Think about you’re a enterprise investor. You discover an ideal firm. You purchase 16% of the corporate for $8m at $50m post-money valuation. Six months later, the corporate raises $100m at $500m. Issues have gone very nicely.
Your 8m has 10xed. Naturally, you journey an imaginary horse across the room, galloping with glee.
Now you face an necessary strategic query: Do you make investments your full pro-rata of $8m? Professional-rata is the appropriate to speculate extra to keep up their share possession. Enterprise companies reserve capital for these financings.
For those who make investments a further $8m to keep up your possession, the funding a number of falls to three.3x: 80m / (8m + 16m). Two-thirds of your {dollars} are invested at a a lot increased value.
Which path do you pursue? Keep pat to maximise the funding a number of? Or double right down to $16m and juice the holding worth – the whole worth of the place?
This is among the core strategic questions enterprise companies debate.
Within the final ten years, the dominant technique has been optimizing the holding worth. Valuation multiples expanded; the general public market lapped up excessive development expertise corporations; acquirers devoured others at premium costs. Particular function autos, development/alternative funds, LPs investing immediately alongside VCs – these are all ways to optimize holding worth.
The latest 60% correction within the public market may compel you to contemplate a unique view than the dominant one within the final decade.
What if the third spherical is a down spherical? Your funding a number of will compress and it’s possible you’ll be compelled to speculate extra to keep up your possession – referred to as a pay-to-play provision. Your nice return may degrade to a mediocre final result as a consequence. Investing $24m to get a 3x isn’t unhealthy in absolute phrases, however a far cry from the glory of your latest dwelling workplace rodeo.
Fund measurement ought to issue into the choice. Suppose your fund is $75m. This funding, which is about 10% of the fund, will return the fund. Sensational.
Make investments one other 16m and 30% of your fund rides on one firm. Is that clever? It is dependent upon your outlook and confidence within the enterprise (and whether or not your LP Settlement permits it).
Fairly than doubling down, you can allocate these $8m to a brand new funding in an earlier stage firm at a decrease valuation. Which choice will generate a greater return?
The larger your confidence in secure costs within the fundraising market, the extra possible you might be to double down. The much less assured, the larger your reservations about reserves.
The way you reply this query for each firm will affect your fund’s final efficiency and how typically you’ll be chewing gravel or be ace-high celebrating in your steed.
