What your follow-on rate says about your firm

The number that actually distinguishes firms

Two funds can hold identical reserve percentages and behave nothing alike. One puts follow-on money into most of its portfolio in small amounts. The other puts it into a handful of companies in large amounts. Same reserve, opposite strategies, and the reserve figure discloses neither.

What does disclose it is the follow-on rate: the share of portfolio companies that receive additional capital, and how concentrated those cheques are. That pair is close to a signature, because it encodes the firm's honest answer to a question it rarely states out loud.

What the typical shape looks like

Across the Blue Future Partners survey of emerging managers, the number of companies receiving a follow-on drops by roughly half at each successive round, while the median follow-on cheque rises about 78 percent above the previous one. The characteristic shape is a narrowing funnel with a rising cheque: fewer companies, more money each.

Some of that narrowing is not a choice. CB Insights tracked more than 1,100 US companies that raised seed rounds between 2008 and 2010 and found 48 percent reaching a Series A, around 30 percent a Series B, and 15 percent a Series C, with nearly 67 percent stalling somewhere without exiting or raising again. A fund cannot follow into a round that never happens. Roughly half the narrowing in any firm's follow-on rate is simply the market's own attrition.

The remainder is the firm. And separating the two is the whole exercise: a firm following into 20 percent of its portfolio in a market where 48 percent raise again has made a real selection decision. A firm following into 45 percent has essentially followed everyone who was able to raise.

Two coherent positions

The most instructive thing about this question is that the two most articulate practitioners on it reach opposite conclusions, and both are internally consistent.

Charles Hudson took the empirical route. His firm classified every follow-on cheque it had ever written as either offence, meaning they wanted more of a company they believed in, or defence, meaning something else, usually a bridge for a company that needed one. The audit found both categories were called correctly about 75 to 80 percent of the time, which is a genuinely high hit rate. His conclusion was not to do more of both but to separate them sharply: be aggressive on offence, and write the smallest cheque possible, including zero, on defence. His firm reserved about a quarter of the fund and kept it for roughly the top fifth of the portfolio.

Eric Paley took the structural route to the opposite answer. His position is that venture funds are made on the first cheque and destroyed on the follow-on cheques. The argument is about cost basis: a seed fund that reserves heavily ends up with a weighted average cost basis at Series B prices while still describing itself as a seed investor, which forfeits the one structural advantage seed investing has. The first cheque, he argues, is the highest-returning cheque any fund writes, and capital moved out of first cheques and into later ones is capital moved to a worse price.

These are not really in conflict. Hudson is describing a firm that has measured its own selection ability and found it good. Paley is describing what happens to a firm that has not, or has and found otherwise. Both are coherent; they are answers to the same question from firms with different honest answers about themselves.

What the signature encodes

Read together, a firm's follow-on rate and cheque concentration say how much it trusts its own judgment at the moment it has to exercise it, which is considerably earlier than anyone would like.

A high rate with small cheques is a firm buying optionality across the portfolio. It is a coherent position, and what it says is that the firm does not believe it can pick the winner yet and would rather stay in the game broadly. A low rate with large cheques is the opposite claim, and it is equally coherent: this firm believes it knows, and is willing to be measured on that. Hudson's firm sits here. So, in a sense, does Paley's, at the limit where the rate approaches zero.

The incoherent combinations are the informative ones. A high follow-on rate with large cheques is a firm that has not chosen, and it runs out of capital; what that looks like has its own page. A large reserve with a low follow-on rate is the quieter failure: capital held back for years, never deployed, and returned at the end having earned nothing while the management fee was charged on it throughout.

Where the model reads it

The platform records follow-on rounds against each position, so a firm's realized follow-on rate and the shape of its cheques are visible in its own data rather than in a survey. That record is what turns this from an abstraction into something a General Partner can check: how many companies actually received a second cheque, how large those cheques were relative to the first, and how that compares to what the fund said it would do.

The model does not score the answer. There is no correct follow-on rate, and a firm at either pole is doing something defensible. What the model surfaces is whether the realized pattern matches the declared reserve strategy, because that gap is where the number stops being a signature and starts being a drift.

Sources

• An LP take on VC portfolio constructionRodrigo Ferreira, Blue Future Partners, published on OpenVCThe shape of follow-on behaviour across sixty-plus emerging managers: how participation narrows by round and how cheque sizes move.
• The Venture Capital FunnelCB InsightsRound-by-round survival for more than 1,100 US seed companies from the 2008 to 2010 cohorts, tracked through 2018.
• Lessons from 600+ Investments, Founder Profiles that Win, Reserve Strategies that Drive Returns, and the Hidden Potential in Consumer StandoutsCharles Hudson on The Full Ratchet, episode 488The offence and defence audit of every follow-on cheque the firm had written.
• Dispelling Conventional Wisdom in VC, Part 2: Should Seed Investors Follow-on?Eric Paley on The Full Ratchet, episode 136The case that heavy follow-on drags a seed fund's cost basis to Series B levels.