Strategies for Optimal Follow-On Investments
Best Practices From Hundreds of Fund Managers
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Brought to you by Tactyc - Forecasting and Planning for Data-Driven VCs
Tactyc is used by over 400 funds globally for Portfolio Modeling, Portfolio Management and Reporting.
The platform enables funds to build a rock-solid construction plan in minutes and update it with actual investments to evaluate how performance deviates from plan. Managers can model individual deals, strategize reserves and evaluate exit scenarios for each deal along with tracking company performance and KPIs.
Tactyc generates actionable insight to enable data-driven capital allocation decisions and LP-ready reports such as company tearsheets to simplify the reporting process.
Today, I’m excited to have Anubhav Srivastava, Founder and CEO of Tactyc contribute a guest post to explore what data-driven approaches beyond sourcing, screening, and due diligence can look like.
Thank you Anubhav for sharing how modern investors can leverage data-driven approaches to improve follow-on allocations below.
Post-launch, a fund manager’s focus shifts from portfolio construction to active portfolio management — and a frequent pain point is follow-on reserve sizing on active deals. Most managers grapple with optimal follow-on reserve for a deal and oftentimes struggle to determine how follow-on reserves should change over time.
We’ve surveyed the best practices of hundreds of emerging managers and in this post, we shed light on the quantitative frameworks used to answer both of these questions.
Misconceptions About Follow-On Investments
Before we begin, let’s address a few misconceptions we’ve seen regarding follow-on strategies:
Most managers take a balanced approach — they’ll follow on in deals where the managers continue to have conviction while passing on a few where the exit expectations have drastically reduced.
We’ve noticed that the decision to follow on is frequently sentiment-driven. Managers may “fall in love” with a deal, fall prey to the sunk cost fallacy, or make follow-on investments based on their relationships with founders.
Optimal Follow-On Investment Workflow
To avoid these pitfalls, we’ve noticed most successful data-driven managers follow a quantitative workflow that periodically takes into account a company’s expected performance to size reserves, rebalance reserves, and eventually deploy reserves.
This is what the workflow looks like:
Executing the above workflow in action requires a bit of math. This is where Tactyc comes in — a portfolio scenario-planning platform that automatically executes this workflow.
The Workflow in Action
Let’s say we’ve made a $1.5M seed investment in Company X — and our underwrite case expects the company to exit at a $150mm valuation. We’ve built the underwrite case in Tactyc as follows: