John Felix of Pattern Ventures has written an excellent X thread dissecting the important topic of reserves in early-stage VC:
Here’s my 2 cents on it:
For emerging managers running smaller, early-stage funds, the biggest challenge with effectively deploying reserves is a lack of access to adequate & updated information on how the business is *really* doing.
Series A & beyond firms have well-defined information rights and get data from the company on a regular cadence via board meetings, monthly update calls, or investor update emails.
As micro-funds writing $100-500K checks into pre-seed & seed rounds (often on SAFEs), we are at the mercy of the founder in terms of what they choose to share with us.
Even if one works hard to build a relationship with the founder via adding value, the real underlying health of the business still gets communicated either extremely passively (via intermittent emails) or in person with a significant lag (say, a lunch or dinner every 6 months, which is like dog years in today’s tech cycle).
So even if an emerging manager would love to double down on likely winners (& it also makes sense from a portfolio construction perspective), I question their ability to effectively underwrite follow-on rounds under these constraints.
In this scenario, it ends up being either blindly following an external signal (“Tier 1 VC is doing the round, so it must be a good company”) or a gut (emotional?) call on the founder/ market (“I just love this founder and believe they will build an amazing company”).
Neither of these is an analytically rigorous way of deploying follow-on dollars.
Perhaps for emerging managers running smaller pre-seed/seed firms, the optimal answer is what Dave McClure had suggested some time back:
(1) Take as many shots on goal as possible with the 1st check, buying as much ownership as possible & at the lowest price possible.
(2) Instead of reserves, do one-off SPVs in significantly de-risked follow-on rounds (Series B & beyond).
PS: Benjamin Narasin of Tenacity recently shared some great insights around portfolio construction on an episode of the Team Ignite Ventures podcast.
After spending more than 2 decades in venture, here’s Ben’s portfolio construction:
- Tenacity Fund I: $60M
- $1-3M avg. checks, 10-20% ownership (am guessing ~30-40 companies?)
- One-and-done first checks, no reserves, pro-rata rights passed on to LPs
