What are Pro-rata Rights?
Pro-rata rights give an investor the option to maintain their ownership percentage when a company raises later rounds of capital by investing more money. Pro-rata rights typically appear on either a term sheet or a side letter agreement.
Why are Pro-rata Rights important?
If a company is doing well, early stage investors may want to follow-on. While they won't benefit from the same return potential they'd get at the initial valuation, putting more capital in at Seed, Series A or Series B could still offer huge returns. And you want to maintain ownership in your winners...right?
When you first invest in a company, you don't have to know whether or not you're going to follow on. Pro-rata rights give you optionality, and your investment framework/thesis can help you decide if and when to make that follow on investment.
Should I exercise my pro-rata rights to back winners or focus on making more investments to get more shots on goal?
As with all investment decisions, it depends. This is a big topic of conversation for Angel Squad members as they get the opportunity to double down on top performing Hustle Fund portfolio companies progressing to later stages.
When thinking about follow-on, consider the original valuation you came in at, the valuation of the new round and how that impacts return potential. Also, what's your opportunity cost? If you follow on, will you have the capital available to invest in other early stage companies where the return potential could be greater?
- Elizabeth Yin on ownership and pro-rata rights
- Pro-rata rights - Holloway
- The myths of follow-on investing debunked - Elizabeth Yin
- Pro-rata is easier to get than ever today, but investors are thinking twice - Eric Bahn