I remember the first time I got a follow-on investment offer. It felt like a vote of confidence, a sign that we were on the right track. We’d raised our seed round, hit our milestones, and now our lead investor was ready to double down. At least, that’s what I thought.
It wasn’t until I was on the other side of the table, as an investor myself, that I realized how naive I’d been. That follow-on offer wasn’t just a pat on the back. It was a calculated move in a much larger game, a game with unwritten rules that founders are rarely privy to. I’ve seen it play out over and over again in my 200+ angel investments. The VC has a playbook. It’s time you had one too.
So, let’s pull back the curtain. Here’s what’s really going on when your VC offers you a follow-on investment.
The Real Reasons for a Follow-On Round
First things first, let's be clear: a follow-on investment isn't always about your stellar performance. Of course, hitting your numbers helps. But there are other, more selfish reasons why a VC might want to put more money into your company.
One of the biggest is portfolio strategy. VCs need to deploy a certain amount of capital in a given fund. If they have a lot of dry powder and not enough new deals, they’ll look to their existing portfolio. Your company might just be in the right place at the right time. It's less about you and more about their fund's allocation needs.
Another reason is signaling. A follow-on investment from a reputable firm can be a powerful signal to the market. It can attract other investors and make it easier to raise your next round. Your VC knows this, and they might use a follow-on to “re-up” their conviction and get other investors excited. I've seen this happen with companies in my own portfolio. A small follow-on from me can suddenly make a company a hot deal.
And then there's the less glamorous reason: pro-rata rights. Most VCs have a clause in their investment agreement that gives them the right to maintain their ownership percentage in future rounds. If they don't exercise these rights, their stake gets diluted. So, sometimes, a follow-on is just about protecting their existing investment, not necessarily about a newfound belief in your company's explosive growth.
The Games VCs Play
Now, here's where it gets interesting. Once a VC decides to offer a follow-on, the games begin. They have a playbook, and it's designed to give them the upper hand. Here are a few of the moves you can expect.
The “Exploding” Term Sheet: This is a classic. The VC will give you a term sheet with a very short expiration date, often just a few days. They’ll tell you it’s a “special” deal, and you need to act fast. The real reason? They want to create a sense of urgency and prevent you from shopping the term sheet around to other investors. Don't fall for it. A good deal will still be a good deal next week.
The “Friendly” Advice: Your VC will suddenly become your best friend. They’ll offer you all sorts of advice on your business, your team, and your strategy. They’ll tell you they’re just trying to help. But what they’re really doing is gathering information. They want to know your weaknesses, your fears, and your advantages. Be careful what you share.
The Valuation Squeeze: This is the most common game of all. The VC will try to convince you that your valuation is lower than you think it is. They’ll use all sorts of metrics and comparables to make their case. They might even tell you that the market is “soft” or that other investors are “skittish.” It’s all a negotiation tactic. Know your numbers, and don’t be afraid to push back.
I once had a VC try to cut my valuation in half during a follow-on negotiation. They told me my market was smaller than I thought and that my team wasn't experienced enough. I knew they were wrong. I had the data to prove it. I walked away from the deal and ended up raising at a much higher valuation from another firm. It was a risky move, but it paid off.
Your Counter-Playbook
So, how do you counter these moves? How do you level the playing field? Here’s your playbook.
First, do your homework. Before you even start talking to your VC about a follow-on, you need to know your numbers inside and out. You need to have a clear understanding of your valuation, your growth prospects, and your competition. You should also talk to other founders who have raised follow-on rounds from your VC. Find out what their experience was like.
Second, create competition. The best way to get a good deal is to have multiple offers. Don’t just talk to your existing investors. Reach out to other VCs as well. Let them know you’re raising a round. The more interest you have, the more power you’ll have in negotiations.
Third, don’t be afraid to walk away. This is the most important rule of all. If you’re not happy with the terms, don’t be afraid to say no. There will always be other investors. I know it’s hard to turn down money, especially when you need it. But taking a bad deal can be worse than taking no deal at all.
The Bottom Line
Follow-on investing is a complex game with a lot of unwritten rules. VCs have been playing it for a long time, and they’re very good at it. But that doesn’t mean you have to be a pawn in their game. By understanding their motives, anticipating their moves, and having a playbook of your own, you can level the playing field and get the deal you deserve.
Remember, you’re the one building the company. You’re the one creating the value. Don’t ever let a VC make you feel like you’re lucky to have them. They’re lucky to have you.
Understanding the Different Flavors of Follow-On Money
Not all follow-on money is the same. The structure of the deal can have a huge impact on your company, so you need to understand the different options. Here are the most common ones you'll encounter:
Priced Round: This is the most traditional type of financing. In a priced round, you and your investors agree on a new valuation for your company, and you issue new shares at that price. This is usually the best option if you're in a strong position and can command a high valuation. It provides a clean structure and sets a clear benchmark for future fundraising.
Convertible Note: A convertible note is a loan that converts into equity at a later date, usually during your next priced round. It's a way to raise money quickly without having to set a valuation. This can be a good option if you're in a hurry or if you're not ready to set a valuation yet. However, be careful with the terms. The conversion discount and valuation cap can have a big impact on your ownership down the road.
SAFE (Simple Agreement for Future Equity): A SAFE is similar to a convertible note, but it's not a loan. It's a warrant to purchase equity in a future priced round. SAFEs have become increasingly popular in recent years, especially for early-stage companies. They're simple, founder-friendly, and don't accrue interest. However, like convertible notes, the valuation cap and discount are key terms to negotiate.
I've used all three of these structures in my own companies and investments. There's no one-size-fits-all answer. The right choice depends on your specific situation. The important thing is to understand the pros and cons of each and to negotiate the best possible terms for your company.
A War Story: The Time I Almost Lost My Company
I want to share a personal story that I've never told publicly before. It was during the early days of RemoteTeam. We were running out of money, and we desperately needed a bridge round to keep the lights on. Our lead investor, who had been our biggest champion, agreed to provide the financing. We were relieved.
But then the term sheet came. It was brutal. They wanted a 2x liquidation preference, a participating preferred stock, and a whole bunch of other terms that would have given them complete control of the company. It was a classic vulture deal, preying on our desperation.
My co-founder and I were devastated. We felt betrayed. We had a choice: take the deal and lose control of our company, or turn it down and risk going bankrupt. We spent a week agonizing over the decision. We talked to our advisors, our lawyers, and our families. In the end, we decided to fight back.
We went back to our investor and told them that their terms were unacceptable. We laid out our case, backed by data and a clear vision for the future. We also, very discreetly, started talking to other investors. It was a high-stakes game of chicken. For a few days, it looked like they were going to pull the plug. I barely slept. But then, at the last minute, they blinked. They came back with a much more reasonable term sheet, and we closed the deal.
That experience taught me a valuable lesson: you always have more power than you think you do. Even when you're desperate, you don't have to take a bad deal. It also reinforced the importance of building relationships with multiple investors. You never want to be beholden to just one.
Frequently Asked Questions
How has this view evolved over time?
My thinking on most topics has changed significantly over the years. Early in my career, I held many conventional views that experience proved wrong. I try to update my beliefs when the evidence changes.
How can I apply this thinking to my own situation?
Start by identifying the core principle behind the opinion, not the specific example. Then ask yourself: does this principle apply to my context? If yes, test it in a small, low-risk way before going all in.
Do all experts agree with this view?
No, and that's fine. The best ideas in business are often contrarian. I share my perspective based on my experience and data, but I encourage you to seek out opposing viewpoints and form your own conclusions.