One area that doesn’t seem well understood is how investor pro-rata rights work. When an investor buys a portion of a startup, whether as an angel or VC, they almost always also get the right to invest in subsequent rounds to maintain their same percentage of ownership. If the investor doesn’t continue to put in more money each time the company raises a round, the percentage of ownership in the business goes down. Here’s how it might look:
- Angel investor puts in $100,000 for 5% of a startup as part of the seed round ($2 million post-money valuation)
- Startup raises a $3 million Series A at a $7 million pre-money valuation and a $10 million post-money valuation
- If the angel investor doesn’t invest any additional money at the Series A, the 5% ownership is reduced to 3.5%
- If the angel investor does want to participate pro-rata, the angel investor has to put in $150,000 (5% of the $3 million), and thus still own 5% of the company, but has now invested a total of $250,000
This process of needing to invest more money in each subsequent round to maintain ownership continues until the company goes out of business, is acquired, or goes public. Additionally, ownership, as a percentage, is still likely to be reduced, regardless of subsequent rounds, by things like new stock option pools. Ownership, as a percentage of a startup, is a moving target, and investors participating pro-rata, or not, is an important component.
What else? What are some more thoughts on investor pro-rata rights?