Without getting too much in the weeds, there are a lot of variables here that can influence what % the investor eventually gets:
The note needs to be converted (or at least assumed converted) to arrive at a %. If you do a new $1 million round, Investor X has the right to purchase 1.74% of that round.īut a very important wrinkle is that, if the seed round in which the rights were granted is a convertible note round (it almost always is), the investor’s ownership percentage isn’t set yet so there’s no easy way to calculate the formula. So, for example, if Investor X paid $50K for 100,000 shares, and the total fully diluted capitalization is 5,750,000 shares, then his pro rata percentage is about 1.74% (100K/5.75MM). This means that the denominator by which the particular investor’s ownership is divided (to determine their pro rata %) is the entire capitalization of the Company, including outstanding shares, options, warrants, and shares reserved but unissued under the Company’s equity plan. Pro Rata of Fully Diluted– The Classic Engagement.īy far the most common (and company favorable) definition of “pro rata” in seed rounds is pro rata of the Company’s fully diluted capitalization.
STOCK PRO RATA SERIES
While seed investors’ requiring some form of pro-rata is understandable (I’ve found California seed investors demand it much more often than Texas investors), Founders need to be aware that the more follow-on investment rights they grant in their seed, the less flexibility they have in bringing in large, potentially better VCs in the Series A round.That “bigger fish” that wasn’t around for your seed round will expect at least 15-20% of the Company in the A round, or it won’t “move their needle.” Getting that VC to this threshold becomes very hard if you’ve already promised your existing investors a huge portion of the A-round.īeing too relaxed about your seed investors’ follow-on investment rights will either (i) force you to give away a very large percentage of your company in the Series A (to “feed” everyone), and/or (ii) give your existing investors the ability to block a term sheet from that outside investor you really want. But the point of this post is that how “pro rata” is defined can have substantial consequences in future financings. These are usually called “pro rata” rights because, on a basic level, the investor gets the right to purchase her “pro rata percentage” of future rounds. For these reasons, seed investors will often require, as a condition to their investment, the right to make follow-on investments in future rounds. Also, institutional VCs will typically only write seed checks if they have a reasonable shot at securing a substantial position (15-20%+) in a Series A round. Because of the economics of seed investing, the ability of seed investors to secure follow-on positions in their “winners” is critical to their portfolio returns. No one covers the entire issue of why prorata rights are important to seed investors better than Mark Suster: What all Entrepreneurs Need to Know About Prorata Rights. The greater the flexibility in taking Series A term sheets, the more competition, the higher the valuation for the company. Founders’ interests, however, are completely the opposite – get large, influential seed investors on the cap table, but minimize their ability to control who leads the Series A.Large seed round investors have an incentive to gain as much control over the composition of your Series A round as they can get – to maintain (or increase) their ownership % of the cap table, and to reduce competition from new outside investors, who might be better for your company.However, if you don’t read an investor’s “pro rata” terms carefully, you’ll find that you’re no longer the bachelor (or bacholerette) you thought you were.
Nutshell: Taking seed investment from institutional investors is supposed to be akin to getting engaged they’ve made a credible commitment to you, but your options are still open to walk if a better Series A partner shows up.
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