Follow-on Investment

A follow-on investment is an additional investment by an existing investor in a later financing round. The investor increases their exposure instead of participating only in the first round. This allows them to maintain their stake and benefit more strongly from further development. Pro-rata rights make this possible, entitling the investor to participate proportionally in later rounds and defend its percentage. Without participating it is diluted like every other existing shareholder.

From a venture fund's perspective managing these reserves is among the most important decisions of all: a substantial part of fund capital is set aside for follow-ons from the outset, often on a similar scale to initial investments, because portfolio returns depend less on the number of first cheques than on consistently increasing exposure to the winners. The hardest question is the boundary with throwing good money after bad: putting further capital into a weak company simply because money has already gone in is a classic fallacy, which is why professional investors assess every follow-on as if it were a new investment. For the company, existing investors' willingness is a powerful external signal: if they do not participate, attracting new capital becomes considerably harder.

In buyout funds the same question appears in a different form, as additional equity for a platform's acquisitions. A simple test has proven useful in individual decisions: would one invest in this company for the first time today, not already being a shareholder and knowing the current figures? If the answer is negative, additional capital is as a rule not justified, regardless of the amount already invested. It should also be checked whether participating is necessary to retain preferential rights, since pay-to-play provisions can cause protective rights to lapse on non-participation.