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Rethinking Follow-On Investments in Seed-Stage VC Funds

  • dzaidi
  • Mar 31
  • 14 min read






The Conventional Wisdom: Double Down on Winners

In early-stage venture capital, the prevailing wisdom is that securing follow-on investments (pro rata allocations in later rounds) is crucial to boosting fund returns. Seed and pre-seed fund managers commonly reserve a significant portion of their fund (often 40–60%) for follow-ons, aiming to “double down” on portfolio winners​.


The logic is straightforward: by investing more in startups that show promise, a fund can increase its ownership in the eventual big successes, leveraging insider knowledge to make an informed bet​. Indeed, many LPs expect GPs to have a follow-on strategy, and managers often fight hard for pro-rata rights in seed deal. In theory, follow-ons should be de-risked – the seed investor has a close relationship with the team and better insight into the company’s traction, so any additional capital is deployed with greater confidence than the initial check​.


However, while this strategy is intuitively appealing, is always following on truly optimal for seed funds? Recent data and research suggest that the “always follow your winners” mantra may not universally maximize fund performance. There are scenarios where heavy follow-on participation can dampen returns, introduce opportunity costs, or even lead to adverse selection in the portfolio. Below, we examine empirical evidence – from simulated portfolio models to actual fund outcomes – to evaluate when follow-on strategies help or hurt seed-fund performance in the U.S. venture market.


Simulation Evidence: Follow-On vs. Spray-and-Pray

A fascinating study by AngelList’s head of data science, Abraham Othman, simulated 10,000 seed-stage portfolios to compare follow-on strategies​. The simulation considered three approaches for a seed investor deploying a fixed amount of capital annually:

  • Never Follow-On: Invest in new seed deals only (a “spray-and-pray” strategy, with zero reserves)

  • Always Follow-On: Always invest pro rata in a company’s Series A if available, using some fund capital that otherwise could have gone to new deals

  • Selective Follow-On (“Double Down on Winners”): Only follow on when the startup’s value at Series A has at least doubled since the seed round​


Crucially, because total capital is fixed, any dollar put into a follow-on is a dollar not spent on a new seed investment. This introduces a trade-off between concentrating capital in apparent winners versus spreading bets to catch more new opportunities. The results of Othman’s simulation are insightful: not following on had the highest typical returns. The “Never Follow” strategy produced the highest median fund outcome across simulations, and it beat the other strategies in head-to-head comparisons most of the time​. By contrast, “Always Follow” yielded a higher mean return, but its performance was skewed by occasional big winners​. In other words, always following creates a more volatile outcome – it can pay off spectacularly in the rare cases you back an outlier success through multiple rounds, but in most cases it underperforms a broader seed-only approach.


Why would adding more money to winners often reduce median performance? The simulation highlights an opportunity cost to follow-ons. In many runs, a fund that reserved capital for follow-ons missed out on investing in an additional new seed deal that could have been the next big hit​. The data showed that unless a seed fund was lucky enough to be in one of the top few companies of the entire cohort, the forgone new investment often would have been more valuable than the follow-on check​. Put simply, if your follow-on capital isn’t placed into a true outlier, you might have been better off using that money to fund the next seed deal in your pipeline. This dynamic was illustrated by a cluster of simulated portfolios where the “Always Follow” strategy actually missed the biggest winner in the market due to capital being tied up in earlier follow-ons – those portfolios saw lower returns than a “never follow” approach that remained flexible​.



Notably, Othman’s study found that a hybrid strategy of selectively “doubling down” only when the seed investment had doubled in value didn’t clearly outperform the extremes​. The selective approach had outcomes very close to the all-or-nothing strategies, suggesting that reliably picking only the future stars is extremely hard in practice. Overall, the simulation results pointed to a sobering conclusion: absent perfect foresight, a broadly diversified seed portfolio (i.e. no follow-ons, more new bets) tended to outperform or match the alternatives in most scenarios​. The benefit of follow-ons mostly appeared in cases where an investor managed to participate in a massive winner, which is the exception rather than the rule.


The AngelList finding is backed up by power-law math. Seed returns are extremely skewed – a few investments generate most of the returns​ . If you spread your bets widely, you maximize the chance of including those big outliers in your fund. If instead you concentrate capital via follow-ons, you’re effectively betting on fewer total companies, which raises the risk that you pick wrong and miss the outliers. As Othman put it, any selective policy, without perfect prediction, is likely to be outperformed eventually by an indexing approach that buys “every credible deal”​. In venture, more shots on goal can trump trying to sharpen your aim, given how unpredictable breakout success can be.


The Hidden Cost of Reserves: Portfolio Drag and Dilution of Returns

If follow-ons are not consistently lifting performance, why not? One reason is that maintaining large reserve allocations can introduce portfolio drag on a fund’s returns. A 2022 analysis by Sapphire Partners termed it the “dirty secret” of venture reserves: while reserves sometimes boost returns, they more frequently drag down fund multiples​. The rationale is straightforward arithmetic. When a seed fund sets aside, say, 50% of its capital for follow-ons, it’s essentially running a fund twice the size of its initial-check portfolio. To generate the same overall fund multiple, those reserve dollars need to earn as high a return as the seed dollars. In practice, that’s hard to achieve. If the reserves only produce mediocre outcomes (say 1–2× return on those follow-on checks), the weight of that capital pulls down the fund’s total multiple​.


Sapphire’s team found that many early-stage funds indeed see this effect. They observed that in their portfolio of VC managers, outperformance almost always came from a few great companies – often one or two deals that returned 25×, 50×, or more – whereas the average outcome on the rest was about 1× (capital returned, at best)​. In such a power-law scenario, pouring a lot of reserve money into anything other than the big winners inevitably dilutes the overall return. If a GP “sprays” follow-on capital across many portfolio companies that reach Series A, the likely result is that some of those follow-on bets will only achieve 1–3× outcomes or even fail – mathematically lowering the fund’s composite multiple. For example, Sapphire modeled a “spread the wealth” follow-on strategy (follow on in 17 of 25 seed investments) and found it yielded about a 3.4× gross return on the reserve capital. This broad follow-on approach dragged a hypothetical fund’s gross multiple down from 5.5× to 4.5× (net TVPI dropping from 4.0× to ~3.3×) compared to a similar portfolio with no follow-ons​. In a worse scenario where the fund missed its one big winner but still deployed reserves to others, the model showed the fund’s net multiple plummeting to ~2.5×​. These scenarios vividly illustrate “portfolio drag”: unless follow-on dollars are largely concentrated in the highest-multiple outcomes, they reduce the fund’s overall return profile​.


Another often overlooked factor is how reserves raise the bar for success. Allocating follow-on capital effectively increases the denominator of a fund (total invested), so the exits need to be correspondingly larger to achieve the same multiple. For instance, a $50M seed fund that invests only in initial rounds might need a ~$660M exit (at ~7.5% ownership) to return the fund. But if that fund doubles to $100M with reserves, even if it increases ownership to 10%, it would require a $1 billion exit to return the fund​. In other words, by putting more dollars to work, the GP has to hit bigger home runs to avoid diluting performance. This math can work if reserves are funneled into true breakout companies – but if not, the result is a lot of extra capital coming back at just 1–2×, dragging on the multiple​.


It’s telling to note that GP incentives and LP outcomes can diverge here. Even if follow-ons reduce a fund’s TVPI (total value multiple), they can increase absolute carry dollars for the GP by virtue of deploying more capital. In Sapphire’s model, a scenario where follow-ons hurt the net multiple (dropping from 4.0× to 2.5×) still showed the GP’s carry pool increasing from $44M to $48M due to the larger investment base​. This potential conflict is one reason many LPs probe managers on their reserve strategy​. A heavy follow-on strategy means LPs are effectively betting on the GP’s ability to pick winners again at the A/B round – and if that bet is wrong, the LPs eat the downside of a lower multiple, while the GP might still collect more fees and carry on a bigger fund. Savvy LPs know that reserves can be a double-edged sword, and they often prefer disciplined or modest follow-on approaches unless a GP has a proven edge in selecting follow-ons.


Opportunity Cost and Adverse Selection in Follow-Ons

Beyond pure return math, follow-on investing carries opportunity costs and potential adverse selection issues that can trip up seed fund managers. The opportunity cost is implicit in all the above: every dollar reserved for a follow-on round is a dollar not invested in a new startup. In a world where new high-potential startups are constantly emerging, holding back too much capital can mean fewer shots at finding the next unicorn. The AngelList simulation underscored this – some “always follow” portfolios missed out on the best seed deals in their simulation universe because their capital was tied up elsewhere​. Especially in periods of rapid startup formation, an overly aggressive follow-on program could mean under-investing in fresh deals, perhaps causing the fund to under-deploy into what might have been a top performer.


There is also a time opportunity cost: if follow-on rounds happen very quickly (as they did in the frothy market of 2020–2021), a seed fund may be forced to make Series A decisions only months after the seed round, sometimes before meaningful new data emerges​. In such cases, following on provides little informational advantage – you’re paying a higher price without much more certainty than you had at seed. Meanwhile, that capital could have been spent on another seed deal where you start at a much lower valuation. The current market has indeed slowed down this frenzy, but the principle remains: follow-ons are most valuable when they are based on clear evidence of traction, yet often the timing of rounds (and competitive pressure) doesn’t allow enough evidence to accrue​.


Adverse selection is another concern. In theory, a seed investor should have first and best access to invest in their outperforming companies. In practice, however, the hottest companies often have oversubscribed follow-on rounds led by brand-name VCs, leaving little room for seed funds beyond maybe their pro-rata. Those rounds also come with lofty valuations. PitchBook data shows that even at early stages, top-quartile startups command valuations more than double the median (e.g. a 75th-percentile Series A pre-money around $100M vs. a median of ~$46M)​. Buying into such a round means paying up, which can compress the eventual multiple on that follow-on investment. Thus, even when a seed fund holds a winner, fully exercising pro-rata might yield a lower ROI on the follow-on dollars (albeit still a good absolute outcome if the company keeps skyrocketing).


On the flip side, when a portfolio company is not setting the market on fire, a seed fund may find it has plenty of room (or even requests) to contribute follow-on capital – precisely because outside investors are less eager. This is the classic adverse selection problem: a fund may end up plowing reserves into its middling companies by default, since the stars don’t need the help or are too expensive to chase. Supporting a struggling portfolio company with an inside round might preserve its runway (and avoid a damaging signal of failure), but it often results in deploying good money after bad. As VC investor Eric Paley has pointed out, when things are going great, founders don’t really need their seed investors’ follow-on money (in fact, they may prefer to minimize insider participation to make room for value-adding new VCs). But when things are going poorly, the seed VC’s money is not enough to save the day – and they may be reluctant to invest anyway​. In other words, follow-on capital tends to be most welcome in scenarios where it’s least likely to generate huge returns. This adverse selection dynamic can lead to pro-rata allocations being underutilized or misallocated: the best companies limit insider upsizing, while the worst outcomes quietly absorb disproportionate time and reserves.


To be clear, having the option to follow on is still valuable. Seed investors gain a level of control and flexibility with pro-rata rights. The key question is how often exercising that option truly pays off. The data suggests it’s a minority of cases. Many veteran seed GPs recognize this and set their reserve strategies accordingly: some choose to reserve very little and focus on initial bets (avoiding any negative signal if they don’t follow on, because it’s their stated model), whereas others reserve more but are highly selective, investing follow-ons only in companies showing breakout metrics or securing top-tier lead investors. The worst outcomes seem to come from automatically following on across the board without regard to clear winner signals – that approach, as we saw, resembles scenario “B” in the Sapphire analysis (broad follow-ons yielding ~3× on reserve capital and shrinking the fund multiple)​.


Fund Size and Stage Matter: Small Funds, Higher Multiples

It’s instructive to zoom out and look at how fund size and stage focus correlate with performance in venture capital. Seed and pre-seed funds are typically smaller and target earlier-stage opportunities, while larger funds often spread into later rounds. Historical data indicates that smaller, early-stage funds have delivered higher returns on average – which aligns with the idea that taking more early-stage risk (and investing in more new companies) can pay off. According to Cambridge Associates data, U.S. early-stage VC funds (investing largely at seed/Series A) had a ~20% pooled IRR over a 10-year period, significantly outperforming later-stage funds which averaged around 12%​. Similarly, an analysis of 253 venture funds (pre-2019 vintages) showed a clear inverse relationship between fund size and returns. Funds under $100M (mostly seed-focused) had a mean TVPI of ~4.3×, whereas funds larger than $500M averaged only ~2.7× – with the small funds also exhibiting wider variance (higher risk/reward)​. In short, big returns tend to come from smaller funds that concentrate on early-stage bets, whereas mega-funds or later-stage funds produce more modest multiples.


Why is this relevant to follow-on strategy? Because an aggressive follow-on strategy can, in effect, make a seed fund act like a larger, later-stage fund. If a $50M seed fund holds half its capital for Series A and B rounds of its companies, its investment profile starts to resemble that of a later-stage investor on those dollars – with lower upside potential per dollar. The fund’s overall size (in terms of deployed capital across stages) grows, and its return profile likely shifts toward the mean of larger funds (lower multiple, lower variance). By contrast, a seed fund that focuses the bulk of its capital at the earliest stage stays “small” in spirit – it places more small bets that can each yield 50× or 100× if they hit. This isn’t just theory; we see it in practice with some acclaimed seed funds that achieved top-quartile or decile performance by running very concentrated initial portfolios and doing minimal follow-on, often ceding later rounds to bigger VCs. Their small fund size and strategy enabled outsized multiples when a few bets paid off. Of course, this comes with volatility – many small funds will flame out or barely return capital if they don’t hit an outlier. But for LPs seeking venture alpha, data suggests the risk/reward trade-off has historically been favorable in smaller, early-stage funds​.


It’s worth noting that the venture landscape has evolved: today, many seed funds address this by raising separate “opportunity funds” or side vehicles for follow-ons, so that the core seed fund’s performance isn’t diluted by large follow-on checks. This allows LPs to choose – they can participate in the upside of follow-ons via the opportunity fund if they believe in the GP’s access and judgment, or they can stick with the higher-risk, higher-multiple seed fund. The prevalence of such arrangements underlines the point that follow-on capital can fundamentally change the return calculus for a given fund.

Striking the Right Balance for Follow-On Strategy

So, are follow-on investments in seed funds “always optimal”? The evidence says no – not categorically. A follow-on strategy can add value when executed under the right conditions, but it is far from a guaranteed win and can even backfire. For seed and pre-seed fund managers, the optimal approach likely lies in a balanced, highly intentional reserves strategy rather than a reflexive “all-in” on every next round. Here are a few distilled insights for strategy:

  • Prioritize Finding Outliers: Ultimately, no amount of follow-on finesse will save a fund that doesn’t bet on big winners in the first place. Data from both AngelList and Sapphire finds that portfolios live or die by the presence of a few outliers​. Make sure your initial investment strategy maximizes exposure to high-potential deals – that’s the foundation. As one analysis put it, having more winning shots on goal at seed tends to beat pouring more money into known quantities​.


  • Reserve with Rigor (or Not at All): If you do allocate reserves, do so with a clear-eyed plan. The best use of reserves is to heavily back your future stars – which presupposes you can identify them early. If your edge or model doesn’t support that (and be honest – very few investors can consistently know which seed deals will be 100×), consider a smaller reserve pool or a fixed rule (e.g. only follow in X% of companies that meet defined traction milestones). The worst outcome is sprinkling follow-on money on many companies without conviction, as this almost guarantees average results that will underperform a no-follow strategy​. As the Sapphire analysis showed, reserves only accrete to performance if concentrated in the top outcomes​.


  • Be Mindful of “Winner’s Curse” Valuations: When you do follow on, pay attention to entry price. It’s easier to justify doubling down when the Series A valuation is reasonable relative to ultimate upside. But in hot markets, seed investors often face sky-high uprounds (the 75th percentile Series A in recent data was ~$100M pre-money​

    sapphireventures.com). At those prices, even a great company might only return a few × on a Series A investment. Ensure that follow-on checks clear a higher internal hurdle rate, since they usually have less magnitude of upside than your seed check did.


  • Avoid Follow-On Bias and Obligation: Don’t let fear of sending a bad signal or a sense of loyalty drive follow-on decisions. Many experienced seed GPs explicitly tell founders upfront that not investing in a later round should not be taken as a negative signal, because their model is to concentrate only on certain bets or to limit fund size. By managing expectations, they give themselves freedom to say no to follow-ons that don’t meet a high bar. Every underperforming follow-on you don’t do is capital that can go into a new deal or be saved for a truly standout company. As one VC quipped, when a portfolio company is flying high, it doesn’t need your extra money – and when it’s floundering, your extra money won’t save it​. In either case, following on for the wrong reasons is value-destructive for the fund.


  • Consider Externalizing the Follow-On: As mentioned, some seed managers raise opportunity funds or SPVs for later rounds. This can be a strategic way to let your LPs co-invest in winners without burdening the core fund. If your seed fund’s performance fees (carry) are meant to reward picking great seed deals, you might preserve that strategy, and separately offer follow-on allocations to LPs who want more exposure. This segregates the high-upside seed portfolio from the lower-risk follow-on capital, allowing each to be evaluated on its own merits. It can also mitigate the signaling issue (the company still gets follow-on support, just from a different pocket of money).


In summary, follow-on investing is not a one-size-fits-all boon for seed funds. The decision to follow on should be treated as a new investment decision subject to the same rigorous return potential criteria as any new deal – perhaps even stricter, since the easy upside has already been captured at seed. The empirical research suggests that defaulting to an automatic follow-on policy is suboptimal. Many seed funds would improve their median outcomes by either following on very selectively or not at all in most cases​. Of course, there will always be those few situations where doubling or tripling down on a winner yields spectacular results – and every GP hopes to have those. The trick is designing your fund strategy so that you don’t erode overall performance in pursuit of them.


For venture fund managers, the takeaway is to critically assess the true value of your follow-on rights. Are they an engine of outsized returns, or an insurance policy with a steep premium? By examining real data and not just industry lore, GPs can calibrate their follow-on strategy to strike the right balance between fueling winners and fueling overall fund success. In the end, the goal is to maximize your fund’s return to LPs, not necessarily to max out your ownership in every company. Sometimes the best follow-on decision is to pass – and let your seed winners ride with someone else’s money, while you hunt for the next seed-stage outlier.


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