The follow-on multiple equals the first-round multiple divided by the step-up, and half the fund sits on it.
Usually, and by a predictable amount: a follow-on returns the company's multiple from the first round divided by the step-up in price since then. In an illustrative 28-company seed fund, the initial cheques returned 3.6376x and the follow-on reserves 1.7886x, and because 52.11 per cent of the capital went in as follow-ons, the published 2.6741x is the weighted average of the two. Split the multiple before judging the manager or the reserve policy.
Worked in full in Venture Capital by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A venture fund's gross multiple mixes two different decisions. The initial cheque is the investment decision: the manager picks a company and a price. The follow-on is a later decision, usually to defend a pro rata stake in a company that has already raised at a higher valuation. Both sit in the same line of the portfolio report, at the same company name, so a fund that is excellent at first rounds and indifferent at reserves shows one blended number. An investor choosing between managers, or a partnership setting its reserve ratio, needs the two numbers apart.
| Item | Capital | Proceeds | Multiple |
|---|---|---|---|
| Initial cheques, 28 companies | 62.5 | 227.35 | 3.6376x |
| Follow-on reserves, 16 companies | 68.0 | 121.62 | 1.7886x |
| Fund, gross | 130.5 | 348.98 | 2.6741x |
Each company's position is recorded in two parts: the initial cheque with its multiple, and the reserve with its own multiple. The top five companies by proceeds look like this:
| Company | Initial cheque | Initial multiple | Reserve | Reserve multiple | Step-up | Position multiple |
|---|---|---|---|---|---|---|
| Aldwyn | 3.0 | 42.00x | 12.0 | 6.00x | 7.00 | 13.20x |
| Brackenhall | 2.5 | 14.00x | 9.0 | 2.00x | 7.00 | 4.61x |
| Corriemore | 3.0 | 6.20x | 7.5 | 1.30x | 4.77 | 2.70x |
| Dunsyre | 2.5 | 4.40x | 6.0 | 1.00x | 4.40 | 2.00x |
| Ellisland | 2.5 | 3.60x | 5.5 | 0.85x | 4.24 | 1.71x |
Initial multiple: Σ(cheque × initial multiple) / Σ cheques = 227.35 / 62.5 = 3.6376x.
Reserve multiple: Σ(reserve × reserve multiple) / Σ reserves = 121.62 / 68.0 = 1.7886x.
Blend: (1 − 52.11%) × 3.6376 + 52.11% × 1.7886 = 2.6741x, the fund's gross multiple.
Step-up for one company: initial multiple / reserve multiple. Aldwyn: 42.00 / 6.00 = 7.00, so the follow-on paid seven times the first-round price per share.
In Excel: =SUMPRODUCT(Reserve,ResMult)/SUM(Reserve) beside =SUMPRODUCT(Cheque,InitMult)/SUM(Cheque), and =InitMult/ResMult per line.
The step-up is the mechanism, not an anomaly. A follow-on entering at seven times the first price returns seven times less, whatever the company does afterwards. Across the fifteen follow-ons that returned anything, step-ups run from 3.33 to 7.00 (the sixteenth was written off on both cheques, so it has no step-up to read). The initial cheques earned 2.0338 times the reserves' multiple, a gap of 1.8490 turns.
The reserve multiple is itself driven by one company. Aldwyn's follow-on returned 72.00, which is 59.20 per cent of all reserve proceeds; without it the reserves returned 0.8862x, below cost. Twelve of the sixteen follow-ons returned less than they cost: 33.5 of capital came back as 15.88, a multiple of 0.4739x. The initial cheques produced 65.15 per cent of the fund's proceeds on 47.89 per cent of its capital.
The counterfactual a partnership will ask for: had the fund withheld reserves from the six companies whose initial cheques ended below cost, it would have saved 8.0 of capital that returned only 1.07, and the fund's gross multiple would have been 2.8400x instead of 2.6741x. That is a rear-view calculation, since the partnership did not know the outcome when it wrote the cheques, but it shows where the reserve policy cost money.
| Reserve share of capital | Fund gross multiple |
|---|---|
| 0% | 3.64x |
| 25% | 3.18x |
| 52.11% | 2.67x |
| 75% | 2.25x |
Holding the multiples constant is the simplification: a fund that reserves nothing writes more first cheques, and the next cheques may not be as good. But the direction is unambiguous, and the break-even is easy to state. A follow-on at a step-up of 4.0 needs the company to reach 4.0 times the first-round price just to return cost, and 10.70 times to match this fund's 2.67x. At a step-up of 7.0 it needs 18.72 times.
Fees do not change the comparison. Spread pro rata over capital, they lower both halves by the same proportion, so the ratio of 2.0338 survives every fee allocation.
Reading a company's blended position multiple as the return on the follow-on. Aldwyn shows 13.20x as a position, which makes the 12.0 follow-on look like a brilliant decision; on its own it returned 6.00x, a fine result bought at a 7.00 step-up. The second mistake is the reverse: concluding that reserves are always value-destroying. A follow-on at a 2.0 step-up into a company that eventually reaches 6 times its first price returns 3.0x, better than this whole fund. The question is always the price paid, not the label on the money.
Split every venture fund's gross multiple into initial cheques and follow-ons: here 3.6376x against 1.7886x, with step-ups of 3.33 to 7.00 explaining the gap and one company carrying most of the reserve proceeds. The twenty-eight positions, each with its step-up and the reserve counterfactual, are in the free workbook for this case. For how many companies a reserve can afford to defend, see how many companies a venture reserve pool actually defends.
Sum the proceeds attributable to the follow-on money and divide by the follow-on capital, separately from the initial cheques. In the worked fund 68.0 of reserves returned 121.62, a multiple of 1.7886x, against 3.6376x on 62.5 of initial cheques.
The ratio of the price per share paid in the follow-on to the price paid in the first round. It equals the initial multiple divided by the reserve multiple: a company that returned 42.00x on the first cheque and 6.00x on the follow-on had a step-up of 7.00.
Not as a rule. The follow-on return is the company's eventual multiple of the first-round price divided by the step-up, so a follow-on at a 2.0 step-up into a company reaching 6 times its first price returns 3.0x. In the worked fund, withholding reserves, in hindsight, from the six companies whose first cheques ended below cost would have lifted the fund from 2.6741x to 2.8400x.
This article is one calculation from Venture Capital. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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