Understanding Pro-Rata Rights: A Guide for Startup Founders

As a startup founder, you are bound to encounter various financing terms and concepts while raising capital for your business. One such concept is “pro-rata rights.” In this blog, we will discuss pro-rata rights, their importance, and their implications for startup founders and investors.

What are Pro-Rata Rights?

Pro-rata rights, also known as participation rights or preemptive rights, are contractual provisions that allow existing investors to maintain their ownership percentage in a company during future equity financings. These rights provide investors with the option to participate in subsequent investment rounds and purchase additional shares to avoid dilution of their ownership stake.

Nerd note: Pro rata comes from Latin and translates to “in proportion,” which means shares being allocated will be distributed in equal portions.

Pro-Rata Rights explained to a teenager

Pro-rata rights are like getting a fair share of a pizza when new friends join the party.

Imagine you and four friends order a large pizza and split it evenly, so each of you gets 1/5 of the pizza. Now, let’s say two more friends join the party, and you all decide to order another large pizza. To keep things fair, you want everyone, including the new friends, to have an equal share of the total pizza.

Pro-rata rights work in a similar way but for investments in a company. When people invest money in a startup, they own a part of the company. As the company grows and raises more money, new investors come in, and the ownership gets divided among more people. To make sure the early investors don’t lose out on their fair share, they have the right to invest more money to maintain their percentage of ownership. This is called pro-rata rights.

So, pro-rata rights help early investors keep their fair share of a company as it grows and new investors join in.

How do Pro-Rata Rights Work Simply?

Let’s consider a simple example to illustrate how pro-rata rights function. Imagine you have raised $1 million in a seed round, and an investor has contributed $100,000, resulting in a 10% ownership stake in your startup. Later, your startup raises an additional $2 million in a Series A round.

Without pro-rata rights, the investor’s ownership stake would be diluted due to the issuance of new shares. However, with pro-rata rights, the investor has the option to invest an additional amount to maintain their 10% ownership stake. In this case, the investor would need to contribute $200,000 to the Series A round to preserve their 10% stake.

Fred Wilson explains it as such:

You invest $50k in a seed round at a $5M cap and own 1% of the company. The next round is a $3M round at $9M pre, $12M post. If you don’t participate, you will be diluted 25% and will then own 0.75% of the company. On the other hand, if you buy 1% of the round, a $30k investment, you will continue to own 1% of the company. Your ‘pro-rata right’ in this situation is a $30k allocation in the next round.”

Why are Pro-Rata Rights Important to Investors?

It isn’t actually clear whether pro-rata rights are worth the paper they are printed on.

Abraham Othman Ph.D. — Head of Data Science, AngelList wrote a paper you can read. I don’t want to get too nerdy, so the short version is the optimal strategy AngelList found is Never Follow.

followon pro rata

Naval wrote:

Personally, I think follow-ons are overrated. I’ve always done better just by doing more early stage checks. I know that’s hard to scale, but that’s where a basket of early fund managers is very useful.

For follow ons to be so important you’d have to believe that late stage venture is underpriced relative to early stage venture. There’s a sweet spot at the Series A, but after that the late stage is extremely competitive.

  1. Keep investing if they want to: it’s not clear cut that ‘following on’ in startups is always the best strategy, but investors want to be able to ‘double down’ on the winners in their portfolio
  2. Protection against dilution: As a startup raises more capital, the number of outstanding shares typically increases. This can dilute the ownership stake of existing investors. Pro-rata rights offer investors a chance to maintain their ownership percentage by investing in future funding rounds.
  3. Maintaining influence: Investors with a significant ownership stake often have a say in a company’s strategic decisions. Pro-rata rights allow these investors to maintain their influence as the company grows.
  4. Fostering investor confidence: By offering pro-rata rights, a startup can demonstrate its commitment to its investors and their long-term involvement, which can help build trust and foster stronger relationships.
  5. Attracting experienced investors: Pro-rata rights can be an attractive incentive for sophisticated investors who can provide valuable expertise, connections, and resources to help your startup grow. Many investors expect there to be provisions for a pro-rata.

A detailed example of pro-rata rights (causing an issue)

A big issue with pro-rata rights is that there might not be ‘room’ for new investors. Let me explain how this situation can arise.

Let’s say you have a startup called TechX. In the seed funding round, TechX raises $1 million from three investors: Investor A, Investor B, and Investor C. The three investors receive the following ownership stakes in TechX:

  • Investor A: $500,000 (50% of $1 million) = 50% ownership
  • Investor B: $300,000 (30% of $1 million) = 30% ownership
  • Investor C: $200,000 (20% of $1 million) = 20% ownership

Now, TechX is successful and decides to raise more money in a Series A financing round. The company aims to raise another $1 million, bringing the total capital raised to $2 million.

If there were no pro-rata rights, the new investor (Investor D) would take a 50% ownership stake in TechX ($1 million of the $2 million total capital). The original investors’ ownership stakes would be diluted as follows:

  • Investor A: 25% ownership (50% of their original stake)
  • Investor B: 15% ownership (50% of their original stake)
  • Investor C: 10% ownership (50% of their original stake)

However, the original investors have pro-rata rights, which means they have the option to maintain their ownership percentage by investing more money in the Series A round. Here’s how much each investor would need to invest to maintain their ownership stake:

  • Investor A: Wants to maintain 50% ownership, so they need to invest an additional $1 million (50% of the new total capital of $2 million).
  • Investor B: Wants to maintain 30% ownership, so they need to invest an additional $600,000 (30% of the new total capital of $2 million).
  • Investor C: Wants to maintain 20% ownership, so they need to invest an additional $400,000 (20% of the new total capital of $2 million).

If all the original investors exercise their pro-rata rights, the Series A round would need to accommodate a total investment of $2 million (the $1 million targeted for the round plus the additional investments by the original investors). The new ownership structure would be as follows:

  • Investor A: 50% ownership
  • Investor B: 30% ownership
  • Investor C: 20% ownership
  • Investor D: 0% ownership (no room for a new investor in this scenario)

In this example, the pro-rata rights protected the original investors from dilution and allowed them to maintain their ownership stakes in TechX as it raised additional capital. However, the pro-rata rights also made it more challenging to accommodate new investors in the Series A round.

How standard are pro-rata rights in a startup financing round?

Pro-rata rights are fairly common in startup financing rounds, particularly during the early stages of a company’s development, such as seed and Series A rounds.

However, the prevalence of pro-rata rights may vary depending on factors such as:

  • the stage of the company,
  • the type of investors involved,
  • the company’s growth prospects,
  • and the specific terms negotiated in investment agreements.

In some cases, pro-rata rights may be limited to certain investors, such as:

  • Lead investors,
  • strategic investors,
  • or those who have invested above a specific threshold.

Pro-rata is key to an investor’s follow-on strategy

Jason Calacanis wrote:

Pro rata rights are a must and you should never do a deal without them.”

Andy Sparks wrote:

In the 2018–2019 fundraising climate, it’s safe to say we’re at ‘peak pro rata.’ Everybody wants pro rata, even those who don’t entirely understand how it works or affects companies.”

Chris Harvey explains that a big part of an investor’s fund model will depend on their follow-on strategy and how they approach “reserve ratios”. For example, a $60M fund with a 1:2 (initial check-to-reserves) will use $20M for its initial investment and save $40M for future investment in the same company.

Reserve ratios generally fall into three buckets:

  • Never follow—1:0 (initial check-to-reserves)
  • Follow your winners—3:1, 2:1
  • Always follow—1:1, 1:2+

Put simply, their reserve strategy one that operates horizontally or vertically?

  • Horizontal: Spread capital in more companies—lower ownership targets
  • Vertical: Concentrated portfolio—increase ownership targets

But underlying these follow-on strategies is a key assumption: That you can even get into the next round. Which leads to the next point…

Scenarios in which investors might lose their pro-rata rights during a financing round

Pro-rata rights are not a given. Early investors can lose their rights.

Jeff Morris wrote:

“When firms squeeze out early investors who have Pro Rata rights, the entire cap table suffers as a result. Angels remember the firms who do this & are less likely to send future deals their way. They are also less inclined to help the company. Respect the early investors.”

It’s the same kind of power dynamics at play that Jason Calacanis wrote in his book Angel: How to Invest in Technology Startups:

“When I got in this industry, I [was told I] had to eat a bunch of shit from other investors, it’s part of the game.”

  1. Bullying: Some later-stage investors say “we want the whole deal or we are out” and guess what happens? Just because an angel has the right, it doesn’t mean they can keep it.
  2. Pay-to-play provisions: Some investment agreements may include “pay-to-play” provisions, which require investors to participate in future financing rounds to maintain their pro-rata rights. If an investor fails to meet the pay-to-play requirements, they could lose their pro-rata rights.
  3. Renegotiation of investment terms: In some cases, a startup may renegotiate the terms of a financing round, which could result in the modification or elimination of pro-rata rights for certain investors. This could happen if the startup is struggling to attract new investors, and the elimination of pro-rata rights is seen as a way to make the investment more attractive.
  4. Legal disputes or breaches of contract: If an investor is involved in a legal dispute with the startup or breaches the terms of their investment agreement, they may lose their pro-rata rights as a consequence of the dispute resolution or breach of contract.
  5. Change in investor’s status: If an investor’s status changes—for example, if they become insolvent, are acquired by another firm, or are no longer considered an accredited investor—they might lose their pro-rata rights due to the change in circumstances.
  6. Expiration of pro-rata rights: Some investment agreements may include an expiration date for pro-rata rights, after which the rights no longer apply. If a financing round takes place after the expiration date, investors may lose their pro-rata rights.

Do investors always do their pro-rata?

Many investors care about pro-rata rights. Fred Wilson said:

“The ability to follow your winners and defend your position is absolutely critical to producing top tier returns.”

Investors do not always exercise their pro-rata rights, and there are several reasons why they might choose not to:

  1. Limited capital: Investors may not have sufficient funds available to invest more money in a startup to maintain their ownership stake during a new financing round. This could be due to their own cash constraints or commitments to other investments. Typically most investors will ‘reserve’ cash from their fund to do follow on which is frequently 50% of the fund.
  2. Diversification strategy: Investors often diversify their portfolios by investing in multiple startups across different sectors or stages. They might choose not to exercise their pro-rata rights in one company to allocate funds to other investment opportunities that they believe have a better potential for growth or returns.
  3. Performance concerns: If an investor has concerns about a startup’s performance or growth prospects, they might decide not to invest additional capital in the company, even if it means their ownership stake will be diluted. This can be an issue to founders because it can create a ‘signalling risk’.
  4. Change in investment focus: An investor’s strategy or focus might change over time, leading them to concentrate on other sectors or investment stages that are more aligned with their current objectives. In such cases, they may not exercise their pro-rata rights.
  5. Relationship with founders or other investors: Sometimes, investors might choose not to exercise their pro-rata rights due to conflicts or disagreements with the founders, management team, or other investors in the startup.
  6. Cap table management: In some cases, investors might decide not to exercise their pro-rata rights to keep the cap table (a record of the company’s ownership structure) less crowded, making it easier for the startup to attract new investors in future financing rounds.

While pro-rata rights offer investors the option to maintain their ownership stake in a startup, it is ultimately up to the investor to decide whether or not to exercise these rights based on their individual circumstances, investment strategy, and perception of the startup’s potential for success.

An example of pro-rata rights in a legal agreement

Here’s an example of legal phrasing for pro-rata rights in an investment contract. Please note that this is a general example and the actual phrasing in a contract may vary depending on the specific terms and conditions agreed upon by the parties involved. Always consult with a legal professional when drafting or reviewing contract language.

Pro-Rata Rights: Subject to the terms and conditions set forth herein, each Investor shall have the right (but not the obligation) to participate, on a pro-rata basis, in any future issuance of equity securities by the Company (the “Pro-Rata Right”). For the purpose of this provision, an Investor’s pro-rata share shall be equal to the percentage of the Company’s outstanding equity securities held by such Investor, on a fully diluted basis, immediately prior to the issuance of such future equity securities.

To exercise the Pro-Rata Right, the Company shall provide written notice (the “Offer Notice”) to each Investor, setting forth the material terms of the proposed issuance, including the type of securities being issued, the price per share, the total number of shares offered, and any other material terms and conditions. Each Investor shall have a period of fifteen (15) days from the date of the Offer Notice to provide written notice to the Company of their intent to exercise their Pro-Rata Right, specifying the number of shares they wish to purchase.

If any Investor declines to exercise their Pro-Rata Right or fails to respond within the specified period, the Company shall have the right to offer the remaining unsubscribed shares to other existing or new investors, subject to the same material terms and conditions as set forth in the Offer Notice.

The Pro-Rata Right shall not apply to any issuance of equity securities in connection with stock splits, stock dividends, recapitalizations, mergers, acquisitions, or similar transactions approved by the Company’s Board of Directors.

This Pro-Rata Right shall terminate upon the earlier of: (i) the closing of a firm commitment underwritten public offering of the Company’s equity securities pursuant to an effective registration statement filed under the Securities Act of 1933, as amended; (ii) a Change of Control of the Company; or (iii) [insert any other termination events, if applicable].

Some general tips a lawyer might offer

Here are some things a lawyer might tell you. Much of this might be obvious to you but in case you want to have questions to ask them specifically to save some money and time.

  1. Understand the implications: Understand the concept of pro-rata rights and their implications on future financing rounds. This knowledge will help founders make informed decisions and negotiate effectively.
  2. Balance investor interests: Consider the interests of both existing and new investors when negotiating pro-rata rights. While it’s important to maintain strong relationships with current investors, it’s also crucial to attract new investors and ensure that pro-rata rights don’t hinder future fundraising efforts.
  3. Define terms and conditions: Clearly define the terms and conditions related to pro-rata rights in the investment agreements. This includes specifying the circumstances under which pro-rata rights can be exercised, any limitations or qualifications, and the timeframes for exercising these rights.
  4. Consider investor qualifications: Limit pro-rata rights to certain investors, such as accredited investors or investors who have contributed above a specific threshold. This can help manage the complexity of future financing rounds and ensure that only experienced, value-adding investors can exercise pro-rata rights.
  5. Set clear expectations: Communicate clearly with investors about the company’s growth plans and future fundraising rounds. This can help manage expectations and reduce potential conflicts related to pro-rata rights.
  6. Review existing agreements: Review existing agreements to ensure there are no conflicts or inconsistencies related to pro-rata rights. This can help avoid potential legal disputes down the line.
  7. Document everything: Properly document all agreements related to pro-rata rights, including any amendments or waivers. This can help protect the interests of both the founders and investors and provide a clear record of the agreed-upon terms.
  8. Seek professional advice: And… lawyers will obviously tell you to fork over cash for legal advice to ensure that you are making well-informed decisions and that their agreements comply with applicable laws and regulations.

Some general tips an investor might offer

The standard advice you will get from VCs on pro-rata rights would include:

  1. Understand investor perspective: Investors generally appreciate pro-rata rights as they offer the opportunity to maintain their ownership stake and avoid dilution in future financing rounds. Founders should understand this perspective and use it to build trust with their investors.
  2. Attract strategic investors: Offering pro-rata rights can be an incentive for strategic investors who can bring more than just capital to your startup, such as industry expertise, connections, and resources. When negotiating pro-rata rights, prioritize investors who can add significant value to your business.
  3. Maintain flexibility: While offering pro-rata rights can be beneficial, ensure that they don’t overly restrict your startup’s ability to raise capital in the future. Consider offering pro-rata rights on a case-by-case basis or limiting them to certain investors, like those who have invested above a specific threshold.
  4. Communicate openly: Transparency is key when discussing pro-rata rights and other investment terms. Communicate your startup’s growth plans, future fundraising intentions, and the implications of pro-rata rights clearly to your investors. Open communication can help manage expectations and foster stronger relationships.
  5. Leverage investor relationships: Existing investors with pro-rata rights can be valuable allies in attracting new investors. They can vouch for your startup and encourage others to invest. Involve them in your fundraising process and leverage their networks to expand your pool of potential investors.
  6. Consider alternative structures: If offering pro-rata rights seems challenging or problematic, consider alternative structures like offering rights of first refusal, which give existing investors the right to match new investment offers before they are accepted. This can provide some protection against dilution without being as restrictive as pro-rata rights.
  7. Focus on value creation: Pro-rata rights should not be the sole focus of your negotiations. Instead, concentrate on growing your startup and creating value for your investors. Strong business performance can help you attract new investors and maintain healthy relationships with existing ones, regardless of the pro-rata rights offered.

What are the common scenarios in which founders can face challenges related to these rights?

Some of these scenarios include:

  1. Over-commitment to pro-rata rights: If a founder grants pro-rata rights to too many investors, it may limit the startup’s ability to raise future capital. This is because a significant portion of the new shares issued during future financing rounds may be reserved for existing investors exercising their pro-rata rights, leaving less room for new investors to participate.
  2. Hindering new investors: Some potential new investors may be discouraged from investing in a startup if existing investors have substantial pro-rata rights. They might be concerned that their investment will be diluted, or they may not be able to acquire a sufficiently large stake in the company to justify their investment.
  3. Investor conflicts: Pro-rata rights can sometimes lead to conflicts among investors, particularly if some investors are unable or unwilling to exercise their rights during a funding round. This can create tension between investors and potentially disrupt the fundraising process.
  4. Valuation challenges: If a startup is struggling to raise capital at a higher valuation, pro-rata rights can compound the problem. Founders may be tempted to accept a lower valuation in order to accommodate the pro-rata rights of existing investors, which can lead to a downward spiral of valuations in subsequent funding rounds.
  5. Inefficient allocation of capital: Pro-rata rights can sometimes result in an inefficient allocation of capital. For example, if an investor exercises their pro-rata rights in a financing round despite having limited interest or expertise in the startup’s current focus, the capital may not be put to the best use, and the startup could miss out on attracting new investors with more relevant experience and resources.
  6. Founder dilution: If founders do not negotiate anti-dilution provisions for themselves, they may face excessive dilution of their ownership stake due to existing investors exercising their pro-rata rights in future financing rounds. This could potentially reduce the founders’ control and influence over the company.

While pro-rata rights can be advantageous in certain situations, these examples highlight the importance of carefully considering their implications and managing them effectively.

How founders can effectively negotiate pro-rata rights

Here are some tips for the effective negotiation of pro-rata rights:

  1. Understand the implications: Before negotiating pro-rata rights, educate yourself on the concept, its benefits and challenges, and how it can impact your startup’s future fundraising efforts. This knowledge will enable you to make informed decisions and negotiate effectively.
  2. Prioritize strategic investors: Focus on offering pro-rata rights to investors who bring significant value to your startup, such as industry expertise, connections, and resources. Prioritizing strategic investors can help maximize the benefits of pro-rata rights for your business.
  3. Balance investor interests: When negotiating pro-rata rights, consider the interests of both existing and potential new investors. Strive to find a balance that maintains strong relationships with current investors while not hindering your ability to attract new investors.
  4. Set clear terms and conditions: Clearly define the terms and conditions related to pro-rata rights in your investment agreements, including any limitations, qualifications, and timeframes for exercising these rights. Clear documentation can help prevent future conflicts and misunderstandings.
  5. Maintain flexibility: Consider offering pro-rata rights on a case-by-case basis or limiting them to certain investors, such as those who have invested above a specific threshold. This can help maintain flexibility in future financing rounds and ensure that pro-rata rights do not become overly restrictive.
  6. Communicate openly: Transparency is key when discussing pro-rata rights and other investment terms with your investors. Openly communicate your startup’s growth plans, future fundraising intentions, and the implications of pro-rata rights to manage expectations and foster strong relationships.
  7. Leverage alternative structures: If offering pro-rata rights is challenging or problematic, explore alternative structures like rights of first refusal or participation rights, which can provide some protection against dilution without being as restrictive as pro-rata rights.


Pro-rata rights can play a crucial role in maintaining investor confidence and ensuring long-term relationships with your investors. By understanding the concept and its implications, you can make informed decisions about offering and negotiating pro-rata rights with your investors. Always consult with legal and financial advisors to ensure that you navigate these rights and agreements effectively, and strike a balance that benefits both your startup and its investors.

If you are worried about the terms of your deal, you can book a call with me and I’ll have an honest commercial discussion with you about what matters and what is ridonkulous.

By following these expert tips, you can effectively negotiate pro-rata rights in a way that maintains strong investor relationships and supports the long-term success of your startup.

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