds of VC investing.

The challenge in early-stage investing is trying to foresee where massive growth will take place over the lifecycle of these investments. With a long time horizon and external factors such as luck and timing, it’s impossible to be right every time about which companies will grow and which ones will fail – but portfolio balancing helps.

As GPs, we spend time managing the portfolio of our Brightspark Canadian Opportunities Fund (BCOF) for its investors. However, if you’re part of the 85% of our investors that choose to customize their portfolio themselves by investing on a deal-by-deal basis in Single Purpose Vehicle (SPV) syndicates – here’s what you should know:

Starting point: How much to invest?

It’s important to budget how much of your total portfolio you want to allocate to venture capital - this depends on your personal investment objectives and risk tolerance.

From there, you’ll want to think about building a diversified portfolio of multiple investments. Successful venture capitalists have spoken about the power of diversification - investing in multiple companies is one of the best ways to mitigate the high risks of early-stage investing.

Then, you want to allocate a budget for follow-on investments to maintain your ownership in the company. Think of it as the capital that you’ll allocate to “double down on your winners” where there is an opportunity to do so in follow-on rounds.

As a reference, the BCOF reserves approximately 50-60% of its total investment capital to allocate in future follow-on rounds of its best performing portfolio companies.

Follow on rounds

Behind the scenes, startup founders and their Board are often thinking of when to raise the next round of financing. Follow-ons are usually tied to a milestone, traction, or market opportunity.

Most early-stage companies will raise many rounds of funding in their lifetime. Because Brightspark typically invests at an early stage (Seed or Series A), you could get many opportunities to participate in follow on rounds.

Just like institutions, Brightspark SPVs always have baked-in follow-on rights for its investors, which means that you will have priority to participate in follow-on rounds based on the SPV's allocated pro-rata of the round.

When presented with an opportunity to participate in a follow-on for a company you’re invested in, ask yourself whether you want to “double down”, or if you are satisfied with your exposure in this investment.

In practice

This strategy has made a significant difference to Brightspark and institutional VC investors over many years. When you strategically rebalance your portfolio, winners emerge as significant parts of your portfolio and provide a solid balance against the less successful holdings. Many investors say that reserve allocation plays an important role in driving venture returns than the initial investment bets.

We have seen this with our investments in Radian6 (we invested in Series A, participated in follow-ons, and exited at 26x) and in Hopper (we invested at Seed, participated in all follow-ons, now the company is valued at $US3.5B).

For example, let's say you make five new investments in startups. Then, you re-invest in two of those that are doing really well. You consequently raise your percentage of winners - you now have seven “investments” with four winners in total. Repeat this a few times and the few winners become very lucrative.

This strategy can lead to a supercharged portfolio. Of course, beware of being too concentrated in any specific investment, but doubling down on winners can lead to superb results if you are able to invest in companies before massive valuation growth.

Follow-ons as new opportunities

In addition to taking a close look at re-investment opportunities in your portfolio, as a member of our network you may sometimes receive “follow-on” opportunities in companies that you have not yet invested in before. This happens occasionally when there is an extra allocation for the SPV in a large round.

These companies are often raising new rounds to capitalize on their momentum - they could represent meaningful ways to improve your portfolio and are an important part of portfolio management.

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