Evaluate every check, including follow-on investments, independently from prior commitments. The decision should be based solely on the current risk-adjusted value of that capital, not on past investments, which prevents throwing good money after bad.
Related Insights
Entrepreneurs often get burned by a failed investment (like a bad ad agency) and become hesitant to invest in that area again. This is a cognitive trap. The first loss was the money spent; the second, more significant loss is the opportunity cost of not trying again with a better strategy.
Small funds and solo GPs can gain an edge by not reserving capital for follow-on rounds. This strategy enforces discipline, avoids cognitive biases like sunk cost, and recognizes that the skill set for pre-seed diligence is fundamentally different from that required for later-stage investments.
To avoid confirmation bias and make disciplined capital allocation decisions, investors should treat every follow-on opportunity in a portfolio company as if it were a brand-new deal. This involves a full 're-underwriting' process, assessing the current state and future potential without prejudice from past involvement.
To avoid emotional, performance-chasing mistakes, write down your selling criteria in advance and intentionally exclude recent performance from the list. This forces a focus on more rational reasons, such as a broken investment thesis, manager changes, excessive fees, or shifting personal goals, thereby preventing reactionary decisions based on market noise.
To avoid emotional spending that kills runway, analyze every major decision through three financial scenarios. A 'bear' case (e.g., revenue drops 10%), 'base' case (plan holds), and 'bull' case (revenue grows 10%). This sobering framework forces you to quantify risk and compare alternatives objectively before committing capital.
Deciding whether to invest more capital into a struggling portfolio company is a major point of conflict. The management team advocates strongly for the infusion, believing it can turn things around. However, investor experience shows that such 'bridge' rounds are rarely successful, making it a difficult decision.
Before committing capital, professional investors rigorously challenge their own assumptions. They actively ask, "If I'm wrong, why?" This process of stress-testing an idea helps avoid costly mistakes and strengthens the final thesis.
Objectively track whether new information strengthens or weakens your belief in each holding on a monthly basis. This simple journaling practice forces a regular review, helping you decide whether to add capital or trim a position based on fundamentals, not share price movement.
A core discipline from risk arbitrage is to precisely understand and quantify the potential downside before investing. By knowing exactly 'why we're going to lose money' and what that loss looks like, investors can better set probabilities and make more disciplined, unemotional decisions.
To combat endowment effect and status quo bias, legendary trader Paul Tudor Jones advises viewing every position as if you were deciding to put it on today. This creates a zero-based mindset, forcing you to justify each holding's continued place in your portfolio.
