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The Power of Reinvestment in the Venture Capital World

Shalom Nahum, Itzik Nahum

February 5, 2025

Introduction

Over the past decade, our research into hundreds of funds’ investment models revealed that funds practicing reinvestment often achieved over 3x TVPI for their LPs. At SerVC and ORCA, we analyzed various scenarios to demonstrate the significant impact of reinvestment. A key challenge to implementing reinvestment effectively is that fund expenses typically consume about 20% of the total commitment, leaving only 80% available for investment. This article highlights the benefits of reinvestment and shows how it can significantly enhance your fund's performance.

Understanding Reinvestment

Reinvestment involves putting the proceeds received from sold portfolio companies back into the fund, rather than distributing them to investors immediately. The Limited Partnership Agreement (LPA) typically sets limits on the reinvestment amount, with common practice allowing investment between 100% and 120% of the commitment. Usually, funds are only able to invest around 80% of their commitment, as 20% is budgeted for expenses.

There are a few main reasons why reinvestment is an important strategy to implement. The primary advantage of reinvestment is that it allows you to invest the entire commitment of the fund (or slightly more according to your LPA). It is comparable to raising additional capital for the fund, providing you with more resources, mainly for additional follow-on investments. Reinvestment can also increase your total investment in the portfolio companies by up to 50%, allowing you to capitalize on your winning companies. Additionally, investors expect 100% of their commitment to be invested. Although this is an unrealistic expectation since the fund has expenses, it’s one that can be achieved with reinvestment. Lastly, it can significantly increase your fund multiple. The details will be discussed further below.

Why planning Matters?

The biggest challenge of reinvesting is timing. Since we cannot time exits, the proceeds from the sale of the first portfolio company often arrive too late, after the investment period has ended. This causes two issues: 1) The fund is not allowed to invest in new companies and therefore must invest their follow-on in existing companies and 2) The valuation of existing companies you want to double down on is already too high. Therefore, when working on the initial investment model of the fund, which can be efficiently done using ORCA VC software, you might want to consider making one or two later-stage investments at the beginning of the fund, to increase your chances of reinvesting successfully. This is how proper planning ensures your fund is ready to seize these opportunities and make the most of reinvestment.

Scenario Analysis: The Impact of Reinvestment

To show the power of reinvestment, we created a simple scenario based on a $100 million fund with 20% expenses over it’s lifetime achieving a 4x return on its portfolio. Here’s a quick comparison:

As we see in the chart above, reinvesting $20M increases the fund multiple from 2.76 to 3.40. This is a significant overall improvement that will impress your investors.

Sensitivity Analysis

To assess how reinvesting affects fund performance, we conducted a sensitivity analysis on the reinvested capital. We examined how varying the reinvestment amount and its potential multiple, whether low or high, directly influences overall returns. The results show a clear correlation: smart reinvesting can significantly boost returns.

In the chart below, you can see that even a small increase in the multiple on reinvested amounts can significantly boost the fund's net multiple. For instance, reinvesting at 110% with a 2x multiple on the reinvested amount raises the net multiple from 2.76x to 3.00x net to the LPs.

Suggested Strategy for Modeling and Managing Reinvestment

To optimize your fund's potential for reinvestment, consider the following steps:

Plan for a strategic early investment
1. Initial Investments: Begin by making one or two later-stage investments early in the fund's life cycle, focusing on companies with strong potential for quick M&A exits. This strategy increases the likelihood of generating early proceeds that can be reinvested.
2. First Alternative Approach: Begin by making one or two early-stage investments, focusing on companies with strong potential for quick acquisition. You can concentrate on industries where companies have already been acquired by a large company, and competitors may look for similar acquisitions. This strategy increases the likelihood of generating early proceeds that can be reinvested.
3. Second Alternative Approach: If you find yourself in a situation where one company is in the "Hype zone" and receiving what you consider to be bubble valuations, you can sell a small portion of your stake through a secondary sale to take advantage of the high valuation. You can then reinvest the proceeds.
Reinvest Proceeds Deliberately: Allocate the first 1-2 proceeds from exits and reserve them for potential follow-on investments in your top portfolio companies. Since about 30% of portfolio companies typically provide over 80% of the fund’s proceeds, reinvesting in the later stages of your top two companies can significantly enhance the fund’s overall performance while also reducing risk.

Conclusion

Reinvestment is a powerful strategy in venture capital, offering a clear path to enhanced fund performance and provide superior returns. At SerVC and ORCA, our scenarios and analyses highlight the transformative potential of strategic reinvestment.

Here are our main insights from this research:

These days, raising new funds for VCs is a significant challenge. Reinvesting is comparable to raising additional capital for the fund. It can increase your total investment in the portfolio by up to 50% (allowing you to invest 120% of the commitment compared to just 80% without reinvestment).
Most of the investors we've spoken with expect their investment in the fund to deploy at least 100% of its commitment, which effectively means reinvesting the amount spent on expenses.
Since 80% of VC proceeds are generated by the top-performing companies, reinvesting in the later stages of those companies can increase the fund’s multiple while reducing risk.
Reinvestment can meaningfully increase your TVPI, even if the reinvestment amount doesn’t perform as high as the fund.

To receive the Excel model with insights on how our strategies can optimize your fund’s performance, press the button below. We’d be happy to connect and discuss how we can enhance your fund’s reinvestment strategy.

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The Power of Reinvestment in the Venture Capital World

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