5 ms·

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the futu

by avemuri 12y ago

Forgive me if this is a naive question, but why are pro-rata rights considered standard? It seems like it's essentially the right to dilute founders in the future to maintain your ownership. Yes you're investing early, but that's priced into the valuation. I suppose the right has value, so perhaps a lower valuation would be justified. But why do pro-rata rights always elicit this moral outrage when called into question?

pbreit 12y ago
If the pro-rata rights exist, it's seems obvious that trying to void them is at least unethical. But pro-rata rights make perfect sense to me. I don't see it as "the right to dilute founders" but more "thanks for taking a risk on us when it was far from clear that things might work out...I know your economics necessitate a follow on like this".
- avemuri 12y ago
  Agreed on the first point, I didn't mean to say honoring the contract is up for debate. On the second, yeah I'd want my helpful early investors to continue to be meaningfully invested. But what about unhelpful ones? I guess I'm asking why is it standard to promise this right before you've worked with an angel. The angel took a risk, but that risk was priced into the valuation in theory. I'm in India. A ROFR was also once considered standard here. "We took the early risk, so we should get first dibs on the whole round." That went south because it was jeopardizing fundraising and angels didn't have deep enough pockets to do whole Series As anyway. I guess I'm applying the same logic there. If a pro-rata jeopardizes fundraising and causes all these headaches, why not just take it out and adjust the angel round valuation accordingly.
patio11 12y ago
You're conflating two very different sources of moral outrage. One is that, prior to investors and founders memorializing their agreement on pro-rata rights in a contract, some investors feel like they're entitled to them because they're a standard term. One reason why they're standard is detailed below. The present controversy is that after investors/founders committed to pro-rata rights, later investors convinced founders to not honor those pre-existing commitments. Yes you're investing early, but that's priced into the valuation. Many investors would say "If you're investing and not getting pro-rata rights, the valuation you've negotiated is not a meaningful number, because it can be retroactively renegotiated by parties who do not necessarily have to include you in that conversation. It is thus not conveniently possible to award investors with, nor desirable for investors to seek, an attractive valuation for taking on extra risk by investing early unless that attractive valuation comes with pro-rata rights."
- avemuri 12y ago
  Agree, you're right on honoring the term once it's been agreed to. Lazy conflation on my part. I'm not sure I follow how the valuation is retroactively renegotiated. Later investors can't dilute an angel unfairly without diluting the founders unfairly too. In cases where the investor dilutes the angel but issues new shares to founders, the angel can simply veto the financing, right? Or are you saying a 5MM premoney valuation with pro-rata rights would be worth vastly less without pro-rata, so much so, that it's a nonstarter?
danielweber 12y ago
The angel has little power against later VC rounds besides the protections he negotiated for upfront. Since it's purely in the VC's interest to screw the angel, the angels make it a standard to negotiate this protection. And of course people get upset when a negotiated protection is tossed aside.
deleted 12y ago
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by avemuri 12y ago

pbreit 12y ago

If the pro-rata rights exist, it's seems obvious that trying to void them is at least unethical. But pro-rata rights make perfect sense to me. I don't see it as "the right to dilute founders" but more "thanks for taking a risk on us when it was far from clear that things might work out...I know your economics necessitate a follow on like this".

avemuri 12y ago
Agreed on the first point, I didn't mean to say honoring the contract is up for debate. On the second, yeah I'd want my helpful early investors to continue to be meaningfully invested. But what about unhelpful ones? I guess I'm asking why is it standard to promise this right before you've worked with an angel. The angel took a risk, but that risk was priced into the valuation in theory. I'm in India. A ROFR was also once considered standard here. "We took the early risk, so we should get first dibs on the whole round." That went south because it was jeopardizing fundraising and angels didn't have deep enough pockets to do whole Series As anyway. I guess I'm applying the same logic there. If a pro-rata jeopardizes fundraising and causes all these headaches, why not just take it out and adjust the angel round valuation accordingly.

patio11 12y ago

You're conflating two very different sources of moral outrage. One is that, prior to investors and founders memorializing their agreement on pro-rata rights in a contract, some investors feel like they're entitled to them because they're a standard term. One reason why they're standard is detailed below. The present controversy is that after investors/founders committed to pro-rata rights, later investors convinced founders to not honor those pre-existing commitments. Yes you're investing early, but that's priced into the valuation. Many investors would say "If you're investing and not getting pro-rata rights, the valuation you've negotiated is not a meaningful number, because it can be retroactively renegotiated by parties who do not necessarily have to include you in that conversation. It is thus not conveniently possible to award investors with, nor desirable for investors to seek, an attractive valuation for taking on extra risk by investing early unless that attractive valuation comes with pro-rata rights."

avemuri 12y ago
Agree, you're right on honoring the term once it's been agreed to. Lazy conflation on my part. I'm not sure I follow how the valuation is retroactively renegotiated. Later investors can't dilute an angel unfairly without diluting the founders unfairly too. In cases where the investor dilutes the angel but issues new shares to founders, the angel can simply veto the financing, right? Or are you saying a 5MM premoney valuation with pro-rata rights would be worth vastly less without pro-rata, so much so, that it's a nonstarter?

danielweber 12y ago

The angel has little power against later VC rounds besides the protections he negotiated for upfront. Since it's purely in the VC's interest to screw the angel, the angels make it a standard to negotiate this protection. And of course people get upset when a negotiated protection is tossed aside.

deleted 12y ago

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