Now that Inflexion Fund is well into it’s life, I spent some time today reviewing how our reserve approach is working out across the portfolio (short answer: great). When I say reserves, I mean the amount of money or “dry powder” a fund mentally reserves for follow-on rounds in their companies. It’s a concept that isn’t immediately obvious to some entrepreneurs and even many investors.
As an early stage investor, I like to reserve at least $2 for every $1 of initial investment. Many funds focus on a $1 to $1 reserve and some funds may hold as much as $10 dry powder behind their initial $1 invested. Entrepreneurs would do well to ask potential investors about their reserve approach (as part of their overall investing strategy).
In particular, if an investor stumbles on the question or holds minimal reserves (or zero), consider it a big red flag. It typically means the investor hasn’t done enough early-stage investing or they just sprinkle money around with a goal of heavying up in only one or two favorites. Their money is still green, but you might have mismatched expectations going forward — especially when you need that extra little support that the investor never budgeted for. An investor that doesn’t reserve properly can also impact your ability to raise future capital, because lack of insider reserves can signal weakness to new investors.
So, have you faced this issue before? What happened?