Pro-rata rights

Images-1I have been doing angel investing now for over four years.  I have been taking in deal information vicariously through Fred for the past 25.  I have learned a lot these past four years.  It is like anything, the more you do it the better you get at it. 

Yet, in the world of angel investing, there is always huge risk no matter how good you think you are.  Every deal is different, every idea is different, every entrepreneur is different, the timing of every deal is different, the group of investors and advisors are different.  There is only one thing that can be consistent on each deal, the legal paperwork. 

I am happy to take a risk on an entrepreneur or an idea that has been executed on.  An idea that is just starting to show some traction but I am not willing to take a risk on a legal document.  Both categories are very different.  It sounds crazy that I'd be willing to risk my money on a deal but not on a legal document but the most important piece of starting a business is the legal foundation. 

Certainly as deals grow to larger investments in their Series A and Series B rounds there can be some creative thinking behind a legal document. The beginning of a company is not creative but pretty standard stuff. 

I will walk away from a bad document.  I am also willing to walk away if I don't get my pro-rata rights.  Many angels invest in the first round and sometimes they invest again in the second round, and then they are out when round three takes place.  I don't want to be out.  I feel like I took the biggest risk coming in at the very beginning and with that I want to continue keeping my percent of the company that I bought in the first round by continuing to participate (invest) in each round at my pro-rata share.  I am in it for the upside.  If the company is proving to be successful then I want to be rewarded in the upside for my risk. 

Most VCs use documents on their Series A that say unless someone (angel) invests a significant number (say $350-1M) then they can not continue with their pro-rata rights on the next round.  I think it is absolute bullshit.  The VCs should allow the angels to continue to put in their pro-rata share if they want to. 

It is like buidling a house.  When you start, you love (well I don't) your architect as they are your first contact as you start to build your dream.  Then once they have finished that part you then hand over the finished documents to a contractor.  Then you move towards loving your contractor and are in their camp no matter what happens because they are building your home.  You hope that the contractor and architect have a good working relationship because you want to continue those relationships too when the house is built.  There is value to the first person in your deal.  Sometimes there isn't but if they are engaged properly, there can be. 

I certainly want to see success, at any level, at all times.  I really want to help the entrepreneur build their dream and I want to make sure I can continue being part of the dream at every turn. Some turns get wider and my input will be less frequent but I still want to be part of the process. 


Comments (Archived):

  1. Eric Friedman

    I like when you write these types of posts because a lot of people think it, but fewer say it.

    1. Gotham Gal

      ūüôā thanks eric

  2. ellen

    since I am not from the tech community could you explain  what happens if you are an angel investor and you put in 100,000 and then the first round comes in with 6 million dollars what happens to your investment? Do you still own shares?  Are they watered down?  Is there a good read to better inform me about this type of investing and how do you protect yourself?  The obvious is get a good lawyer but there must be some books about the subject.

    1. Gotham Gal

      Brad Feld wrote a book called Burning Entrepreneur.The legal docs are set up at the start before anyone’s money goes in. Everyone must sign off on the same documents on each individual round. There could be several rounds of financing throughout the life of a company If you our in 100k on the first round and with that you own 1% of the company you will need to put in money thru subsequent rounds to maintain your levelAs more money gets put in you will get diluted if you don’t put more money in as the company becomes worth more. So 100k investment of a company valued at 10m post investment (meaning after the money comes in. Pre valuation is prior to the investment and post is after funding). Then you would own 1%. If the next valuation is 18 pre-money and the company raises 5m then your 100k is diluted unless you put in your pro-rata share to keep your 1% of the companyMake sense?

      1. MG

        and to clarify, you are saying that as an angel, you would like to keep your 1% ownership through the next round (18 pre-money) without putting in more money?   Or that you would get a discount in someway, so instead of having to put in $x you would only need to add 50% of x?Sorry, just trying to understand this better as I am about to embark on seeking angel funding (woman led NYC tech business!).

        1. Gotham Gal

          The only way to keep my 1% is to put more money into the next round. After being in the first round my pro-rata share would not be as high to capture 1% holding because I put money in the first round. Its all in the math Generally lawyers advise Entrepreneurs on their Furst round documents not to give anyone that right. The reason is that VCs which lead the next round will only give a pro-rata right to an investor putting in minimal amount of 350k or more basically cutting out the original angels from going forward after that round. They want to have money in from larger pools of cash

    2. ellen

       It makes sense. I will get the book.Thank you. 

  3. Abdallah Al-Hakim

    thanks for tremendously useful post. I didn’t know about the pro-rata rights for angel investors in subsequent rounds of funding. It does seem unfair that the angel investors are cut out of the dea after being the first ones to take a risk on a particular startup

    1. Gotham Gal


  4. bfeld

    Awesome post Joanne. I just added some on at Ask the VC and highlighted the importance of angels understanding this.

  5. Startup Tweeting Service

    Thanks for posting….you are 100% correct on all points.

  6. Greg Cohn

    Out of curiosity, are you directing the pro-rata comments at entrepreneurs or later-series VC’s?

    1. Gotham Gal


  7. Guest

    Hi Joanne- ¬†How do you feel about pro-rata rights w/ angels that aren’t professional like you are (i.e. friends & family)? ¬†ps. ¬†your architect comment had me cracking up this morning. ¬†

  8. JLM

    .In life you do not get what you deserve, you get what you negotiate.Everything in life is negotiable.A great document never saved one from a scoundrel.A bad document never forced an honorable person to otherwise breach their honor.Know what you want and then go get it..

  9. Eric Klein

    As an entrepreneur I tend to agree with you, those who took the big risk with us should be part of the whole process.In looking at a new seed round we are looking to put in that seed investors are not diluted in the next round of investing by allocating those shares up front. This way we can keep everything fair and easy without having to reset expectations later. It also keeps the founder’s share undiluted in the next round.After that it is up to the company (read founders and seed investors) to make sure that no one is screwed over. It comes down to doing things fairly from day 1.I am not sure how well this will fly, but it is the philosophy that we are using.

    1. Gotham Gal

      good for you. i believe doing things right and fairly will come back at you in spades.

      1. Eric Klein


  10. hardaway

    Thank you. I have been angel investing for thirty years, and I have never been able to claim those rights, although I always thing I am entitled to them. From now on, I will claim them or walk away, as you do. It is never too late to learn.

  11. WinkieBoy

    I will add 1x preferred stock + pro-rata rights.

    1. Walker

      No idea what this means – pro rata rights are an anti dilution governance protection, preferred stock is a form of investing capital that is equity like with some quasi debt features.

      1. WinkieBoy

        As, I am also willing to walk away if I don’t get 1x preferred stock + pro-rata rights.

  12. Graham Segal

    This may be a naive question but is it possible (and would it be beneficial) to better protect your pro-rata rights to initially work out a deal with the founders at actual start up, where in return for your initial contribution of, say, $100K, you become a member of the founder team? This would, no doubt, mean that you would have a greater role in the conduct and management of the company (no bad thing) and would give you stronger voice in how future events are managed.The other query I have is this. There seems to be an ongoing debate as to whether the number of shares held is more important or whether the percentage of the shares held.should be the priority objective. I would be interested in Angels views about this point.sincerely,Graham

  13. Walker

    Anti dilution provisions are standard protections for minority investors who otherwise would be subject to unfair dilution by a controling or group of controlling shareholders. So are drag along and tag along rights to protect investors in the event of a sale which give the minority the right to tag along (i.e., sell at the same price) or be dragged along (get bought out (i.e., enable a company to be sold in its entirety). Logical, sound, necessary and basic corporate governance.

  14. Sam Iam

    (i) Keeping your “percent” is just arbitrary and unconnected with reality. Unless your “percent” is tied to some special blocking or control rights or voting rights, it doesn’t matter what your “percent” is. (ii) As an early investor, you are compensated for your risk by having purchased equity at a presumably much lower valuation than subsequent rounds. (iii) If you negotiate pro rata rights in an early round, subsequent investors can easily condition their investment on your retracting those rights. If it’s between the Company getting funding and you backing off your contractual terms, what do you think the outcome will be? (iv) Under what scenario, exactly, is the Company telling you they don’t want your $100k or whatever? Even in a highly oversubscribed round, $100k is a very small piece of a typical Series B or C, you’d really have to have a bad relationship with the founders for them to tell you to take a hike.

    1. Gotham Gal

      Founders cave to big cash

      1. Sam Iam

        Again, under what circumstances is “big cash” so exercised about an additional $100k in a B or C round that they take the time and political capital to strong-arm founders in order to squeeze out an early angel? Why exactly do they hate you so much? It’s a peculiar and unusual circumstance that a company would reject an offer of equity capital when closing a round. Maybe in the case of Uber or some exceptional unicorn investors fight over every dime of allocation, but other than the one-in-a-1000, how can you seriously suggest this is a real concern for angel investors? And if you got in on an early round of Uber, it’s a bit hard to gin up a lot of sympathy for you, you’ve got a massive home run on your hands. You seem to speak from experience, can you give an illustrative example of when/why/how your puny follow-on investment was so despised the founders and “big cash” took the time and effort to shut you out?

        1. Gotham Gal

          It has zero to do with anything but ownership.