Reserve ratio

The split of a strategy's total capital between first positions and money held back for later investment in holdings you already own.

Example

A one-to-one ratio: $50,000 of first cheques and $50,000 reserved for follow-ons.

Important

Decide it before the first cheque. Once you are investing, every attractive new candidate makes a persuasive argument for spending the reserve.

Related terms

  • Dry powder — Capital committed to a strategy but deliberately not yet deployed, held so that a future opportunity can be acted on.
  • Follow-on investment — Investing more money into a company you already hold, usually as part of a later financing round and at a higher valuation.
  • Dilution — The reduction in your percentage ownership of a company when it issues new shares to someone else.

Lessons that explain it

  • A follow-on buys the same company at a higher price, so it needs its own maths — Exercising pro rata rights maintains ownership, but the new money earns a lower multiple than the original investment. Modelling follow-ons across scenarios shows when they add value. (11 min)
  • A fund must return far more than its investments cost to deliver its target to investors — Fees, carried interest and reserves mean a venture fund's portfolio must earn a much higher gross multiple than the net multiple its investors receive. Working backwards shows what a fund needs from its best companies. (12 min)
  • If you invest everything in first cheques, you cannot back your winners — Planning reserves for follow-on investments before making initial investments protects your ability to support your best companies and to maintain ownership where it matters most. (11 min)
  • Write the follow-on policy before the requests arrive — Deciding in advance what would earn more capital removes the pressure, relationships and urgency that distort follow-on decisions when a request is already on the table. (10 min)
  • Every yes spends money that could have gone somewhere else — An investment decision is a comparison with alternatives: another deal, a follow-on in an existing holding, keeping reserves, or not investing at all. Naming the alternative clarifies the decision. (9 min)
  • Reserves and dry powder: the money you deliberately do not invest — Holding capital back looks like indecision and is frequently the most consequential decision in the portfolio. It is also not free, and the honest version of the argument prices both sides. (13 min)

All 578 terms in the Investing glossary