What is Follow-on Funding or Follow-on Investment?

Follow-on investment, which is also known as Follow on Investment refers to additional money raised by a company after a previous funding round. Follow-on funding is normally meant for financing the growth of the company through expansion, hiring more people, product development, entering into new markets, among other things.

Follow-on funding can be obtained from existing investors, new investors, or both. In case there are existing investors that invest additional money in the company, then that is a follow-on investment, whereas new investors refer to investors that have never invested in the company before.

Why Investors Make Follow-on Investments?

• Pro-rata rights:  Most early investors obtain pro-rata rights in their original investment agreement, giving them the option to invest in subsequent rounds so as to preserve their ownership percentage in light of the issuance of new shares.
• Conviction and informational advantage: The current investor will have a seat on the board of directors, have access to financial statements, and receive reports from the founders regularly; in other words, they know much more about the company than any new investor and can make decisions more easily and with much more conviction.
• Preservation from dilution: Every time shares are issued and early investors do not participate in follow-ons, their ownership percentages decrease. The follow-on investment allows preserving or increasing their ownership percentages.
• Signaling: Follow-ons by current investors send a strong signal to potential new investors that those who know the company best continue believing in it.

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