Do You Still ❤️ Me?
When times are good and term sheets are flowing, founders don’t think a lot about whether or not their investors will follow-on in the future. But in times like these, when the pace of deals is slowing, it’s essential that founders know where they stand with their investors. And most don’t have a clue.
For many founders, asking an existing investor if they’re willing to follow-on is as intimidating and awkward as asking a partner if they still love you.
What if they say no…?
For others, the need to ask at all seems preposterous.
Of course, they still love me! Of course, they’ll follow-on…
As with any relationship, it’s important to check with your investors in on a regular basis. Unfortunately, the topic of follow-on investment rarely comes up during founder-investor check-ins. Only a handful of founders I’ve ever worked with have asked me about follow-on investment outside of an active fundraising process.
In startups, as in life, we usually don’t talk about money until we need more.
Let’s have “The Talk”
For each investor on the cap table, founders should know the answer to two questions:
What is your follow-on policy? (Under what conditions, if any, would you consider a follow-on investment -- and how much would that investment be?)
Where do I currently stand with you? (If I were to raise money today, would you invest?)
The answers to both of these questions can change over time — so you should check in on this periodically. VCs will generally have a consistent policy, but where you stand with them may ebb and flow. Angel investors, on the other hand, can vary wildly. Most don’t have a firm “policy” and where you stand can change both as a result of your progress and their personal financial situation.
Here are some questions that you can use as the basis for “the talk”:
Can you tell me what your follow-on policy is?
When we raise our next round, will you follow-on?
Under what conditions would you consider following on?
If we needed an injection of capital today, would you participate?
What percentage of companies do you follow-on with, and under what conditions?
Will you lead or participate in a bridge round?
If you haven’t explicitly asked your investors some variation of the above questions, consider doing so next time you speak with them (and not just with VCs, but all of your investors). Ideally, you should maintain a tally of where you stand with each investor and the total amount of capital available from existing investors under various scenarios.
The Answer Is Probably “No”
Here’s the tough part: for the vast majority of startups, under most scenarios the answer to these questions will be “no.”
The reality is that most angel investors don’t follow-on. Many VCs only follow-on when there’s a new lead investor. And even investors who do follow-on can’t do so with all of their investments.
This can seem really unfair. As founders, we long to believe that our investors will “have our backs” no matter what, but the reality is that very few investors (VCs or angels) have the ability to do that financially. Part of this is limited resources. Part of this is investment strategy.
A typical VC investment strategy
For VCs, in particular, follow-on decisions are driven in large part by a formal investment strategy that was decided long before they met you. Sometimes that strategy involves multiple rounds of investment, but frequently it doesn’t. And even when it does, it’s often only in the case of “up rounds” (rounds led at a higher valuation, typically by a new investor). So don’t be surprised if you check in with an investor, only to be told “we don’t do follow-on investments” or “we don’t do bridge rounds.” A lot of investors don’t.
For those who do, they generally only follow-on with a subset of their portfolio. A Seed VC’s investment strategy might look like this:
We will invest in 20 Seed-stage companies over three years. Of those companies, we will set aside funds to do our Series A pro rata in 10 companies and participate in extensions / bridges for up to 3.
What this means is that if more companies need bridges/extensions than the investor has the capacity for (which is often the case), the founders are competing with other companies in the portfolio for that follow-on investment.
What are you Really Saying?
When an investor with the ability to follow-on chooses not to, it means one of three things:
They have lost confidence in the company
They have not lost confidence in the company, but they don’t believe that further investment will change the outcome
They have not lost confidence in the company, but they believe that they will generate better returns by allocating the follow-on capital to a different company
If an investor tells you that they’re not (currently) willing to invest further, don’t be afraid to ask for an explanation. It’s likely to be an awkward conversation, but if done in a professional manner, it can lead to some potentially impactful insights
At one point when I was running DataHero, I spoke with our lead investor (Ryan McIntyre from Foundry Group) about their feelings on the company. He admitted that they were mixed. What followed was a very honest – and difficult – conversation, in which he shared that he did not have full confidence in me as a CEO, due in large part to how I managed board meetings. This caused me to re-evaluate certain aspects of my communication style and how I ran board meetings.
Ultimately, Foundry led both our Seed and Series A rounds.
Most investors are more than willing to explain in detail their follow-on policy and where you currently stand -- but they generally won’t unless asked. As a founder, this is crucial information and I encourage you to ask these questions of all of your investors.
We Won’t Follow-on Does Not Mean We Don’t Love You
This is a really, really important point.
Far too many founders, when told by an investor that they won’t follow-on, react with anger or frustration. Being told by an investor that they won’t invest further can feel like rejection.
You don’t love me anymore!
This is the point at which cynics react with arguments about VCs “showing their true stripes,” only investing when times are good, etc. I find this to be an incredibly unhelpful perspective, because it only reinforces the anger and resentment felt by founders going through tough times. While a “no” can certainly represent a loss of confidence by the investor in some cases, oftentimes a follow-on investment was never actually in the cards.
Regardless, an investor telling you that they won’t follow-on with additional funding does not mean that they’re abandoning you.
Investors want you to succeed – their returns depend on it. Whatever resources they were providing you before “the talk” (time, mentorship, introductions, etc.) are still available after. I’ve seen far too many founders react to the perceived slight of an investor saying no by turning away completely from the investor. That’s generally not the best course of action.
None of this is Easy
Let’s be clear – nothing about this is easy. It’s a difficult topic that strikes at the heart of the often-significant gap between the expectations of founders and investors. But it doesn’t need to be that way. Knowledge is power and, in my humble opinion, you’re far better off knowing where your investors stand in terms of follow-on investing long before you need the money.
So if you haven’t already, reach out to your investors (all of them!) and ask where they stand.
