Last month, I caught up with an angel investor who'd been in the game for about three years. She mentioned something that stuck with me: her biggest regret wasn't about the deals that went south, but about the winners where she got diluted down to almost nothing.

"I owned 2% of this company after my initial $50k investment," she told me. "When they raised their Series A, I couldn't participate. Now I own 0.8% of what's shaping up to be a $500M exit."

This is exactly why pro rata rights matter so much in angel investing. They're your ticket to maintaining ownership in your best companies as they grow and raise subsequent rounds.

If you're looking to level up your angel investing game, you should definitely check out the Angel Squad website to connect with other investors who've navigated these waters successfully.

What Are Pro Rata Rights and Why Do They Matter?

Pro rata rights give you the option—not the obligation—to invest in a company's future financing rounds to maintain your ownership percentage. Think of it like this: if you own 1% of a company and it raises a new round, you have the right to invest enough to keep that 1% stake.

Here's the thing that makes pro rata rights so valuable: missing out on pro rata opportunities can drastically impact returns. Imagine investing $1 million at a $10 million valuation. If the company later exits at $1 billion, your initial stake could be worth $100 million. 

How to Negotiate Pro Rata Rights in Your Initial Investment

The best time to secure pro rata rights is during your initial investment negotiation. Don't wait until later rounds to ask for them—by then, it's usually too late.

Most founders include what's called a "major investor" threshold in their term sheets. Most  major investors get pro-rata rights going forward according. (Kruze Consulting) The key is making sure your check size hits this threshold.

Here's a pro tip: if you're planning to invest $75k but the major investor threshold is $100k, consider increasing your initial investment to secure these rights. The extra $25k upfront could save you from dilution that costs you hundreds of thousands later.

Capital Reserve Strategies for Follow-On Investing

Smart angel investors think about capital allocation from day one. There are two main schools of thought here:

The "All-In" Approach: early-stage investors who don't really want to overthink the investment process. They have a certain amount of money available to invest in a startup, and they invest it. This maximizes your ownership at the lowest cost basis.

The Reserve Strategy: The other strategy is to provide a significant initial capital investment, but retain a percentage of your capital. Sometimes this percentage is called a "reserve”. 

For most angels, I recommend a hybrid approach. Make sure your initial check is large enough to secure pro rata rights, then reserve 50-100% of that amount for follow-on investments. So if you invest $100k initially, keep another $50-100k available for subsequent rounds.

When to Exercise Your Pro Rata Rights

This is where it gets interesting. Having pro rata rights doesn't mean you should always use them. Whether or not to exercise your pro rata rights is a matter of strategy: some investors always participate in follow-on rounds, while others deliberately choose not to.

My take? Exercise your pro rata rights when:

• The company is hitting or exceeding milestones
• The valuation still makes sense relative to progress
• You have high conviction in the team and market
• You can afford to without compromising your ability to make new investments

Skip your pro rata when:

• The company is struggling or pivoting constantly
• The valuation seems way too high for the stage
• You need that capital for more promising new deals
• You've lost confidence in the team or market opportunity

The Impact of Pro Rata Rights on Returns: Real Numbers

Let's get concrete about why this matters. Say you invest $100k in a company at a $5M post-money valuation, giving you 2% ownership. The company then raises:

• Series A: $3M at $15M pre-money ($18M post-money)
• Series B: $8M at $35M pre-money ($43M post-money)
• Exit: $200M acquisition

Without pro rata rights:

• Your 2% gets diluted to roughly 1.2% by exit
• Your return: $2.4M (24x)

With pro rata rights (exercised both rounds):

• You invest another $120k in Series A and $200k in Series B
• Total investment: $420k
• You maintain 2% ownership through exit
• Your return: $4M (9.5x)

The pro rata scenario gives you $1.6M more in absolute returns, even though your multiple is lower due to the additional investment.

Making Pro Rata Rights Work for You

The key insight here is that pro rata rights are fundamentally about portfolio construction. This is consistent with the power-law of early-stage venture investment returns, which suggests spreading your investments around to a variety of early-stage companies makes it more likely to hit on a winner than following on to just a few companies.

Here's my framework for making pro rata work:

1. Secure the rights upfront - Make sure your initial check is large enough
2. Reserve capital strategically - Keep 50-100% of your initial investment available for follow-ons
3. Be selective about exercise - Only follow on in your highest conviction deals
4. Don't neglect new deals - Always leave room in your budget for fresh opportunities

Remember, the goal isn't to exercise every pro rata right you have. It's to have the option when it makes sense and could significantly impact your returns.

The angel investors who consistently generate strong returns understand that pro rata rights are a tool for concentration, not diversification. Use them wisely to double down on your winners while still maintaining a diversified portfolio of early-stage bets.

For more insights on building a winning angel portfolio and connecting with other successful investors, check out Angel Squad.

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