Conduit’s Pro-Rata Field Guide

To borrow from Fred Wilson, pro-rata rights are possibly the most important part of early-stage investing. Pro-rata is particularly impactful for angels and funds investing across pre-seed, seed, and Series A financing rounds.

The earlier the stage, the more essential.

From our lens at Conduit, there are two key points to consider when evaluating the process of obtaining and exercising pro-rata rights: the quantitative breakdown and negotiating leverage.

To put it simply, pro-rata is the option to participate in future financing rounds, in turn enabling you or your firm to maintain your existing ownership percentage in a company.

Critically, these rights protect your investment vehicle from getting wiped out by overly dilutive funding rounds later on in a company’s life cycle.

Here’s a quick breakdown of the mathematics.

Say you cut a $25k angel check into a pre-seed round with a $5 million cap. After this round of financing closes, you hold 0.5% of the company in equity.

A year later, the company goes on to raise a $3m seed at a $12m post-money valuation. If you hold rights from the previous round, you’ll have an option to maintain your 0.5% stake in the company by investing another $15,000. However, without pro-rata rights, your 0.5% stake will be diluted by 25%.

Critically, the impact of your pro-rata rights compounds with each new financing, in the case that the company you back continues to hit its growth targets and raise accordingly.

There are typically two scenarios in which you might fail to secure pro-rata.

First, the round may be extremely competitive. In the midst of a highly sought after financing round, founders will often forgo pro-rata rights for individuals and angel investors. In doing so, the founder or founding team opens up more space on the cap table for larger funds to invest in later rounds without the need to aggregate and negotiate with individual investors.

Second, your network or check size doesn’t warrant pro-rata rights. Often, if you’re cutting a small check into a pre-seed or seed round as an individual, pro-rata preference will be given to larger investors in the round.

While your network or reputation may have been strong enough to secure a small allocation in a highly competitive round, these two assets may not wield enough influence to secure your investment’s accompanying pro-rata rights.

In summary, pro-rata rights are incredibly important to consider as an early-stage investor. Once you understand the quantitative breakdown and negotiating process, you should heavily pursue the addition of pro-rata rights into your investment agreement.

With regard to next steps, there a range of options available.

Chief among them, aside from bolstering your operating reputation and track record, investors have historically pooled resources and networks in a tight-knit syndicate of other well-known angels. In the case that the round is not wildly competitive, this aggregation of reputation and know-how can often move the needle for your ability to secure pro-rata rights in a round.

At Conduit, we connect the world’s best operator-investors and founders building the next generation of startups around the world.

While each individual financing round retains its own unique dynamics, it is critical that as an investor, you thoroughly understand the ramifications of your pro-rata allocation and its impact on your overall financial performance.

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