Follow-On Investment
A follow-on investment is money an existing investor puts into a company's later round — exercising its pro-rata right to keep its stake, or investing more to increase it — from reserves the fund set aside when it first invested. Follow-ons are how venture funds concentrate capital in their winners, how founders read which investors believe in them, and what a new lead investor watches before it commits.
- Also known as
- Follow-on, Follow-on round, Reserves
- Used at
- every round after an investor's first; typically half of a venture fund's capital is reserved for follow-ons into its existing portfolio
- Binding
- the pro-rata right in the shareholders' agreement gives the option; the fund's reserves policy decides whether it is taken
- Typical reserve
- 1–2× the initial investment for seed funds, 1× for later-stage; the reserve is allocated to the companies that are working and withheld from the ones that are not
- Typical signal
- an existing investor taking its full pro-rata is a positive the new lead reads; one declining is a question the new lead asks; one leading the round itself (an "inside round") is either strong conviction or a lack of outside interest
- Parties
- the existing investors and their reserves, the founders, and the new lead, who prices partly on what the insiders do
How follow-on investment works in practice
A seed fund invests €1m in a company at a €10m post-money — 10%. The company raises a Series A of €8m at €32m pre-money. The fund's pro-rata is 10% of the round, €800,000, which keeps its stake at 10%; it can take less and be diluted, or, if the lead allows, more. The fund has reserved €1.5m for this company and takes the full pro-rata. At the Series B, €20m at €80m pre, its pro-rata is €2m; it has €700,000 left and takes that, diluting to 8.6%. At the C it has nothing left and dilutes to 7%. Its €2.5m invested is worth €14m at the C price — the follow-ons doubled its money in the company against what the initial cheque alone would have held.
Reserves policy is the fund's portfolio discipline. Follow-on into every company and the fund's return is the average; follow-on into the winners and starve the rest and the return is the winners'. Funds therefore decide follow-ons company by company, and a decision not to follow is a decision — one the founders learn from the term sheet and the new lead learns from the cap table.
In fintech rounds the follow-on has a regulatory shadow: an investor whose stake crosses 10% through follow-ons becomes a controller, and the regulator's approval is required before, not after.
Example
A Series A fund with 20% of a lending fintech and €4m of reserves faces the Series B: €25m at €75m pre-money, pro-rata €5m. Its options: take €4m (diluting to 19%); take €5m by borrowing €1m from another portfolio company's reserve; or take nothing and dilute to 15%. The company's metrics are ahead of plan and the new lead has asked whether insiders are "supportive". The fund takes the full €5m, reallocating €1m from a company it has decided not to bridge. Two years later the fintech sells for €400m: the fund's 19% is €76m on €9m invested; the €5m follow-on alone returned €38m. The company whose reserve was reallocated closed eight months later, which was why the reserve was available.
Common mistakes
- Following on into every company pro rata, so the reserves go to the average rather than the winners. - Reserves exhausted at the Series A so the fund cannot support the B, and the new lead reads the absence. - Founders treating an insider's follow-on as an entitlement rather than a decision. - An insider follow-on that crosses a control threshold without the regulator's prior approval. - New leads pricing an inside round as validation when the insiders were the only bidders.