Pro-Rata Rights
Quick Facts
- Also called: Participation rights, pre-emptive rights
- Purpose: Allows investors to maintain ownership percentage in future rounds
- Standard: Typically granted to institutional investors (Series A+)
- Variation: Super pro-rata (right to increase ownership)
Pro-rata rights give existing investors the right (but not obligation) to participate in future financing rounds to maintain their ownership percentage. If an investor owns 10% and the company raises more money, pro-rata rights let them invest enough to keep their 10% stake.
In Plain English
Pro-rata rights are like a "first dibs" clause for investors. When you raise your next round, your existing investors can say "we want to invest more to keep our same percentage." Without pro-rata rights, every new round would dilute them. With pro-rata rights, they can choose to avoid dilution by writing another check.
How It Works
Example: Series A investor with pro-rata rights
- Series A: Investor puts in $2M for 20% ownership
- Series B: Company raising $10M at $50M pre-money valuation
- Pro-rata calculation: Investor can invest 20% × $10M = $2M
- Result: If they invest $2M, they maintain ~20% ownership
Without participating, their 20% would be diluted to ~16.7% after the Series B.
Pro-Rata Calculation
The formula is straightforward:
Pro-Rata Amount = Current Ownership % × New Round Size
If you own 15% and the company is raising $20M:
Pro-Rata Amount = 15% × $20M = $3M
Who Gets Pro-Rata Rights
| Investor Type | Typically Gets Pro-Rata? |
|---|---|
| Institutional VCs | Yes (standard) |
| Angel investors | Sometimes (negotiated) |
| Strategic investors | Usually |
| SAFE/Note holders | Rarely (until conversion) |
| Employees | No |
Pro-rata rights are nearly universal in institutional venture deals but less common for small angel checks.
Major vs. Minor Investors
Many term sheets limit pro-rata rights to "major investors"—those exceeding a minimum ownership threshold:
- Series A: Major investor = owns 5%+ of preferred
- Series B+: Threshold may increase to 3-5% of total equity
- Below threshold: May lose pro-rata rights or need lead investor approval
This prevents dozens of small investors from claiming pro-rata in future rounds.
Super Pro-Rata Rights
Some investors negotiate super pro-rata rights—the ability to invest more than their ownership percentage in future rounds. This is aggressive and typically resisted by founders because:
- It limits space for new investors
- It can signal the investor doesn't believe in competitive rounds
- It reduces founder leverage in future negotiations
The Pro-Rata "Problem"
When companies perform well, everyone wants to exercise pro-rata:
- Oversubscribed rounds: Too much investor demand
- Existing investors demand their pro-rata allocation
- New lead investor wants meaningful ownership
- Conflict arises: Not enough room for everyone
Common solutions:
- New lead takes smaller position than desired
- Some existing investors voluntarily waive pro-rata
- Company increases round size
- Secondary sales create room
When Investors Don't Exercise Pro-Rata
Investors may pass on pro-rata for several reasons:
- Fund constraints: No reserves left for follow-ons
- Valuation concerns: Believe the price is too high
- Signaling risk: Passing can signal lack of confidence
- Portfolio construction: Need to diversify across companies
Not exercising pro-rata can be a red flag to new investors ("why aren't the existing investors investing more?").
Pay-to-Play Provisions
Some term sheets include pay-to-play: investors who don't participate in future rounds lose certain rights (conversion to common, loss of anti-dilution, etc.). This pressures investors to continue supporting the company.
Pro-Rata vs. Anti-Dilution
| Pro-Rata Rights | Anti-Dilution |
|---|---|
| Right to invest more | Automatic price adjustment |
| Voluntary participation | Triggers automatically in down rounds |
| Costs money | Free protection |
| Maintains ownership % | Maintains economic value |
Pro-rata lets you choose to avoid dilution; anti-dilution automatically adjusts in certain scenarios.
Practical Takeaways
For founders: Pro-rata rights are standard for institutional investors and generally benign. Watch out for super pro-rata demands, which can limit your options in future rounds. Keep pro-rata limited to major investors to avoid complexity.
For investors: Always negotiate pro-rata rights if you believe in the company long-term. Understand the major investor threshold. Reserve capital in your fund for follow-ons—not exercising pro-rata can damage your reputation and signal lack of conviction.
Related Reading
- Anti-Dilution Provisions — Automatic protection against down rounds
- Cap Table — Where ownership is tracked
- Down Round — When pro-rata decisions get difficult