The Reserve Has a Specific Job
A seed fund's reserve policy determines how much capital is kept for follow-on rounds instead of new investments. The right percentage depends on how many companies the fund backs, which ones it expects to support again and how much ownership it wants to retain as those companies raise more capital.
Reserves fund the later part of the portfolio plan. Initial cheques determine how many companies the fund backs; the reserve determines what it can do as their results begin to differ. If those choices are made separately, the manager may find that it cannot afford the follow-on support it expected to provide.
Why a Seed Fund Needs Follow-On Capital
A successful seed company will usually raise more money. Each new round can dilute the original investor, so the fund's share of a future exit becomes smaller unless it invests again.
Carta's 2025 private-market review reported median dilution of about 16% across seed through Series C rounds. This provides a planning reference rather than a reserve rule for every fund. Without follow-on capital, ownership in successful companies can fall as they raise money.
That constraint takes shape before the portfolio matures. A fund cannot create extra capital simply because preserving ownership later becomes attractive.
A Percentage Changes the Opening Portfolio
A $100 million seed fund with a 40% reserve holds $40 million for later rounds, leaving $60 million for first cheques. A 60% reserve leaves only $40 million for the opening portfolio. More reserves can support companies longer, while less initial capital concentrates the fund from the start.
Each dollar reserved for later is unavailable for a new company today. More first investments and larger reserves fit the same budget only if cheques shrink or the fund grows. The two choices are linked.
What the Reserve Can Fund
Suppose the fund uses its $60 million of initial capital for six $10 million investments. Its $40 million reserve can then provide four follow-ons of $10 million. If all six companies ask for the same amount, the manager must choose among them, invest less than planned, or find capital outside the fund.
This is where reserve policy becomes investment policy. Progress and financing terms give the manager reasons to direct more capital to some firms than others. Equal amounts may look fair on a spreadsheet while treating an outperforming company like one seeking a rescue bridge.
New Evidence Changes the Allocation
The strongest use of reserves is selective. A company may deserve support because customers are staying, revenue quality is improving and a credible new lead investor has validated the round. Another company may be running out of cash because the original thesis has weakened. Both need money, but they do not present the same investment opportunity.
Each cheque reduces the cash available to support another company. Agreed rules make that trade-off clearer before a difficult round. The fact that a company is already in the portfolio says little about the value of investing more.
Ownership and Capital Change Together
Pro-rata support becomes more expensive as companies raise larger rounds. If the fund owns 10% of a company issuing $100 million of new primary shares, maintaining the stake may require roughly $10 million, subject to the round structure. Two such rounds would consume half of a $40 million reserve.
Ordinary pro-rata support and extra investment behind the best companies use the reserve in different ways. Earlier financings or larger rounds can consume it faster than planned, reducing the scope for later choices.
Reserve policy changes how much capital is available for initial checks versus follow-on support. Illustrative $100M seed fund.
Seed Fund Reserve Allocation
A higher reserve ratio protects follow-on capacity but reduces initial deployment.
View allocation data and assumptions
| Reserve ratio | Initial capital | Follow-on reserve |
|---|---|---|
| 30% | $70M | $30M |
| 40% | $60M | $40M |
| 60% | $40M | $60M |
The Expected Value of Each Follow-On
The chart makes the capital constraint visible, but it cannot tell an LP whether the follow-on cheques will be good investments. That depends on the price paid, the ownership retained and the company's prospects at the time of each round. More capital behind a weak position does not repair the original decision.
A follow-on can preserve ownership in a likely winner, changing its contribution after fees, expenses and carry. That connection to the eventual result matters more than whether the fund deploys all its cash.
Questions That Make the Policy Concrete
- How many companies can receive full pro-rata support? The answer depends on the reserve and assumed round sizes.
- What must a company prove before receiving another cheque? Past operating and financing evidence shows how the manager has made that choice.
- Can capital move between companies? Fixed buckets can leave money trapped behind weaker positions.
- What happens when rounds arrive early? Several simultaneous funding needs can force choices the original schedule did not anticipate.
The best reserve policy protects ownership in the companies that earn continued support. Just as importantly, it gives the manager permission to stop funding the ones that do not.
Frequently Asked Questions
Is a 50% reserve too high?
A 50% reserve can suit a concentrated manager with strong pro rata rights. It becomes excessive when too little capital remains to build a credible initial portfolio.
Should every company get follow-on support?
Progress, round terms, price and expected return determine the case for more funding. Each company competes with other uses of the fund's cash.