Category Archives: dry powder

Venture Capital Syndicates

I’ve written before about how tough markets like this really separate the wheat from the chaff within a company. As if your company were a foxhole, you get to see who stays to fight by your side and who runs to another foxhole with more protection; or worse, who runs away from the fight altogether looking for a safe desk job far from the battlefield.

My past posts were more about people within a company, but a similar test of commitment happens within investor syndicates. Most entrepreneurs I’ve met focus on picking their lead investor, but spend little attention on the long-term strength/weakness of the syndicate that forms around that lead. As an investor that typically leads deals, Inflexion spends considerable time and diligence architecting the syndicates in our deals. Most of the time, we select investors we’ve built companies with before, but every now and then we partner with a fund for the first time. That requires a bit more diligence and we look for, at least, the following four things:

1) Value-add: Relevant investing or operating experience for the opportunity. Beyond the dollars, syndicates are about bringing value-add to a portfolio company thru experience and relationships.
2) Congruence: A POV on the opportunity that’s consistent with the entrepreneur and lead investor. Although a quality syndicate requires diversity of experiences and networks, divergent views on the “big opportunity” can be a huge time/resource sink.
3) Dry Powder: A fund size, age and reserve philosophy that suggests they won’t get “over their skis” prematurely. We’d rather a co-investor put in less money up front and reserve appropriately (2X-5X), than go heavy early, leaving little dry powder for critical later rounds.
4) Consistency: A track record of consistent operating and financial decision-making. A co-investor that provides inconsistent guidance can wreak havoc at a board level, and a hair-trigger between greed and fear will whipsaw entrepreneurs and co-investors alike. In the unpredictable world of early-stage venture capital, co-investor consistency is an absolute must.

There are plenty of other factors, like investing style (west coast vs. east coast, home-runs vs. doubles), but those four are at the top of my list. I only want investors in my foxhole who will add significant value beyond their dollars, see the same “big opportunity”, reserve dollars to play when entrepreneurs really need them, and behave in a consistent manner we can rely upon — particularly in tough times. I don’t always get that mix right, but it’s my job as lead investor and commitment to my entrepreneurs to try.

Dry Powder = Venture Capital Reserves

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?