180. Follow Ons Part 3: The Follow-On Death Spiral

VC Minute
Wrapping this up, I've been watching the "Follow-On Death Spiral" for the last year. It's not all bad news through.

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Let’s recap where we are so far and why follow-ons are the most important thing you should be talking to investors about right now. Series A raised the bar; this changed a few years ago and is not coming back down. There are more funds at seed than ever. The two of those combined have led to a lengthening of the seed phase, where you may raise a pre-seed a pre-seed extension, a seed, a seed extension, or even a seed 2. Additionally, the time between fundraises is growing longer than ever, and venture funds are deploying at a significantly slower pace.

Here’s the next thing to think about: funds are putting more into follow-on rounds than ever before. In one of Carta’s recent market reports, they showed how bridge rounds were at all-time highs. For the last year, I’ve been watching what I call the follow-on death spiral at Seed. And yes, I’m being a little bit dramatic. But there is a closed loop that I’m worried about.

Every venture fund has a follow-on strategy. That strategy may be expressed as a proportion of their fund. For example, we have 25% reserves for follow-on. It might be zero; it might be an entirely separate fund. As funds deploy slower and need to buoy their portfolio with follow-ons throughout the whole long seed phase, which eats into their follow-on reserves, they have less capital to deploy into new investments. When this happens across the whole market, with less capital available for new investments, startups have to go back to their current investors for more follow-ons. Which eats into the reserves and down and around and down, it goes.

Now it’s not all bad news. The antidote to this from a macro perspective is that nearly every fund raised more money than their previous fund. And so follow-on reserves are not too much at risk. But it’s definitely a change from a few years ago. So maybe it’s not so much a death spiral, but it’s definitely a hiccup, and it absolutely is something that is going to affect you.

So who cares about the macro, right? What does this mean for you and your startup? It means you need to be digging in with every investor about their follow-ons. You will need them in subsequent rounds. Here are four questions you should ask investors as you get down to the due diligence process:.

1. What is your follow-up strategy?

2. What percent of your fund is allocated for follow-ups?

3. How do you follow up on an investment decision?

4. What’s a recent follow-on investment you’ve made?

Learn about your investors and your prospective investors now, so that when the time comes, you know how to approach them and what they’re going to be looking for.

About AVL Growth Partners
AVL Growth Partners, founded in 2009, is the leading fractional Finance and Accounting firm supporting organizations in pivoting from growth to scale. AVL brings an experienced team of CFOs, Controllers, and Accountants to your organization, delivering transparent, strategic actions for short and long-term success. Transform your financial approach affordably with AVL, supporting companies coast to coast – get to know AVL Growth Partners at avlgrowth.com. (Sponsored)

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