Should you pick your reserve percentage or derive it?

The usual ordering

A familiar reserve percentage can be a useful starting point. The risk is letting it become a fixed answer before testing the fund’s initial checks, company count, ownership targets and follow-on needs.

Try working in both directions: what reserve remains after the initial investment plan and other obligations, and what reserve would the expected follow-on plan require? The gap tells you which assumptions need another look.

Start with the investment assumptions

Anubhav Srivastava, who built Tactyc after watching managers construct portfolios in spreadsheets, describes the common failure as over-reserving upfront and producing a model that is conservative in a way nobody chose. The reserve gets set generously because generosity feels prudent, and then constrains the capital available for initial investments.

His alternative is to compute rather than assume: work out what pro-rata in the next round would actually cost, and weight it by the rate at which portfolio companies reach that round. A fund whose companies graduate at one rate needs a different reserve from a fund whose companies graduate at another, and neither number is knowable by picking a percentage first. The reserve becomes an output of the construction rather than a parameter of it.

A named pool creates pressure to spend it

The second argument is about behaviour rather than modelling. Charles Hudson, whose firm reserved about a quarter of its fund for follow-on, has come to think that having dollars earmarked for a purpose encourages deploying them for that purpose. His concern is that earmarking can make an investment feel expected before its merits have been assessed.

His preference is to keep dollars in competition with each other, so that a follow-on has to win against the alternative use of the same money, which is usually a new position in a company the fund does not own yet. That is a different question from whether the existing company is doing well. A reserve policy can still allow the comparison if the fund’s process explicitly asks for it.

The practical lesson is to keep the alternative use of capital visible. Whether money is labeled as a reserve or remains unassigned, its use still depends on the fund’s mandate, terms and obligations.

Test the dilution assumption

There is a third reason, and it is the quietest. The Blue Future Partners survey found managers expecting ownership at exit to sit close to ownership at entry, assuming an average of 18.5 percent dilution across the whole life of an investment. The author is direct that this is not realistic, and that stakes get diluted substantially regardless of reserves held to defend them.

Maintaining ownership throughout an investment requires more than setting aside money. It depends on future round sizes, valuations, participation rights and access. Test several dilution paths rather than assuming one reserve percentage will keep every stake unchanged.

What follows from treating it as an output

Estimate initial checks using entry valuations and ownership targets, then apply the planned company count. Subtract initial investment capital, fees, expenses and other obligations from the available fund capital. The remainder is a starting point to compare with expected follow-on needs, not automatically an adequate reserve.

Now the percentage has a visible explanation. LPs and GPs can discuss the underlying investment and budget assumptions, and see what would need to change if the planned reserve does not cover the intended follow-on strategy.

It also makes the trade-off visible in the right direction. Raising the reserve is no longer a prudent-sounding adjustment; it is a decision to write smaller cheques, back fewer companies, or take less ownership. Those consequences were always there. Choosing the reserve first is what hides them.

Selection matters alongside size

Laura Thompson’s modeled scenarios at Sapphire hold the reserve percentage constant and vary where the capital lands, producing modeled net outcomes from 2.5x to 5.0x against a 4.0x base case. These are illustrations under specified assumptions, not observed returns or forecasts.

The example shows why reserve size and follow-on selection belong in the same discussion. It does not establish that size never matters or that the winning companies can be identified in advance.

How the model reads it

Architecture accepts a declared reserve share as an input. It then derives an implied initial check from fund size, that share and the target company count. Portfolio Efficiency compares the result with stage reference points. The planning approach described above can help you choose the input; the product does not automatically derive a recommended reserve percentage.

Holding fund size and company count fixed, raising the reserve share lowers the implied initial check. Whether that changes the score depends on where the result falls against the model’s reference points. A larger reserve does not automatically make the configuration worse.

Sources

• Portfolio Construction for VCs, on the EUVC podcastAnubhav Srivastava, CEO of TactycOn managers over-reserving upfront, and risk-weighting the next round's pro-rata by the graduation rate rather than assuming the full amount.
• Lessons from 600+ Investments, Founder Profiles that Win, Reserve Strategies that Drive Returns, and the Hidden Potential in Consumer StandoutsCharles Hudson on The Full Ratchet, episode 488On earmarked reserve dollars encouraging their own deployment, and keeping dollars in competition with each other instead.
• Dirty Secret: Venture Reserves are Not Always a Good ThingLaura Thompson, Sapphire, May 2022The scenario work separating the size of a reserve from its effect on net returns.
• An LP take on VC portfolio constructionRodrigo Ferreira, Blue Future Partners, published on OpenVCThe dilution managers assume when they set a reserve, and why the assumption tends not to survive.